UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x |
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Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2008
OR
o |
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Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 0-24081
EVOLVING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware |
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84-1010843 |
(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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9777 Pyramid Court, Suite 100, Englewood, Colorado |
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80112 |
(Address of principal executive offices) |
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(Zip Code) |
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(303) 802-1000 |
||
(Registrants telephone number, including area code) |
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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ |
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Accelerated filer ¨ |
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Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
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Smaller reporting companyx |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 31, 2008 there were 19,401,786 shares outstanding of Registrants Common Stock (par value $0.001 per share).
EVOLVING SYSTEMS, INC.
Quarterly Report on Form 10-Q
September 30, 2008
Table of Contents
2
PART I FINANCIAL INFORMATION
EVOLVING SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
(unaudited)
|
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September 30, |
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December 31, |
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ASSETS |
|
|
|
|
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||
Current assets: |
|
|
|
|
|
||
Cash and cash equivalents |
|
$ |
5,629 |
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$ |
7,271 |
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Contract receivables, net of allowance of $36 at September 30, 2008 and $66 at December 31, 2007 |
|
4,438 |
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10,959 |
|
||
Unbilled work-in-progress |
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1,871 |
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922 |
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Deferred foreign income taxes |
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4 |
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4 |
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||
Prepaid and other current assets |
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1,636 |
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1,331 |
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||
Total current assets |
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13,578 |
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20,487 |
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Property and equipment, net |
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1,364 |
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1,677 |
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||
Amortizable intangible assets, net |
|
3,232 |
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4,687 |
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Goodwill |
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24,586 |
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26,417 |
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Long-term restricted cash |
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100 |
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100 |
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||
Other long-term assets |
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252 |
|
359 |
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||
Total assets |
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$ |
43,112 |
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$ |
53,727 |
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|
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|
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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|
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||
Current portion of capital lease obligations |
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20 |
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$ |
20 |
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|
Current portion of long-term debt |
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2,000 |
|
2,500 |
|
||
Accounts payable and accrued liabilities |
|
4,703 |
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5,903 |
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||
Deferred foreign income taxes |
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27 |
|
34 |
|
||
Unearned revenue |
|
6,271 |
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10,635 |
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||
Total current liabilities |
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13,021 |
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19,092 |
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||
Long-term liabilities: |
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|
|
|
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Capital lease obligations, net of current portion |
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64 |
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79 |
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||
Other long-term obligations |
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1,219 |
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1,477 |
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||
Long-term debt, net of current portion |
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5,383 |
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8,686 |
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Deferred foreign income taxes |
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630 |
|
878 |
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||
Total liabilities |
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20,317 |
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30,212 |
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||
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Commitments and contingencies (Note 10) |
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Series B convertible redeemable preferred stock |
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5,587 |
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||
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Stockholders equity: |
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Preferred stock, $0.001 par value; 2,000,000 shares authorized; 0 and 478,750 shares of Series B issued and outstanding as of September 30, 2008 and December 31, 2007, respectively (shown above) |
