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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
EVOLVE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3219745
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1400 65th Street, Suite 100, Emeryville, CA 94608
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (510) 428-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO___
---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Shares Outstanding
Class February 8, 2001
----- ----------------
Common stock, $0.001 par value 38,660,163
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TABLE OF CONTENTS
Page
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
As of December 31, 2000 and June 30, 2000............................... 3
Condensed Consolidated Statements of Operations
For the Three and Six Months Ended December 31, 2000 and 1999........... 4
Condensed Consolidated Statements of Cash Flows
For the Three and Six Months Ended December 31, 2000 and 1999........... 5
Notes to Condensed Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............. 22
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings....................................................... 23
Item 2. Changes in Securities and Use of Proceeds............................... 24
Item 3. Defaults Upon Senior Securities......................................... 24
Item 4. Submissions of Matters to a Vote of Security Holders.................... 24
Item 5. Other Information....................................................... 24
Item 6. Exhibits and Reports on Form 8-K........................................ 24
Signatures.............................................................................. 25
2
PART I - FINANCIAL INFORMATION
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Dec. 31, June 30,
2000 2000
--------------- --------------
ASSETS (unaudited) (audited)
Current assets:
Cash and cash equivalents........................................... $ 23,423 $ 18,660
Short term investments.............................................. 14,900 -
Accounts receivable, net............................................ 8,761 3,952
Prepaid expenses and other current assets........................... 4,254 2,273
--------------- --------------
Total current assets............................................ 51,338 24,885
Property and equipment, net............................................. 11,499 8,830
Restricted cash......................................................... 2,000 2,000
Deposits and other assets............................................... 1,897 1,213
Note receivable from related party...................................... 100 100
Goodwill and other intangible assets, net............................... 22,267 26,951
--------------- --------------
Total assets.................................................... $ 89,101 $ 63,979
=============== ==============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable.................................................... $ 5,173 $ 6,467
Accrued liabilities................................................. 7,024 5,965
Capital lease obligations, current portion.......................... 717 762
Deferred revenues................................................... 6,535 7,093
Short term debt..................................................... 733 -
--------------- --------------
Total current liabilities....................................... 20,182 20,287
Capital lease obligations, less current portion......................... 535 852
Long term debt.......................................................... - 3,958
Deferred rent........................................................... 57 -
--------------- --------------
Total liabilities............................................... 20,774 25,097
--------------- --------------
Redeemable convertible preferred stock.................................. - 79,514
Stockholders' equity (deficit)
Common stock........................................................ 38 10
Additional paid-in capital.......................................... 264,813 113,210
Notes receivable from stockholders.................................. (11,775) (9,174)
Unearned stock-based compensation................................... (26,710) (40,295)
Accumulated other comprehensive loss................................ (36) -
Accumulated deficit................................................. (158,003) (104,383)
--------------- --------------
Total stockholders' equity (deficit)............................ 68,327 (40,632)
--------------- --------------
Total liabilities, redeemable convertible preferred stock and
stockholders' equity (deficit)................................ $ 89,101 $ 63,979
=============== ==============
The accompanying notes are an integral part of these
consolidated condensed financial statements
3
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three months ended Six months ended
December 31, December 31,
---------------------- ----------------------
2000 1999 2000 1999
---------- --------- ---------- ---------
(unaudited)
Revenues:
Solutions.............................................. $ 6,440 $ 1,079 $11,487 $ 1,417
Subscriptions.......................................... 2,815 475 4,727 670
---------- --------- ---------- ---------
Total revenues..................................... 9,255 1,554 16,214 2,087
---------- --------- ---------- ---------
Cost of Revenues:
Solutions.............................................. 3,205 459 6,108 644
Subscriptions.......................................... 1,319 261 2,370 722
---------- --------- ---------- ---------
Total cost of revenues............................. 4,524 720 8,478 1,366
---------- --------- ---------- ---------
Gross profit....................................... 4,731 834 7,736 721
Operating expenses:
Sales and marketing.................................... 11,008 2,766 22,056 4,725
Research and development............................... 4,044 1,898 7,874 3,547
General and administrative............................. 2,683 990 5,204 1,657
Stock-based charges................................... 7,692 3,056 16,642 3,872
Amortization of goodwill and other intangible assets... 2,660 - 5,386 -
---------- --------- ---------- ---------
Total operating expenses........................... 28,087 8,710 57,162 13,801
Operating loss............................................. (23,356) (7,876) (49,426) (13,080)
Other income, net.......................................... 988 268 1,783 219
---------- --------- ---------- ---------
Net loss................................................... (22,368) (7,608) (47,643) (12,861)
Beneficial conversion feature of Series I
redeemable convertible preferred stock............... - - 5,977 -
---------- --------- ---------- ---------
Net loss attributable to common stockholders............... $ (22,368) $ (7,608) $ (53,620) $ (12,861)
========== ========= ========== =========
Net loss per common share -- basic and diluted............. $ (0.67) $ (3.15) $ (1.99) $ (2.89)
========== ========= ========== =========
Shares used in net loss per common share
calculation -- basic and diluted..................... 33,157 2,412 27,004 4,448
========== ========= ========== =========
The accompanying notes are an integral part these
consolidated condensed financial statements
4
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six months ended
December 31,
---------- ---------
2000 1999
---------- ---------
(unaudited)
Cash flows from operating activities:
Net loss attributable to common stockholders...................................... $ (53,620) $ (12,861)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on disposal of fixed assets.............................................. 19 --
Common stock options issued to non-employees.................................. -- 16
Allowance for doubtful accounts............................................... 407 78
Depreciation and amortization................................................. 7,101 186
Accrued interest.............................................................. 102 150
Beneficial conversion feature of Series I redeemable convertible preferred
stock....................................................................... 5,977 --
Stock-based charges........................................................... 16,642 3,872
Changes in assets and liabilities:
Accounts receivable....................................................... (5,217) (2,521)
Prepaid expenses and other current assets................................. (556) 167
Note receivable from related party........................................ -- (106)
Deposits and other assets................................................. (684) 15
Accounts payable.......................................................... (1,288) 846
Accrued liabilities....................................................... 1,110 1,379
Deferred revenues......................................................... (558) 3,419
---------- ---------
Net cash used in operating activities................................... (30,565) (5,360)
---------- ---------
Cash flows from investing activities:
Purchase of short term investments................................................ (16,900) (2,264)
Purchases of property and equipment............................................... (5,838) (595)
Purchase of intangibles........................................................... (700) --
Restricted cash on lease.......................................................... -- (2,000)
Proceeds from sale of property and equipment...................................... 13 --
Proceeds from short-term investments.............................................. 2,000 --
---------- ---------
Net cash used in investing activities................................... (21,425) (4,859)
---------- ---------
Cash flows from financing activities:
Payments on debt to related parties............................................... (3,327) --
Payments under capital lease obligations.......................................... (362) (221)
Repurchase of common stock........................................................ (77) (1)
Proceeds from payment on notes receivable......................................... 158 24
Proceeds from exercise of common stock warrants................................... 500 --
Proceeds from exercise of stock options........................................... 849 121
Proceeds from issuance of preferred stock, net of issuance costs.................. 12,577 24,961
Proceeds from initial public offering, net........................................ 46,473 --
---------- ---------
Net cash provided by financing activities............................... 56,791 24,884
---------- ---------
Effect of currency exchange rate change............................................... (38) --
Increase in cash and cash equivalents................................................. $ 4,763 $ 14,665
Cash and cash equivalents at beginning of period...................................... 18,660 2,840
---------- ---------
Cash and cash equivalents at end of period............................................ $ 23,423 $ 17,505
========== =========
The accompanying notes are an integral part of these
consolidated condensed financial statements
5
EVOLVE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of significant accounting policies
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. All adjustments (consisting only of adjustments of a
normal recurring nature) considered necessary for a fair presentation have been
included. Operating results for the three and six month periods ended December
31, 2000 are not necessarily indicative of the results that may be expected for
the year ending June 30, 2001. For further information, refer to the financial
statements and notes thereto included in our Registration Statement filed on
Form S-1, effective August 9, 2000.