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Common stock, $0.001 par value; 40,000,000 shares authorized; 19,388,072 and 17,914,770 shares issued and outstanding as of September 30, 2008 and December 31, 2007, respectively |
|
19 |
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18 |
|
||
Additional paid-in capital |
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81,604 |
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75,317 |
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||
Accumulated other comprehensive income (loss) |
|
(401 |
) |
2,144 |
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||
Accumulated deficit |
|
(58,427 |
) |
(59,551 |
) |
||
Total stockholders equity |
|
22,795 |
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17,928 |
|
||
Total liabilities and stockholders equity |
|
$ |
43,112 |
|
$ |
53,727 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
EVOLVING SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
(unaudited)
|
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Three Months Ended |
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Nine Months Ended |
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||||||||
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2008 |
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2007 |
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2008 |
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2007 |
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REVENUE |
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||||
License fees and services |
|
$ |
4,539 |
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$ |
4,692 |
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$ |
14,713 |
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$ |
13,425 |
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Customer support |
|
4,490 |
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4,619 |
|
13,088 |
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13,468 |
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||||
Total revenue |
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9,029 |
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9,311 |
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27,801 |
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26,893 |
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||||
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COSTS OF REVENUE AND OPERATING EXPENSES |
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||||
Costs of license fees and services, excluding depreciation and amortization |
|
1,977 |
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2,097 |
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6,103 |
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5,962 |
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||||
Costs of customer support, excluding depreciation and amortization |
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1,581 |
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1,532 |
|
4,706 |
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4,741 |
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||||
Sales and marketing |
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2,004 |
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2,003 |
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6,385 |
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6,228 |
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||||
General and administrative |
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1,281 |
|
1,350 |
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3,942 |
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4,549 |
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||||
Product development |
|
792 |
|
665 |
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2,810 |
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1,572 |
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||||
Depreciation |
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189 |
|
189 |
|
671 |
|
729 |
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||||
Amortization |
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371 |
|
396 |
|
1,130 |
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1,176 |
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||||
Restructuring and other recovery |
|
|
|
|
|
|
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(1 |
) |
||||
Total costs of revenue and operating expenses |
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8,195 |
|
8,232 |
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25,747 |
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24,956 |
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||||
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Income from operations |
|
834 |
|
1,079 |
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2,054 |
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1,937 |
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||||
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Other income (expense): |
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Interest income |
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29 |
|
86 |
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146 |
|
231 |
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||||
Interest expense |
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(278 |
) |
(419 |
) |
(897 |
) |
(1,334 |
) |
||||
Gain (loss) on extinguishment of debt |
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(290 |
) |
42 |
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||||
Foreign currency exchange gain |
|
130 |
|
168 |
|
272 |
|
7 |
|
||||
Other expense, net |
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(119 |
) |
(165 |
) |
(769 |
) |
(1,054 |
) |
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Income before income taxes |
|
715 |
|
914 |
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1,285 |
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883 |
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||||
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|
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||||
Income tax expense |
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122 |
|
345 |
|
161 |
|
569 |
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||||
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||||
Net income |
|
$ |
593 |
|
$ |
569 |
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$ |
1,124 |
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$ |
314 |
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|
|
|
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|
|
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||||
Basic and diluted income per common share |
|
$ |
0.03 |
|
$ |
0.03 |
|
$ |
0.06 |
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
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|
||||
Weighted average basic shares outstanding |
|
19,386 |
|
19,201 |
|
19,374 |
|
19,178 |
|