Principles of consolidated financial statements
These condensed consolidated financial statements include the accounts of Evolve
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Use of estimates
We have prepared these financial statements in conformity with generally
accepted accounting principles which require us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue recognition
We derive revenues from fees for licenses and implementation services
("Solutions revenue") and fees from maintenance, application service provider
and subscription agreements ("Subscription revenue"). The Company recognizes
revenues in accordance with the provisions of American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, "Software Revenue
Recognition." This was amended by SOP No. 98-4, "Deferral of the Effective Date
of Certain Provisions of SOP 97-2"and SOP 98-9, "Modification of SOP 97-2 With
Respect to Certain Transactions."
Under SOP 97-2 as amended, the Company recognizes revenues when all of the
following conditions are met:
. The Company has signed a non-cancellable agreement with the customer;
. The Company has delivered the software product to the customer;
. The amount of fees to be paid by the customer is fixed or determinable
and,
. The Company believes that collection of these fees is probable
Generally, the Company has vendor specific objective evidence of fair value for
the maintenance element of software arrangements based on the renewal rates for
maintenance in future years as specified in the contracts. In such cases, the
Company defers the maintenance revenue at the outset of the arrangement and
recognizes it ratably over the period during which the maintenance is to be
provided, which normally commences on the date the software is delivered.
Historically, the Company did not have vendor specific objective evidence of
fair value for services specified in certain software arrangements, as the
services were
6
never sold separately. Accordingly the remaining software revenue allocated to
such software license and services are recognized ratably on a straight line
basis over the period during which the services are provided, which is generally
between six and nine months. More recently, the Company has established vendor
specific objective evidence of fair value for services. For certain contracts
which involve significant implementation, customization or services which are
essential to the functionality of the software and which are reasonably
estimable, the license and services revenue is recognized over the period of
each engagement, primarily using the percentage-of-completion method. Labor
hours incurred are used as the measure of progress towards completion. Revenue
for these arrangements is classified as Solutions revenue. A provision for
estimated losses on engagements is made in the period in which the loss becomes
probable and can be reasonably estimated.
The Company recognizes revenue from its application service provider ("ASP")
business, whereby it provides the software, and provides maintenance and other
services to the customer but also hosts the software on its own servers making
the solution available to the customer via the Internet. In such situations,
customers pay a monthly fee for the term of the contract in return for access to
the Company's software, maintenance and other services such as implementation,
training, consulting and hosting. For such ASP software arrangements the Company
does not have vendor specific objective evidence of fair value for the elements
of the contract and accordingly fees from such arrangements will be recognized
on a monthly basis as the hosting service is provided.
Comprehensive income (loss)
We follow Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and display of comprehensive income (loss) and their components in
financial statements. During the quarter ended December 31, 2000, we began
recording comprehensive income (loss) related to translation adjustments from
our operations in the United Kingdom. The statement of comprehensive loss
follows (in thousands):
Three months ended Six months ended
December 31, December 31,
-------------------- --------------------
2000 1999 2000 1999
--------- -------- -------- ---------
(unaudited)
Net loss.............................. $(22,368) $(7,608) $(53,620) $(12,861)
Foreign currency translation
adjustment.......................... (36) -- -- --
-------- ------- -------- --------
Net loss attributable to common
stockholders........................ $(22,404) $(7,608) $(53,620) $(12,861)
======== ======= ======== ========
Segment information
We operate in only one segment, namely professional services software and, as
such, use only one measure of profitability for internal reporting purposes. To
date substantially all of our revenues have been derived from within the United
States.
Note 2. Acquisition of InfoWide, Inc.
On March 31, 2000, we acquired all the common stock of InfoWide, Inc. for a
total consideration of 1.8 million shares of our common stock and related
expenses. The acquisition consideration, together with transaction expenses, was
valued at $33.0 million. InfoWide was incorporated on April 15, 1998 under the
laws of the state of Delaware. InfoWide provides a web-hosted, financial
management package designed for professional services organizations. The
acquisition was accounted for as a purchase and the results of operations of
InfoWide have been included in the consolidated financial statements from the
date of acquisition.
The following unaudited pro forma consolidated financial information presents
the combined results of Evolve and InfoWide as if the acquisition had occurred
on July 1, 1999, after giving effect to certain adjustments, principally the
amortization of goodwill and other intangibles assets. The unaudited pro forma
consolidated financial information does not necessarily reflect the results of
operation that would have occurred had the acquisition been completed on July 1,
1999 (in thousands, except per share amounts).
7
Three months Six months
ended ended
Dec. 31, 1999 Dec. 31, 1999
--------------- ---------------
Pro forma total revenues......................... $ 1,577 $ 2,113
=============== ===============
Pro forma net loss............................... $ (10,574) $ (18,652)
=============== ===============
Basic and diluted pro forma net loss per share... $ (2.49) $ (2.30)
=============== ===============
Shares used to compute basic and
diluted pro forma net loss per share......... 4,245 8,115
=============== ===============
Note 3. Contingencies
From time to time, we may become involved in litigation relating to claims
arising from our ordinary course of business. In January 2000 PeopleSoft, Inc.
filed an action in the California Superior Court, Alameda County, alleging
claims arising out of our employment of former employees of PeopleSoft, and
seeking preliminary and permanent injunctions to preclude additional hiring of
PeopleSoft employees. PeopleSoft's claims include our inducing breach of
contract of their employees and unfair competition. PeopleSoft filed a motion
for preliminary injunction enjoining us from recruiting additional PeopleSoft
employees or disclosing any PeopleSoft trade secrets. The court denied this
motion in July 2000 due to PeopleSoft's failure to show that it was neither
likely to succeed in the litigation on the merits of their complaint nor had it
shown that it would be harmed if the injunction were not issued. PeopleSoft has
appealed the court's ruling on the motion. We do not believe that the motion,
even if granted on appeal, will have a material impact on our business. The
parties conducted a mediation in September 2000 but were unable to reach an
agreeable settlement. Since the mediation, the parties have continued to engage
in settlement discussions. We continue to believe that PeopleSoft's claims are
without merit, and continue to contest these claims. However, this litigation,
whether or not determined or settled in our favor, may be costly and may divert
the efforts and attention of our management from normal business operations.
In management's opinion, the outcome of this litigation is not expected to
have a material impact on the consolidated financial statements. We believe
that there are no other claims or actions pending or threatened against us,
the ultimate disposition of which would have a material adverse effect on us.
8
Note 4. Net Loss per Share
Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during each period. Since we have a net loss
for all periods presented, net loss per share on a diluted basis is equivalent
to basic net loss per share. Common shares issuable upon exercise of stock
options and warrants and upon conversion of convertible preferred stock are
excluded because the effect would be anti-dilutive. A reconciliation of the
numerator and denominator (both in thousands) used in the calculation of basic
and diluted net loss per share follows:
Three months ended Six months ended
December 31, December 31,
------------------------- -------------------------
2000 1999 2000 1999
------------ ----------- ------------ -----------
(unaudited)
Numerator:
Net loss.......................................... $(22,368) $(7,608) $(47,643) $(12,861)
Beneficial conversion feature of Series I
redeemable convertible preferred stock.......... - - 5,977 -
------------ ----------- ------------ -----------
Net loss attributable to common stockholders...... $(22,368) $(7,608) $(53,620) $(12,861)
============ =========== ============ ===========
Denominator:
Weighted average common shares.................... 38,456 5,662 32,534 9,953
Weighted average unvested common shares
subject to repurchase........................... (5,299) (3,250) (5,530) (5,505)
------------ ----------- ------------ -----------
Shares used in computing basic and diluted
net loss per share.............................. 33,157 2,412 27,004 4,448
============ =========== ============ ===========
At December 31, 2000 and 1999, the weighted-average exercise price of
outstanding stock options was $6.50 and $0.98, respectively. The
weighted-average purchase price of restricted stock subject to repurchase was
$2.25 and $0.83 as of December 31, 2000 and 1999, respectively.
Note 5. Change in Par Value
On August 15, 2000, the Company filed for a change in par value of its common
stock from $0.01 to $0.001 per share. The change in par value has been reflected
in our condensed consolidated financial statements for all periods presented.
Note 6. Recent Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," that
requires companies to record derivative financial instruments on their balance
sheets as assets or liabilities, measured at fair value. Gains or losses
resulting from changes in the values of those derivatives would be accounted for
depending on the use of the derivative instrument and whether it qualifies for
hedge accounting. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133," that amends SFAS No. 133 to be effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. In June 2000, the FASB
issued SFAS No. 138, "Accounting for Derivative Instruments and Hedging
Activities--An Amendment of FASB No. 133." SFAS 138 amends the accounting and
reporting standards for certain derivatives and hedging activities such as net
settlement contracts, foreign currency translations and intercompany
derivatives. Management adoption of SFAS 133 did not have a material effect on
our consolidated financial statements.
9
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements filed with the SEC. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. We have
complied with the guidance in SAB 101 for all periods presented.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions involving Stock Compensation," an
interpretation of Accounting Principles Board ("APB") Opinion No. 25. FIN 44
clarifies the application of Opinion 25 for the definition of employee for
purposes of applying Opinion 25, the criteria for determining whether a plan
qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. FIN 44 became effective July 1, 2000, but certain conclusions cover
specific events that occurred after either December 15, 1998, or January 12,
2000. The adoption of FIN 44 did not have a material impact on the consolidated
financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion in conjunction with the interim
unaudited condensed financial statements and related notes included in this
report, and with Management's Discussion and Analysis of Financial Condition and
Results of Operations and related financial information contained in the
Company's Registration Statement on Form S-1 (Registration No. 333-32796).
Except for historical information, this Report may contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These forward-looking
statements involve risks and uncertainties, including, among other things,
statements regarding our anticipated costs and expenses. Our actual results may
differ significantly from those projected in the forward-looking statements.
Factors that might cause or contribute to these differences include, but are not
limited to those discussed in the section below entitled "Factors That May
Affect Future Results of Operations." You should carefully review the risks
described in our Registration Statement filed on Form S-1 under "Risk Factors."
You are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Quarterly Report on Form 10-Q. We
undertake no obligation to publicly release any revisions to the forward-looking
statements or reflect events or circumstances after the date of this document.
Overview
We are a leading provider of Internet-based end-to-end solutions for automating
professional service organizations. Our ServiceSphere software suite integrates
and streamlines the core processes that are critical to professional services
organizations: managing project opportunities, professional resources and
service delivery. We license our Evolve ServiceSphere solution directly to
services organizations and provide related implementation, integration,
training, maintenance and hosting services.
Evolve was founded in February 1995. From our inception through December 1998
our activities, funded by the capital we raised, consisted primarily of building
our business infrastructure, recruiting personnel and developing our software
and service offerings. The Evolve ServiceSphere product suite was first made
commercially available in March 1999 and we recognized our first revenues from
ServiceSphere sales during the quarter ended March 31, 1999. Our revenues
increased during each sequential quarter for the remainder of 1999 and 2000. We
have incurred substantial losses since inception and we anticipate that we will
continue to incur operating losses as we make the investments necessary to
expand our business. Our accumulated deficit at December 31, 2000, was $158.0
million.
Our headcount increased from 110 employees at December 31, 1999 to 361 employees
at December 31, 2000, as we continued to invest in developing our technology and
building a direct sales force, a marketing
10
group and a professional services organization. Our infrastructure expenditures
also increased significantly in 1999 and 2000, as we expanded our facilities
domestically and internationally and enhanced our information systems.
In August 2000, we completed an initial public offering of 5,750,000 shares of
our common stock, resulting in proceeds of approximately $46.5 million, net of
offering costs.
Results of Operations
Three and six months ended December 31, 2000 and 1999
Revenues
Total revenues were $9.3 million for the three months ended December 31, 2000,
as compared to revenues of $1.6 million for the comparable 1999 period. Total
revenues increased to $16.2 million for the six months ended December 31, 2000
from $2.1 million for the same period in 1999. The increase in revenues reflects
the growth of sales of our software and services subsequent to the first
commercial sale of ServiceSphere during the quarter ending March 31, 1999.
Solutions revenue principally consists of software licenses and implementation
services while Subscriptions revenue is principally composed of applications and
maintenance subscriptions. For the three months ended December 31, 2000,
Solutions revenues and Subscriptions revenues were $6.4 million, or 70% of total
revenues, and $2.8 million, or 30% of total revenues, respectively. For the
three months ended December 31, 1999, Solutions revenues and Subscriptions
revenues were $1.1 million, or 69% of total revenues, and $475,000, or 31% of
total revenues, respectively. For the six months ended December 31, 2000,
Solutions and Subscriptions revenue were $11.5 million or 71% of total revenues,
and $4.7 million or 29% of total revenues, respectively. For the comparable
prior year period Solutions and Subscriptions revenue were $1.4 million or 68%
of total revenues, and $670,000 or 32% of total revenues, respectively.
Cost of Revenues
Our cost of revenues includes the costs associated with our Solutions and
Subscriptions revenues. The cost of our Solutions revenues consists principally
of payroll-related costs for employees and consultants involved in providing
services for implementation, training and consulting. The cost of our Solutions
revenues also includes royalties due to third parties for integrated technology,
printing costs of product documentation, duplication costs for software media
and shipping costs. The cost of our Subscriptions revenues consists primarily of
the payroll-related costs for employees involved in providing support services
to customers under maintenance contracts as well as payroll costs for employees
and consultants involved in providing services for implementation, training and
consulting for customers under subscription. Cost of Subscriptions also includes
hosting fees required to service our ASP customers.
Total cost of revenues was $4.5 million for the three months ended December 31,
2000 compared to $720,000 for the three months ended December 31, 1999. Cost of
Solutions revenues was $3.2 million and the cost of Subscriptions revenues was
$1.3 million for the three months ended December 31, 2000. Cost of Solutions
revenues was $459,000 and the cost of Subscriptions revenues was $261,000 for
the quarter ended December 31, 1999. For the six months ended December 31, 2000,
total cost of revenues was $8.5 million compared to $1.4 million for the six
months ended December 31, 1999. Cost of Solutions revenues was $6.1 million and
the cost of Subscriptions revenues was $2.4 million for the six months ended
December 31, 2000. Cost of Solutions revenues was $644,000 and the cost of
Subscriptions revenues was $722,000 for the six months ended December 31, 1999.