||||
Weighted average diluted shares outstanding |
|
19,746 |
|
19,550 |
|
19,809 |
|
19,546 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
EVOLVING SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data)
(unaudited)
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Accumulated |
|
|
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|||||
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Additional |
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Other |
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Total |
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|||||
|
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Common Stock |
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Paid-in |
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Comprehensive |
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Accumulated |
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Stockholders |
|
|||||||
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Shares |
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Amount |
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Capital |
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Income (Loss) |
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Deficit |
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Equity |
|
|||||
Balance at December 31, 2007 |
|
17,914,770 |
|
$ |
18 |
|
$ |
75,317 |
|
$ |
2,144 |
|
$ |
(59,551 |
) |
$ |
17,928 |
|
Stock option exercises |
|
5,054 |
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|
|
4 |
|
|
|
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|
4 |
|
|||||
Common stock issued pursuant to the Employee Stock Purchase Plan |
|
31,998 |
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|
|
52 |
|
|
|
|
|
52 |
|
|||||
Stock-based compensation expense |
|
|
|
|
|
645 |
|
|
|
|
|
645 |
|
|||||
Preferred stock conversion |
|
1,436,250 |
|
1 |
|
5,586 |
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|
|
|
|
5,587 |
|
|||||
Comprehensive income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Net income |
|
|
|
|
|
|
|
|
|
1,124 |
|
|
|
|||||
Foreign currency translation Adjustment |
|
|
|
|
|
|
|
(2,545 |
) |
|
|
|
|
|||||
Comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
(1,421 |
) |
|||||
Balance at September 30, 2008 |
|
19,388,072 |
|
$ |
19 |
|
$ |
81,604 |
|
$ |
(401 |
) |
$ |
(58,427 |
) |
$ |
22,795 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
EVOLVING SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
|
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
||
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
||
Net income |
|
$ |
1,124 |
|
$ |
314 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
||
Depreciation |
|
671 |
|
729 |
|
||
Amortization of intangible assets |
|
1,130 |
|
1,176 |
|
||
Amortization of debt issuance costs |
|
112 |
|
181 |
|
||
Stock-based compensation |
|
645 |
|
543 |
|
||
Gain on disposal of property and equipment |
|
|
|
(1 |
) |
||
(Gain) loss on extinguishment of debt |
|
290 |
|
(42 |
) |
||
Foreign currency transaction gains, net |
|
(272 |
) |
(7 |
) |
||
Benefit from foreign deferred income taxes |
|
(186 |
) |
(132 |
) |
||
Change in operating assets and liabilities: |
|
|
|
|
|
||
Contract receivables |
|
6,494 |
|
4,616 |
|
||
Unbilled work-in-progress |
|
(1,067 |
) |
(1,118 |
) |
||
Prepaid and other current assets |
|
(450 |
) |
299 |
|
||
Accounts payable and accrued liabilities |
|
(517 |
) |
358 |
|
||
Unearned revenue |
|
(4,158 |
) |
(3,035 |
) |
||
Other |
|
(255 |
) |
532 |
|
||
Net cash provided by operating activities |
|
3,561 |
|
4,413 |
|
||
|
|
|
|
|
|
||
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
||
Purchases of property and equipment |
|
(755 |
) |
(445 |
) |
||
Proceeds from sale of property and equipment |
|
|
|
1 |
|
||
Earnout payments from business combinations |
|
|
|
(24 |
) |
||
Reduction in restricted cash |
|
|
|
200 |
|
||
Net cash used in investing activities |
|
(755 |
) |
(268 |
) |
||
|
|
|
|
|
|
||
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
||
Capital lease payments |
|
(15 |
) |
(16 |
) |
||
Principal payments on long-term debt |
|
(7,798 |
) |
(1,641 |
) |
||
Proceeds from issuance of long-term debt |
|
4,000 |
|
|
|
||
Payments for debt issuance costs |
|
(347 |
) |
|
|
||
Proceeds from issuance of common stock |
|
56 |
|
71 |
|
||
Net cash used in financing activities |
|
(4,104 |
) |
(1,586 |
) |
||
|
|
|
|
|
|
||
Effect of foreign exchange rate changes on cash |
|
(344 |
) |
(28 |
) |
||
|
|
|
|
|
|
||
Net increase (decrease) in cash and cash equivalents |
|
(1,642 |
) |
2,531 |
|
||
Cash and cash equivalents at beginning of period |
|
7,271 |
|
5,076 |
|
||
Cash and cash equivalents at end of period |
|
$ |
5,629 |
|
$ |
7,607 |
|
|
|
|
|
|
|
||
Supplemental disclosure of other cash and non-cash transactions: |
|
|
|
|
|
||
Interest paid |
|
$ |
1,070 |
|
$ |
640 |
|
Income taxes paid |
|
$ |
354 |
|
$ |
79 |
|
Conversion of preferred stock into common stock |
|
$ |
5,587 |
|
$ |
5,389 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
EVOLVING SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
Organization We are a provider of software solutions and services to the wireless, wireline and IP carrier markets with long-standing relationships with many of the largest carriers worldwide. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (OSS). We offer software products and solutions in three core areas: service activation solutions used to activate complex bundles of voice, video and data services for traditional and next generation wireless and wireline networks; numbering solutions that enable carriers to comply with government-mandated requirements regarding number portability as well as providing phone number management and assignment capabilities; and mediation solutions supporting data collection for both service assurance and billing applications.
Interim Consolidated Financial Statements The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in our opinion, reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance with GAAP and SEC regulations for interim financial statements. The results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that we will have for any subsequent period. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2007 included in our Annual Report on Form 10-K.
Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires 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, as well as the reported amounts of revenue and expenses during the reporting period. We made estimates with respect to revenue recognition for estimated hours to complete projects accounted for using the percentage of completion method, allowance for doubtful accounts, income tax valuation allowance, fair values of long-lived assets, valuation of intangible assets and goodwill, useful lives for property, equipment and intangible assets, business combinations, capitalization of internal software development costs and fair value of stock-based compensation amounts. Actual results could differ from these estimates.