The increase in cost of Solutions revenues was primarily attributable to
increased costs associated with employees and consultants involved in providing
implementation, training and consulting services to our expanded customer base.
The number of employees in our services organization has increased to 125 as of
December 31, 2000 from 21 at December 31, 1999. The increase in total cost of
Subscriptions revenues was primarily due to increased payroll costs for
employees and third-party consultants involved in providing support services to
customers under maintenance and application subscription contracts.
11
For the six months ended December 31, 2000, gross margins improved to 48% from
35% in prior year. The improvement in gross margins is attributable to an
increase in total revenues and the increase in the number of time and material
consulting engagements as opposed to lower margin fixed fee arrangements.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of employee
salaries, benefits and commissions, and the costs of advertising, public
relations, website development, trade shows, seminars, promotional materials and
other sales and marketing programs. Additionally, sales and marketing expenses
include costs of service personnel that have not been treated as part of cost of
revenues. Sales and marketing expenses increased to $11.0 million for the
quarter ended December 31, 2000, from $2.8 million for the quarter ended
December 31, 1999. Sales and marketing expenses for the six months ended
December 31, 2000 increased to $22.1 million from $4.7 million for the same
period in prior year. The increase in sales and marketing expenses resulted
primarily from building our domestic and international direct sales force,
investing in our sales and marketing infrastructure and increasing our marketing
initiatives. The number of employees in our sales and marketing organization has
increased to 107 as of December 31, 2000 from 30 at December 31, 1999. We expect
that the absolute dollar amount of sales and marketing expenses will continue to
increase due to the planned growth of our sales force which includes the
establishment of sales offices in additional domestic and international
locations.
Research and Development. Research and development expenses consist primarily of
personnel and related costs associated with our product development efforts,
including fees paid to third parties for consulting services. Research and
development expenses increased to $4.0 million for the three months ended
December 31, 2000, from $1.9 million for three months ended December 31, 1999.
Research and development expenses for the six months ended December 31, 2000 and
1999, were $7.9 million and $3.5 million, respectively. The increase in research
and development expenses related primarily to an increase in research and
development personnel to 84 at December 31, 2000 from 39 at December 31, 1999.
Fees paid to third party consultants increased in 2000 as specialized technical
experts were utilized to accelerate the delivery of some of our development
initiatives. We believe that an essential part of our future success is the
investment we make in our research and development organization. We expect that
the absolute dollar amount of research and development expenses will increase in
future periods.
General and Administrative. General and administrative expenses consist
primarily of employee salaries and expenses related to executive, finance and
administrative personnel. General and administrative expenses increased to $2.7
million for the three months ended December 31, 2000, from $990,000 for the
three months ended December 31, 1999. For the six months ended December 31,
2000, general and administrative expenses were $5.2 million compared to $1.7
million for the comparable prior year period. The increase in general and
administrative expenses resulted primarily from the addition of executive,
finance and administrative personnel to support the growth of our business.
Legal fees related to our litigation with Peoplesoft further contributed to an
increase in General and Administrative expenses in 2000. The number of
executive, finance and administrative employees increased to 45 at December 31,
2000 from 20 at December 31, 1999. We expect general and administrative expenses
to increase in absolute dollars in the future.
Amortization of Goodwill and Other Intangible Assets. In connection with the
acquisition of InfoWide, Inc. on March 31, 2000, we recorded $32.6 million in
goodwill, purchased technology and other intangible assets including in-process
technology of $3.1 million. During the three and six months ended December 31,
2000, we expensed $2.7 million and $5.4 million, respectively, associated with
the amortization of these and other intangible assets which are being amortized
over periods not exceeding 36 months.
Stock-Based Charges. Stock-based charges consist of amortization of deferred
compensation in connection with stock option grants and sales of restricted
stock to our employees at exercise or sales prices below the deemed accounting
fair market value of our common stock. We recorded stock-based charges of $7.7
million and $16.6 million for the three and six months ended December 31, 2000,
respectively and $3.1 million and $3.9 million for the three and six months
ended December 31, 1999, respectively. Stock-
12
based charges, if allocated across our functional areas, would affect the
following items in the condensed consolidated statements of operations (in
thousands):
Three months ended Six months ended
December 31, December 31,
-------------------- --------------------
2000 1999 2000 1999
-------- -------- -------- --------
(unaudited)
Cost of revenues:
Solutions............................ $ 622 $ 136 $ 1,366 $ 137
Operating expenses:
Sales and marketing.................. 2,282 705 4,902 778
Research and development............. 1,433 479 2,956 520
General and administrative........... 3,355 1,736 7,418 2,437
-------- -------- -------- --------
Totals............................ $ 7,692 $ 3,056 $16,642 $ 3,872
======== ======== ======== ========
Other Income (Expense), net. Other income (expense), net increase for the three
and six months ended December 31, 2000 is primarily attributable to interest
income derived from increased cash balances resulting from the completion of our
Series I Preferred Stock issuances in June and July 2000 and our initial public
offering in August 2000.
Liquidity And Capital Resources
Net cash used by operations for the six months ended December 31, 2000 was $30.6
million compared to net cash used by operations of $5.4 million for the
comparable period of the prior year. Net cash used by operating activities,
after adjustment for non-cash items, for the six months ended December 31,
2000 resulted primarily from net losses during the period.
Net cash used by investing activities for the six months ended December 31, 2000
was $21.4 million compared to net cash used by investing activities of $4.9
million for the same period in 1999. Cash used by investing activities in 2000
resulted primarily from the purchase of short-term investments of $16.9 million,
and the purchase of property and equipment of $5.8 million. Additions to
property and equipment were primarily related to a move of our corporate offices
to a new facility in July 2000.
Net cash provided from financing activities for the six months ended December
31, 2000 was $56.8 million compared to $24.8 million in the same prior year
period. Current year activity was primarily attributable to proceeds from the
issuance of common stock in our initial public offering completed in August
2000, and to a lesser extent from issuance of preferred shares under our
Series I funding round in July 2000.
At December 31, 2000, we had cash, cash equivalents and investments of $38.3
million. Included in the balance at December 31, 2000 is a short-term investment
of $2.0 million in commercial paper issued by Pacific Gas & Electric which
matured on January 18, 2001 and is currently in default. We believe that the
ultimate realization of this investment is probable. In January 2001, we entered
into a credit arrangement providing a line of credit of $7.5 million and a $7.5
million term loan credit facility. We believe that our current cash and
investment balances, cash flow from operations and accessibility of funds from
our credit arrangements will be sufficient to meet our working capital and
capital expenditure requirements for at least the next twelve months. We may
also utilize cash to acquire or invest in complementary businesses or to obtain
the right to use complementary technologies.
Factors That May Affect Future Results of Operations
Our business is difficult to evaluate because our operating history is limited.
It is difficult to evaluate our business and our prospects because our revenue
and income potential are unproven. We commenced recognizing sales revenues in
the first quarter of 1999. Because of our limited
13
operating history, there may not be an adequate basis for forecasts of future
operating results, and we have only limited insight into the trends that may
emerge in our business and affect our financial performance.
We have incurred losses since inception, and we may not be able to achieve
profitability.
We have incurred net losses and losses from operations since our inception in
1995, and we may not be able to achieve profitability in the future. As of
December 31, 2000, we had an accumulated deficit of approximately $158.0
million. Since inception, we have funded our business primarily from the sale of
our stock and by borrowing funds, not from cash generated by our business. We
expect to continue to incur significant sales and marketing, research and
development, and general and administrative expenses. As a result, we expect to
experience continued losses and negative cash flows from operations. If we do
achieve profitability, we may not be able to sustain or increase profitability
on a quarterly or annual basis in the future.
Our future operating results may not follow past trends due to many factors, and
any of these could cause our stock price to fall.
We believe that quarter-to-quarter comparisons of our operating results are not
a good indication of future performance. Although our operating results have
generally improved from quarter to quarter in the recent past, our future
operating results may not follow past trends. It is likely that in some future
quarters our operating results may be below the expectations of public market
analysts and investors due to factors beyond our control, and as a result, the
price of our common stock may fall.
Factors that may cause our future operating results to be below expectations and
cause our stock price to fall include:
. the lack of demand for and acceptance of our products, product
enhancements and services; for instance, as we expand our target
customer focus beyond the information technology service
consultancies and into internal information technology of
corporate customers as well as into overseas markets, we may
encounter increased resistance to adoption of our business process
automation solutions;
. unexpected changes in the development, introduction, timing and
competitive pricing of our products and services or those of our
competitors;
. any inability to expand our direct sales force and indirect
marketing channels both domestically and internationally;
. difficulties in recruiting and retaining key personnel in a highly
competitive recruiting environment;
. unforeseen reductions or reallocations of our customers'
information technology infrastructure budgets;
. any delays or unforeseen costs incurred in integrating
technologies and businesses we may acquire.
We plan to increase our operating expenses to expand our administration,
information technology infrastructure, consulting and training, maintenance and
technical support, research and development and sales and marketing groups. Our
operating expenses are based on our expectations of future revenues and are
relatively fixed in the short term. If revenues fall below our expectations in
any quarter and we are not able to quickly reduce our spending in response, our
operating results for that quarter would be lower than expected and our stock
price may fall.
We may lose existing customers or be unable to attract new customers if we do
not develop new products or enhance our existing products.
14
If we are not able to maintain and improve our product line and develop new
products, we may lose existing customers or be unable to attract new customers.
We may not be successful in developing and marketing product enhancements or new
products on a timely or cost-effective basis. These products, if developed, may
not achieve market acceptance. As an example, we have added service delivery
management functions to our ServiceSphere suite and we have built enhanced
delivery management functionality in part through integration of the technology
of InfoWide, Inc. However, we have only recently made these enhancements
generally available, and we cannot be certain that any of these enhancements
will meet the needs or expectations of our customers.
A limited number of our customers expect us to develop product enhancements that
may address their specific needs. For instance, we have shared with some of our
customers our internal product roadmap which includes descriptions of new
functional enhancements such as improved time and expense management for future
releases of our software. If we fail to deliver these enhancements on a timely
basis, we risk damaging our relationship with these customers. We have
experienced delays in the past in releasing new products and product
enhancements and may experience similar delays in the future. These delays or
problems in the installation or implementation of our new releases may cause
some of these customers to forego additional purchases of our products or to
purchase those of our competitors.
If the market for process automation solutions for professional services
organizations does not continue to grow, the growth of our business will not be
sustainable.
The future growth and success of our business is contingent on growing
acceptance of, and demand for, business process automation solutions for
professional services organizations. All of our historical revenues have been
attributable to the sale of automation solutions for professional services
organizations. This is a relatively new enterprise application solution
category, and it is uncertain whether major services organizations will choose
to adopt process automation systems. While we have devoted significant resources
to promoting market awareness of our products and the problems our products
address, we do not know whether these efforts will be sufficient to support
significant growth in the market for process automation products. Accordingly,
the market for our products may not continue to grow or, even if the market does
grow in the immediate term, that growth may not be sustainable.
If we fail to expand our relationships with third-party resellers and
integrators, our ability to grow revenues could be harmed.
In order to grow our business, we must establish, maintain and strengthen
relationships with third parties, such as information technology ("IT")
consultants and systems integrators as implementation partners and hardware and
software vendors as marketing partners. If these parties do not provide
sufficient, high-quality service or integrate and support our software
correctly, our revenues may be harmed. In addition, these parties may offer
products of other companies, including products that compete with our products.
Our contracts with third parties may not require these parties to devote
resources to promoting, selling and supporting our solutions. Therefore we may
have little control over these third parties. We cannot assure you that we can
generate and maintain relationships that offset the significant time and effort
that are necessary to develop these relationships, or that, even if we are able
to develop such relationships, these parties will perform adequately.
Our services revenues have a substantially lower margin than our software
license revenues, and an increase in services revenues relative to license
revenues could harm our gross margins.
A significant shift in our revenue mix away from license revenues to service
revenues would adversely affect our gross margins. Revenues derived from
services we provide have substantially lower gross margins than revenues we
derive from licensing our software. The relative contribution of services we
provide to our overall revenues is subject to significant variation based on the
structure and pricing of arrangements we enter into with customers in the
future, and the extent to which our partners provide implementation,
integration, training and maintenance services required by our customers. An
increase in the percentage of total revenues generated by the services we
provide could adversely affect our overall gross margins.
Difficulties with third-party services and technologies, as well as power
interruptions, could disrupt our business, and many of our communication and
hosting systems do not have backup systems.
15
Many of our communications and hosting systems do not have backup systems
capable of mitigating the effect of service disruptions. Our success in
attracting and retaining customers for our ServiceSphere application service
provider ("ASP") offering and convincing them to increase their reliance on this
solution depends on our ability to offer customers reliable, secure and
continuous service. This requires that we provide continuous and error-free
access to our systems and network infrastructure. We rely on third parties to
provide key components of our networks and systems. For instance, we rely on
third-party Internet service providers to host applications for customers who
purchase our solutions on an ASP basis. We also rely on third-party
communications services providers for the high-speed connections that link our
Web servers and office systems to the Internet. Any Internet or communications
systems failure or interruption could result in disruption of our service or
loss or compromise of customer orders and data. These failures, especially if
they are prolonged or repeated, would make our services less attractive to
customers and tarnish our reputation.
In addition, California has recently been experiencing a shortage of electric
power supply that has resulted in intermittent loss of power in the form of
rolling blackouts. While neither we nor our third-party Internet service
providers or communications services providers have experienced any power
failures to date that have prevented us from continuing our operations, the
continuance of blackouts may affect our ability to operate our business.
Our markets are highly competitive and competition could harm our ability to
sell products and services and reduce our market share.
Competition could seriously harm our ability to sell additional software
solutions and subscriptions on prices and terms favorable to us. The markets for
our products are intensely competitive and subject to rapidly changing
technology. We currently compete against providers of automation solutions for
professional services organizations, such as Changepoint and Niku. In addition,
we may in the future face competition from providers of enterprise application
software or electronic marketplaces. Companies in each of these areas may expand
their technologies or acquire companies to support greater professional services
automation functionality and capabilities. In addition, "in-house" information
technology departments of potential customers have developed or may develop
systems that substitute for some of the functionality of our product line.