Foreign Currency Translation Our functional currency is the U.S. dollar. The functional currency of our foreign operations, generally, is the respective local currency for each foreign subsidiary. Assets and liabilities of foreign operations denominated in local currencies are translated at the spot rate in effect at the applicable reporting date. Our consolidated statements of operations are translated at the weighted average rate of exchange during the applicable period. The resulting unrealized cumulative translation adjustment, net of applicable income taxes, is recorded as a component of accumulated other comprehensive income (loss) in stockholders equity. Realized and unrealized transaction gains and losses generated by transactions denominated in a currency different from the functional currency of the applicable entity are recorded in other income (loss) in the period in which they occur.
Principles of Consolidation The consolidated financial statements include the accounts of Evolving Systems and subsidiaries, all of which are wholly owned. All significant intercompany transactions and balances have been eliminated in consolidation.
Goodwill Goodwill is the excess of acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired. Goodwill is not amortized, but tested for impairment annually or whenever indicators of impairment exist. These indicators may include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. For purposes of the goodwill evaluation, we compare the fair value of each of our reporting units to its respective carrying amount. If the carrying value of a reporting unit were to exceed its fair value, we would then compare the fair value of the reporting units goodwill to its carrying amount, and any excess of the carrying amount over the fair value would be charged to operations as an impairment loss.
Intangible Assets Amortizable intangible assets consist primarily of purchased software and licenses, customer contracts and relationships, trademark and tradenames, and business partnerships acquired in conjunction with our purchases of CMS Communications, Inc. (CMS), Telecom Software Enterprises, LLC (TSE) and Tertio Telecoms Ltd. (Evolving Systems U.K.). These finite life assets are amortized using the straight-line method over their estimated lives.
We assess the impairment of identifiable intangibles if events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Factors that we consider significant which could trigger an impairment analysis include the following:
7
· |
|
Significant under-performance relative to historical or projected future operating results; |
|
|
|
· |
|
Significant changes in the manner of use of the acquired assets or the strategy of the overall business; |
|
|
|
· |
|
Significant negative industry or economic trends; and/or |
|
|
|
· |
|
Significant decline in our stock price for a sustained period. |
If, as a result of the existence of one or more of the above indicators of impairment, we determine that the carrying value of intangibles and/or long-lived assets may not be recoverable, we compare the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition to the assets carrying amount. If an amortizable intangible or long-lived asset is not deemed to be recoverable, we will recognize an impairment loss representing the excess of the assets carrying value over its estimated fair value.
Revenue Recognition We recognize revenue from two primary sources: license fees and services, and customer support, in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended and interpreted by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, provides further interpretive guidance for public companies on the recognition, presentation and disclosure of revenue in financial statements. In addition to the criteria described below, we generally recognize revenue when an agreement is signed, the fee is fixed or determinable and collectibility is reasonably assured.
The majority of our license fees and services revenue is generated from fixed-price contracts, which provide for licenses to our software products and services to customize such software to meet our customers use. When the services are determined to be essential to the functionality of the delivered software, we recognize revenue using the percentage-of-completion method of accounting, in accordance with SOP 97-2 and SOP 81-1, Accounting for Long-Term Construction Type Contracts. The percentage of completion for each contract is estimated based on the ratio of direct labor hours incurred to total estimated direct labor hours. Since estimated direct labor hours, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and are reviewed regularly. Amounts billed in advance of services being performed are recorded as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected within 12 months.
We may encounter budget and schedule overruns or underuns on fixed price contracts caused by increased or decreased labor or overhead costs. Adjustments to cost estimates are made in the periods in which the facts requiring such revisions become known. Adjustments to revenue estimates are recorded in the period in which current estimates of total contract revenue and contract costs indicate a change is necessary.
In arrangements where services are not essential to the functionality of the software, we recognize license revenue upon delivery. To the extent that Vendor-Specific Objective Evidence (VSOE) of the fair value of undelivered elements exists, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered. If VSOE for the undelivered elements does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist on the undelivered elements or all of the elements have been delivered.
We recognize services revenue from fixed-price contracts using the proportional performance method of accounting, which is similar to the percentage of completion method described above. Revenue from professional services provided pursuant to time-and-materials based contracts and training services are recognized as the services are performed, as that is when our obligation to our customers under such arrangements is fulfilled.
We recognize customer support, including maintenance revenue, ratably over the service contract period. When maintenance is bundled with the original license fee arrangement, its fair value, based upon VSOE, is deferred and recognized during the periods when services are provided.
Stock-based Compensation We account for stock-based compensation under Statement of Financial Accounting Standards No. 123(Revised), Share-Based Payment (SFAS 123R). This statement replaced SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) and superseded APB Opinion No. 25, Accounting for Stock Issued to Employees. Under SFAS 123R, we apply a fair-value-based measurement method to account for share-based payment transactions with employees and directors and record compensation cost for all stock awards granted after January 1, 2006 and awards modified, repurchased, or cancelled after that date. In addition, we record compensation costs associated with the vesting of unvested options outstanding at January 1, 2006 using the guidance under SFAS 123. Stock-based compensation is a non-cash expense because we settle these obligations by issuing shares of our common stock instead of settling such obligations with cash payments. We recognized compensation cost for stock awards on a straight-line basis over the vesting period using an estimated forfeiture rate. Effective January 1, 2006, stock option grants, restricted stock grants, and employee stock purchase plan purchases were accounted for under SFAS 123R. We used the Black-Scholes model to estimate the fair value of each option grant on the date of grant. This model requires the use of estimates for expected term of the options and expected volatility of the price of our common stock.
8
Recent Accounting Pronouncements In December 2007, the SEC issued Staff Accounting Bulletin 110, Share-Based Payment (SAB 110), which amends Staff Accounting Bulleting 107 (SAB 107), Share-Based Payment, to permit public companies, under certain circumstances, to use the simplified method of SAB 107 for employee option grants after December 31, 2007. Use of the simplified method after December 31, 2007 is permitted only for companies whose historical data about their employees exercise behavior does not provide a reasonable basis for estimating the expected term of the options. We currently use the simplified method to estimate expected term for employee option grants as adequate historical experience is not available to provide a reasonable estimate. SAB 110 is effective for employee options granted after December 31, 2007. We adopted SAB 110 effective January 1, 2008 and will continue to apply the simplified method until adequate historical experience is readily available to provide a reasonable estimate of the expected term for employee option grants.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure eligible items at fair value at specific election dates (the fair value option). Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting period. This accounting standard is effective for us beginning January 1, 2008. We have elected not to apply the fair value option allowed under SFAS 159.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2008, the FASB issued Staff Position No. 157-2, which delayed the effective date of SFAS 157 to fiscal years ending after November 15, 2008 for non-financial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of SFAS 157 did not have a material effect on our consolidated financial statements.
NOTE 2 GOODWILL AND INTANGIBLE ASSETS
We recorded goodwill as a result of three acquisitions which occurred over the period from November 2003 to November 2004. We acquired CMS in November 2003, TSE in October 2004 and Evolving Systems U.K. in November 2004.
Changes in the carrying amount of goodwill by reporting unit were as follows (in thousands):
|
|
License and Services |
|
Customer Support |
|
Total |
|
|||||||||
|
|
U.S. |
|
U.K. |
|
U.S. |
|
U.K. |
|
Goodwill |
|
|||||
Balance as of December 31, 2007 |
|
$ |
|
|
$ |
9,118 |
|
$ |
6,033 |
|
$ |
11,266 |
|
$ |
26,417 |
|
Effects of changes in foreign currency exchange rates |
|
|
|
(819 |
) |
|
|
(1,012 |
) |
(1,831 |
) |
|||||
Balance as of September 30, 2008 |
|
$ |
|
|
$ |
8,299 |
|
$ |
6,033 |
|
$ |
10,254 |
|
$ |
24,586 |
|
We conducted our annual goodwill impairment test as of July 31, 2008, and we determined that goodwill was not impaired as of the test date. From July 31, 2008 through September 30, 2008, no events have occurred that we believe may have impaired goodwill.