Some of our competitors' products may be more effective than our products at
performing particular functions or be more customized for particular customer
needs. Even if these functions are more limited than those provided by our
products, our competitors' software products could discourage potential
customers from purchasing our products. A software product that provides some of
the functions of our software solutions, but also performs other tasks, may be
appealing to these vendors' customers because it would reduce the number of
different types of software necessary to effectively run their businesses.
Further, many of our competitors may be able to respond more quickly than we can
to changes in customer requirements.
Some of our competitors have longer operating histories, significantly greater
financial, technical, marketing or other resources, or greater name recognition
than we do. Our competitors may be able to respond more quickly than we can to
new or emerging technologies and changes in customer requirements. Our
competitors have made and may also continue to make strategic acquisitions or
establish cooperative relationships among themselves or with other software
vendors. They may also establish or strengthen cooperative relationships with
our current or future partners, limiting our ability to promote our products
through these partners and limiting the number of consultants available to
implement our software.
Our lengthy and unpredictable sales cycles for our products and resistance to
adoption of our software could cause our operating results to fall below
expectations.
Our operating results for future periods could be adversely affected because of
unpredictable increases in our sales cycles. Our products and services have
lengthy and unpredictable sales cycles varying from as little as three months to
as much as nine months, which could cause our operating results to be below the
expectations of analysts and investors. Since we are unable to control many of
the factors that will influence
16
our customers' buying decisions, it is difficult for us to forecast the timing
and recognition of revenues from sales of our solutions.
Customers in our target market often take an extended time evaluating our
products before purchasing them. Our products may have an even longer sales
cycle in international markets. During the evaluation period, a variety of
factors, including the introduction of new products or aggressive discounting by
competitors and changes in our customers' budgets and purchasing priorities, may
lead customers to not purchase or to scale down orders for our products.
As we target industry sectors and types of organizations beyond our core market
of IT services consultancies, we may encounter increased resistance to use of
business process automation solutions, which may further increase the length of
our sales cycles, increase our marketing costs and reduce our revenues. Because
we are pioneering a new solution category, we often must educate our prospective
customers on the use and benefit of our solutions, which may cause additional
delays during the evaluation process. These companies may be reluctant to
abandon investments they have made in other systems in favor of our solution. In
addition, IT departments of potential customers may resist purchasing our
solutions for a variety of other reasons, particularly the potential
displacement of their historical role in creating and running software and
concerns that packaged software products are not sufficiently customizable for
their enterprises.
Our revenues depend on orders from our top customers, and if we fail to complete
one or more orders, our revenues will be reduced.
Historically, we have received a significant portion of our revenues from a
small number of customers. No customers accounted for more than 10% of total
revenues for the three or six months ended December 31, 2000. However, a new
contract with EDS (Electronic Data Systems Corporation) is anticipated to
represent more than 10% of our total revenues for the next two quarters. Our
future operating results may be harmed if we are not able to complete one or
more substantial product sales in any future period or attract new customers.
We depend on the continued services of our executive officers, and the loss of
key personnel or any inability to attract and retain additional personnel could
affect our ability to successfully grow our business.
If we are unable to hire and retain a sufficient number of qualified personnel,
particularly in sales, marketing, research and development, service and support,
our ability to grow our business could be affected. Competition for qualified
personnel in high technology is intense, particularly in the San Francisco Bay
Area where our principal office is located. The loss of the services of our key
engineering, sales, service or marketing personnel would harm our operations.
For instance, loss of sales and customer service representatives could harm our
relationship with the customers they serve, loss of engineers and development
personnel could impede the development of product releases and enhancements and
decrease our competitiveness, and departure of senior management personnel could
result in a loss of confidence in our company by customers, suppliers and
partners. None of our key personnel is bound by an employment agreement, and we
do not maintain key person insurance on any of our employees. Because we, like
many other technology companies, rely on stock options as a component of our
employee compensation, if the market price of our common stock decreases or
increases substantially, some current or potential employees may perceive our
equity incentives as less attractive. In that case, our ability to attract and
retain employees may be adversely affected.
Our future success depends upon the continued service of our executive officers,
particularly John Bantleman, our President and Chief Executive Officer, who is
critical to determining our broad business strategy, and to James Bozzini, our
Chief Operating Officer, who is critical to our ability to execute on that
strategy. None of our executive officers is bound by an employment agreement for
any specific term. Our business could be harmed if we lost the services of one
or more of our executive officers or key employees, or if one or more of them
decide to join a competitor or otherwise compete directly or indirectly with us.
If our products do not stay compatible with widely used software programs, our
revenues may be adversely affected.
17
Our software products must work with widely used software programs. If these
software programs and operating environments do not remain widely used, or we do
not update our software to be compatible with newer versions of these programs
and systems, we may lose customers.
Our software only operates on both a computer server running the Microsoft
Windows NT or Sun Solaris operating system and a computer server running
database software from Microsoft or Oracle. In order to increase the flexibility
of our solution and expand our client base, we must be able to successfully
adapt it to work with other applications and operating systems. For example, we
are in the early stages of customer deployment on the Sun Solaris operating
system. Because this development effort is not complete, we cannot be certain
that we will avoid significant technical difficulties which could delay or
prevent completion of the development effort.
Our software connects to and uses data from a variety of our customers' existing
software systems, including systems from Oracle and SAP. If we fail to enhance
our software to connect to and use data from new systems of these products, we
may lose potential customers.
The cost and difficulties of implementing our products could significantly harm
our reputation with customers and harm our future sales.
If our customers encounter unforeseen difficulties or delays in deploying our
products and integrating them with their other systems, they may reverse their
decision to use our solutions, which would reduce our future revenues, could
impact the collection of outstanding receivables and potentially damage our
reputation. Factors which could delay or complicate the process of deploying our
solutions include:
. customers may need to modify significant elements of their existing IT
systems in order to effectively integrate them with our solutions;
. customers may need to establish and implement internal business
processes within their organizations before they can make effective
use of our software;
. customers may need to purchase and deploy significant additional
hardware and software resources and may need to make significant
investments in consulting and training services; and
. customers may rely on third-party systems integrators to perform all
or a portion of the deployment and integration work, which reduces the
control we have over the implementation process and the quality of
customer service provided to the customer.
Our sales are concentrated in the IT services consulting industry, and if our
customers in this industry decrease their infrastructure spending, or we fail to
penetrate other industries, our revenues may decline.
Sales to customers in the IT services consulting industry accounted for a
substantial portion of our revenues in fiscal 1999 and 2000. Given the high
degree of competition and the rapidly changing environment in this industry,
there is no assurance that we will be able to continue sales in this industry at
current levels. Many of our customers and potential customers in the IT services
consultancy industry have witnessed drastic declines in their stock prices,
which could limit our current customers from purchasing additional licenses of
our software, and could prevent potential customers from making the kinds of
infrastructure investments that would allow them to purchase our software in the
first place. In addition, we intend to market our products to professional
services organizations in other industries. Customers in these new industries
are likely to have different requirements and may require us to change our
product design or features, sales methods, support capabilities or pricing
policies. If we fail to successfully address the needs of these customers, we
may experience decreased sales in future periods.
If we lose key licenses, we may be required to develop or license alternatives
which may cause delays or reductions in sales or shipments.
18
We rely on software that we have licensed from third parties, including Poet
Software and Inprise/Borland, to perform key functions of our Evolve
ServiceSphere ePlatform, and we rely on these and other third parties to support
their products for our development and customer support efforts. These companies
could terminate our licenses if we breach our agreements with them, or they
could discontinue support of the products we license from them. This could
result in delays or reductions of sales or shipments of our ePlatform until
alternative software can be developed or licensed.