Identifiable intangible assets are amortized on a straight-line basis over estimated lives ranging from one to seven years and include the cumulative effects of foreign currency exchange rates. As of September 30, 2008 and December 31, 2007, identifiable intangibles were as follows (in thousands):
|
|
September 30, 2008 |
|
December 31, 2007 |
|
Weighted- |
|
||||||||||||||
|
|
(1) |
|
Accumulated |
|
Net |
|
Gross |
|
Accumulated |
|
Net |
|
Average |
|
||||||
Purchased software |
|
$ |
1,912 |
|
$ |
972 |
|
$ |
940 |
|
$ |
2,072 |
|
$ |
700 |
|
$ |
1,372 |
|
4.7 yrs |
|
Purchased licenses |
|
227 |
|
218 |
|
9 |
|
227 |
|
146 |
|
81 |
|
2.3 yrs |
|
||||||
Trademarks and tradenames |
|
815 |
|
262 |
|
553 |
|
896 |
|
192 |
|
704 |
|
7.0 yrs |
|
||||||
Business partnerships |
|
133 |
|
60 |
|
73 |
|
146 |
|
44 |
|
102 |
|
5.0 yrs |
|
||||||
Customer relationships |
|
3,472 |
|
1,815 |
|
1,657 |
|
3,707 |
|
1,279 |
|
2,428 |
|
5.5 yrs |
|
||||||
|
|
$ |
6,559 |
|
$ |
3,327 |
|
$ |
3,232 |
|
$ |
7,048 |
|
$ |
2,361 |
|
$ |
4,687 |
|
5.3 yrs |
|
(1) Changes in intangible values as of September 30, 2008 compared to December 31, 2007 are the direct result of changes in foreign currency exchange rates for the periods then ended.
9
Amortization expense of identifiable intangible assets was $0.4 million and $1.1 million for the three and nine months ended September 30, 2008, respectively, and $0.4 million and $1.2 million for the three and nine months ended September 30, 2007. As Evolving Systems U.K. uses the Great British pound as its functional currency, the amount of future amortization actually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related to identifiable intangibles based on our carrying amount as of September 30, 2008 was as follows (in thousands):
Twelve months ending |
|
|
|
|
2009 |
|
$ |
901 |
|
2010 |
|
810 |
|
|
2011 |
|
720 |
|
|
2012 |
|
458 |
|
|
2013 |
|
343 |
|
|
Thereafter |
|
|
|
|
|
|
$ |
3,232 |
|
NOTE 3 EARNINGS PER COMMON SHARE
Basic earnings per share (EPS) is computed by dividing net income or loss available to common stockholders by the weighted average number of shares outstanding during the period, including common stock issuable under participating securities, such as the Series B Convertible Redeemable Preferred Stock (Series B Preferred Stock). Diluted EPS is computed using the weighted average number of shares outstanding, including participating securities, plus all potentially dilutive common stock equivalents. Common stock equivalents consist of stock options and shares held in escrow. The following is the reconciliation of the denominator of the basic and diluted EPS computations (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
Weighted average common shares outstanding |
|
19,386 |
|
17,686 |
|
19,209 |
|
17,349 |
|
Participating securities |
|
|
|
1,515 |
|
165 |
|
1,829 |
|
Basic weighted average shares outstanding |
|
19,386 |
|
19,201 |
|
19,374 |
|
19,178 |
|
Effect of dilutive securities |
|
360 |
|
349 |
|
435 |
|
368 |
|
Diluted weighted average common shares outstanding |
|
19,746 |
|
19,550 |
|
19,809 |
|
19,546 |
|
Weighted average options to purchase 3.7 million and 3.6 million shares of common stock were excluded from the dilutive stock calculation for the three and nine months ended September 30, 2008, respectively, because their exercise prices were greater than the average fair value of our common stock for those periods.
Weighted average options to purchase 3.5 million and 3.1 million shares of common stock were excluded from the dilutive stock calculation for the three and nine months ended September 30, 2007, respectively, because their exercise prices were greater than the average fair value of our common stock for those periods.