If our products contain significant defects or our services are not perceived as
high quality, we could lose potential customers or be subject to damages.
Our products are complex and may contain currently unknown errors, defects,
integration problems, or other types of failures, particularly since new
versions are frequently released. In the past we have discovered software errors
in some of our products after introduction. We may not be able to detect and
correct errors before releasing our products commercially. If our commercial
products contain errors, we may:
. need to expend significant resources to locate and correct the errors;
. be required to delay introduction of new products or commercial
shipment of products; or
. experience reduced sales and harm to our reputation from dissatisfied
customers.
Our customers also may encounter system configuration problems that require us
to spend additional consulting or support resources to resolve these problems.
Our customers may want a completely integrated solution, including a single user
interface and single database platform. While our product roadmap calls for such
an integrated solution, any delays in delivering such a solution to our
customers may cause them to downgrade their opinion of our software or to
abandon our software.
Because our software products are used for critical operational and
decision-making processes by our customers, product defects may also give rise
to product liability claims. Although our license agreements with customers
typically contain provisions designed to limit our exposure, some courts may not
enforce all or part of these limitations. Although we have not experienced any
product liability claims to date, we may encounter these claims in the future.
Product liability claims, whether or not they have merit, could:
. divert the attention of our management and key personnel from our
business;
. be expensive to defend; and
. result in large damage awards.
We do not have product liability insurance, and even if we obtain product
liability insurance, it may not be adequate to cover all of the expenses
resulting from such a claim. In addition, if our customers do not find our
services to be of high quality, they may elect to use other training, consulting
and product integration firms rather than contract for our services. If
customers are dissatisfied with our services, we may lose revenues.
Our business may suffer if we are not able to protect our intellectual property.
Our success is dependent on our ability to develop and protect our proprietary
technology and intellectual property rights. We seek to protect our software,
documentation and other written materials primarily through a combination of
patent, trade secret, trademark and copyright laws, confidentiality procedures
and contractual provisions. While we have attempted to safeguard and maintain
our proprietary rights, we do not know whether we have been or will be
completely successful in doing so. Further, our competitors may independently
develop or patent technologies that are substantially equivalent or superior to
ours.
We have three patent applications pending in the United States with respect to
the "Team Builder" functionality in our Resource Manager module, the time and
expense functionality of our Time and Expense
19
module; and the enablement of dynamically configurable software systems by our
ServiceSphere software server. While the first two of these applications have
not been issued, we have received notice from the U.S. Patent Office that the
latter application has been allowed. However, there can be no assurance that any
of these applications would survive a legal challenge to its validity or provide
significant protection to us. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or
obtain and use information that we regard as proprietary. Policing unauthorized
use of our products is difficult. While we are unable to determine the extent to
which piracy of our software products exists, software piracy can be expected to
be a persistent problem, particularly in foreign countries where the laws may
not protect proprietary rights as fully as in the United States. We can offer no
assurance that our means of protecting its proprietary rights will be adequate
or that our competitors will not reverse engineer or independently develop
similar technology.
If others claim that we are infringing their intellectual property, we could
incur significant expenses or be prevented from selling our products.
We cannot provide assurance that others will not claim that we are infringing
their intellectual property rights or that we do not in fact infringe those
intellectual property rights. We have not conducted a search for existing
intellectual property registrations, and we may be unaware of intellectual
property rights of others that may cover some of our technology.
Any litigation regarding intellectual property rights could be costly and
time-consuming and divert the attention of our management and key personnel from
our business operations. The complexity of the technology involved and the
uncertainty of intellectual property litigation increase these risks. Claims of
intellectual property infringement might also require us to enter into costly
royalty or license agreements.
We may not be able to obtain royalty or license agreements on terms acceptable
to us, or at all. We also may be subject to significant damages or an injunction
against use of our products. A successful claim of patent or other intellectual
property infringement against us would have an immediate material adverse effect
on our business and financial condition.
We have grown very quickly, and if we fail to manage our growth, our ability to
generate new revenues and achieve profitability would be harmed.
We have grown significantly since our inception and will need to grow quickly in
the future. Any failure to manage this growth could impede our ability to
increase revenues and achieve profitability. Evolve has increased its number of
employees from 110 at December 31, 1999 to 361 employees as of December 31,
2000. In order to manage growth effectively, we must:
. hire, train and integrate new personnel;
. continue to augment our management information systems;
. manage our sales and services operations, which are in several
locations; and
. expand and improve our systems and facilities.
We intend to further expand operations internationally, but we may encounter a
number of problems in doing so which could limit our future growth.
We may not be able to successfully market, sell, deliver and support our
products and services internationally. Any failure to build and manage effective
international operations could limit the future growth of our business.
Expansion into international markets will require significant management
attention and financial resources to open additional international offices and
hire international sales and support personnel. Localizing our products is
difficult and may take longer than we anticipate due to difficulties in
translation and delays we may experience in recruiting and training
international staff. We currently have no experience in developing local
versions of our products, and limited experience in marketing, selling and
20
supporting our products and services overseas. Doing business internationally
involves greater expense and many additional risks, particularly:
. differences and unexpected changes in regulatory requirements,
taxes, trade laws, tariffs, intellectual property rights and labor
regulations;
. changes in a specific country's or region's political or economic
conditions;
. greater difficulty in establishing, staffing and managing foreign
operations; and
. fluctuating exchange rates.
Security concerns, particularly related to the use of our software on the
Internet, may limit the effectiveness of and reduce the demand for our products.
Despite our efforts to protect confidential and proprietary information of our
customers stored on Services.com or our ServiceSphere ASP offering via virtual
private networks and other security devices, there is a risk that this
information will be disclosed to unintended third-party recipients. To the
extent our ability to implement secure private networks on our Services.com site
or for our ServiceSphere ASP service is impaired by technical problems, or by
improper or incomplete procedural diligence by either ourselves or our
customers, sensitive information could be exposed to inappropriate third parties
such as competitors of our customers, which may in turn expose us to liability
and detrimentally impact our customers' confidence in Services.com or our ASP
service.
Resistance to online use of personal information regarding employees and
consultants may hinder the effectiveness of and reduce demand for our products
and services.
Companies store information on the Services.com site, our ASP offering and on
online networks created by our customers, which may include personal information
of their employees, including employee backgrounds, skills, and other details.
These employees may object to online compilation, transmission and storage of
such information, or, despite our efforts to keep such personal information
secure, this information may be delivered unintentionally to inappropriate third
parties such as recruiters. Enterprise applications like ServiceSphere have
always run on secure company intranets. The information contained in
ServiceSphere databases will be exposed to the unpredictable security of the
Internet, which may create unforeseen liabilities for us. ServiceSphere is
currently targeted primarily to the North American market, but to the extent
that European companies and customers will have access to it (given the global
nature of the Internet), and to the extent that our services are utilized by
Europeans, legal action grounded in European privacy laws could prevent
Services.com and our ASP service from succeeding in the European market.
Potential imposition of governmental regulation or taxation on electronic
commerce could limit our growth.
The adoption of new laws or the adaptation of existing laws to the Internet may
decrease the growth in the use of the Internet, which could in turn decrease the
demand for our solutions, increase our cost of doing business or otherwise have
a material adverse impact on our business. Few laws or regulations currently
directly apply to access to commerce on the Internet. Federal, state, local and
foreign governments are considering a number of legislative and regulatory
proposals relating to Internet commerce. As a result, a number of laws or
regulations may be adopted regarding Internet user privacy, taxation, pricing,
quality of products and services and intellectual property ownership. How
existing laws will be applied to the Internet in areas such as property
ownership, copyright, trademark, trade secret and defamation is uncertain. The
recent growth of Internet commerce has been attributed by some to the lack of
sales and value-added taxes on interstate sales of goods and services over the
Internet. Numerous state and local authorities have expressed a desire to impose
such taxes on sales to businesses in their jurisdictions. The Internet Tax
Freedom Act of 1998 prevents imposition of such taxes through October 2001. If
the federal moratorium on state and local taxes on Internet sales is not
renewed, or if it is terminated before its expiration, sales of goods and
services over the Internet could be subject to multiple overlapping tax schemes,
which could substantially hinder the growth of Internet-based commerce,
including use of our Services.com offering.
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If we need additional financing to maintain and expand our business, financing
may not be available on favorable terms, if at all.
We expect to incur net losses before amortization charges for the foreseeable
future. We may need additional funds to expand or meet all of our operating
needs. If we need additional financing, we cannot be certain that it will be
available on favorable terms, if at all. Further, if we issue additional shares
of our capital stock, stockholders will experience additional dilution, which
may be substantial. If we need funds and cannot raise them on acceptable terms,
we may not be able to continue our operations at the current level or at all.
The sale of a substantial number of shares of common stock could cause the
market price of our common stock to decline.
Sales of a substantial number of shares of our common stock in the public
market, or the appearance that such shares are available for sale, could
adversely affect the market price for our common stock. The market price of our
stock could also decline if one or more of our significant stockholders decided
for any reason to sell substantial amounts of our stock in the public market. As
of January 16, 2001, we had 38,453,366 shares of common stock outstanding. Of
these shares, 27,944,718 are freely tradable in the public market, either
without restriction or subject in some cases only to S-8/S-3 prospectus delivery
requirements, and in some cases only to either manner of sale, volume, and
notice requirements of Rule 144 under the Securities Act of 1933, as amended.
The majority of these shares had been subject to lock-up agreements that expired
on February 5, 2001. Of the remaining 10,508,648 shares, eligibility for resale
will be as follows:
. A total of 3,506,741 shares will become eligible for sale, subject
only to the manner of sale requirements of Rule 144, as our right
to repurchase these shares lapses over time with the continued
employment by Evolve of these stockholders.
. On March 31, 2001, 2,001,907 shares issued to stockholders of
InfoWide, Inc., a company we acquired on March 31, 2000, will be
eligible for sale, subject only to volume, manner of sale and
notice requirements of Rule 144 under the Securities Act.
. On June 28, 2001, and July 13, 2001, respectively, aggregate
amounts of 3,007,775 shares and 1,992,225 shares, acquired through
the conversion of preferred stock, will become eligible for sale,
subject only to these same Rule 144 requirements.
As of January 16, 2001, we also have 3,174,413 shares subject to outstanding
options under our stock option plans (plus 224,167 options and warrants issued
outside of any plan), and 3,323,610 shares are available for future issuance
under these plans. We have registered the shares of common stock subject to
outstanding options and reserved for issuance under our stock option plans and
the 2,000,000 shares of common stock reserved for issuance under our 2000
Employee Stock Purchase Plan. Accordingly, shares underlying vested options will
be eligible for resale in the public market as soon as they are purchased.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discusses our exposure to market risk related to changes in
foreign currency exchange rates, interest rates, and equity prices. This
discussion contains forward-looking statements that are subject to risks and
uncertainties. Actual results could vary materially as a result of a number of
factors including those set forth in the risk factors section of this
prospectus.
Foreign Currency Exchange Rate Risk
To date, all our product sales have been made in North America and to a smaller
extent, Europe. As a result of our international operations, our financial
results could be affected by a variety of factors, including changes in foreign
currency exchange rates or weak economic conditions in foreign markets. The
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strengthening of the U.S. dollar could make our products less competitive in
foreign markets given that sales are currently made in U.S. dollars.
Interest Rate Risk
As of December 31, 2000, we had $40.3 million of cash, cash equivalents and
investments, which includes restricted cash of $2.0 million. Included in the
balance at December 31, 2000 is a short-term investment of $2.0 million in
commercial paper issued by Pacific Gas & Electric which matured on January 18,
2001 and is currently in default. We believe that the ultimate realization of
this investment is probable. Declines in interest rates over time would reduce
our interest income. As of December 31, 2000, we had total short-term debt
outstanding of $733,000, which accrued interest at the prime rate. A substantial
portion the outstanding short-term debt amounts were paid down in January 2001.
Funds in excess of current operating requirements are invested in obligations of
the U.S. government and its agencies and investment grade obligations of state
and local governments and large corporations. Due to the nature of our
investments, excluding the $2.0 million in commercial paper issued by Pacific
Gas & Electric, we have concluded that there is no material market risk
exposure. Therefore, no quantitative tabular disclosures are presented.
The basic objectives of our investment program are to ensure:
. safety and preservation of capital,
. sufficient liquidity to meet cash flow requirements,
. attainment of a market rate of return on invested funds
consistent, and
. avoiding inappropriate concentrations of investments.
Equity Risk
We do not own any marketable equity securities. Therefore, we are not subject to
any direct equity price risk.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may become involved in litigation relating to claims
arising from our ordinary course of business. In January 2000 PeopleSoft, Inc.
filed an action in the California Superior Court, Alameda County, alleging
claims arising out of our employment of former employees of PeopleSoft, and
seeking preliminary and permanent injunctions to preclude additional hiring of
PeopleSoft employees. PeopleSoft's claims include our inducing breach of
contract of their employees and unfair competition. PeopleSoft filed a motion
for preliminary injunction enjoining us from recruiting additional PeopleSoft
employees or disclosing any PeopleSoft trade secrets. The court denied this
motion in July 2000 due to PeopleSoft's failure to show that it was neither
likely to succeed in the litigation on the merits of their complaint nor had it
shown that it would be harmed if the injunction were not issued. PeopleSoft has
appealed the court's ruling on the motion. We do not believe that the motion,
even if granted on appeal, will have a material impact on our business. The
parties conducted a mediation in September 2000 but were unable to reach an
agreeable settlement. Since the mediation, the parties have continued to engage
in settlement discussions. We continue to believe that PeopleSoft's claims are
without merit, and continue to contest these claims. However, this litigation,
whether or not determined or settled in our favor, may be costly and may divert
the efforts and attention of our management from normal business operations.
In management's opinion, the outcome of this litigation is not expected to
have a material impact on the consolidated financial statements. We believe
that there are no other claims or actions pending or threatened against us,
the ultimate disposition of which would have a material adverse effect on us.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
None.
(b) Reports on Form 8-K
No reports were filed on Form 8-K or Form 8-K/A during the quarter ended
December 31, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EVOLVE SOFTWARE, INC.
Date: February 14, 2001 By: /S/ JOHN P. BANTLEMAN
----------------------------
John P. Bantleman
President and
Chief Executive Officer
(Principal Executive Officer)
Date: February 14, 2001 By: /S/ DOUGLAS S. SINCLAIR
---------------------------------
Douglas S. Sinclair
Chief Financial Officer,
Corporate Secretary and Treasurer
(Principal Financial Officer)
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