NOTE 4 SHARE-BASED COMPENSATION
We adopted SFAS 123R effective January 1, 2006 using the modified prospective method. We previously applied the intrinsic-value-based method in accounting for the recognition of stock-based compensation arrangements and the fair value method only for disclosure purposes. Our statements of operations from January 1, 2006 forward include charges for stock-based compensation. We recognized $0.2 million and $0.6 million of compensation expense in the consolidated statements of operations for the three and nine months ended September 30, 2008, respectively, with respect to our stock-based compensation plans. We recognized $0.2 million and $0.5 million of compensation expense in the consolidated statements of operations for the three and nine months ended September 30, 2007, respectively, with respect to our stock-based compensation plans. The following table summarizes stock-based compensation expenses recorded in the consolidated statements of operations (in thousands):
10
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
||||
Cost of license fee and services, excluding depreciation and amortization |
|
$ |
16 |
|
$ |
12 |
|
$ |
46 |
|
$ |
46 |
|
Cost of customer support, excluding depreciation and amortization |
|
1 |
|
1 |
|
5 |
|
|
|
||||
Sales and marketing |
|
18 |
|
40 |
|
101 |
|
108 |
|
||||
General and administrative |
|
133 |
|
103 |
|
431 |
|
371 |
|
||||
Product development |
|
21 |
|
6 |
|
62 |
|
18 |
|
||||
|
|
$ |
189 |
|
$ |
162 |
|
$ |
645 |
|
$ |
543 |
|
Stock Option/Incentive Plans
In January 1996, our stockholders approved an Amended and Restated Stock Option Plan (the Option Plan). Under the Option Plan, as amended, 8,350,000 shares were reserved for issuance. Options issued under the Option Plan were at the discretion of the Board of Directors, including the vesting provisions of each stock option granted. Options were granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant. The Option Plan terminated on January 18, 2006; options granted before that date were not affected by the plan termination. At September 30, 2008, 3,824,487 options remained outstanding under the Option Plan.
In March 2007, upon the hiring of our Vice President of World Wide Sales and Marketing, in accordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv), the board of directors approved an inducement award under a stand-alone equity incentive plan. We granted 100,000 non-qualified options to purchase shares of our common stock at an exercise price equal to the closing price of our common stock on the date of grant. The options vest over four years and expire ten years from the date of grant.
In June 2007, our stockholders approved the 2007 Stock Incentive Plan (the 2007 Stock Plan). A maximum of 2,000,000 shares may be issued under the 2007 Stock Plan. Awards permitted under the 2007 Stock Plan include: Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards and Other Stock-Based Awards. Awards issued under the 2007 Stock Plan are at the discretion of the Board of Directors. As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant.
In December 2007, under the 2007 Stock Plan, we awarded a total of 137,500 shares of restricted stock to members of our board of directors and senior management. The fair market value for share-based compensation expensing is equal to the closing price of our common stock on the date of grant. The restrictions on the stock award are released over four years for awards granted to employees and over one year for awards granted to members of the board of directors.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes model. The Black-Scholes model uses four assumptions to calculate the fair value of each option grant. The expected term of share options granted is derived using the simplified method as prescribed by the SEC Staff Accounting Bulletin 107 (SAB 107), Share-Based Payment. In January 2008, we adopted the provisions of Staff Accounting Bulletin 110, Share-Based Payment, which allows us to continue to calculate the expected term of share options granted using the simplified method as prescribed under SAB 107. The risk-free interest rate is based upon the rate currently available on zero-coupon U.S. Treasury instruments with a remaining term equal to the expected term of the stock options. The expected volatility is based upon historical volatility of our common stock over a period equal to the expected term of the stock options. The expected dividend yield is zero and is based upon historical and anticipated payment of dividends. The weighted-average assumptions used in the fair value calculations are as follows:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
Expected term (years) |
|
* |
|
6.1 |
|
6.2 |
|
6.2 |
|
Risk-free interest rate |
|
* |
|
4.69 |
% |
2.70 |
% |
4.70 |
% |
Expected volatility |
|
* |
|
107.18 |
% |
101.9 |
% |
107.68 |
% |
Expected dividend yield |
|
* |
|
0 |
% |
0 |
% |
0 |
% |
* None granted.
11
The following is a summary of stock option activity under the three stock incentive plans for the nine months ended September 30, 2008:
|
|
Number of |
|
Weighted- |
|
Weighted- |
|
Aggregate |
|
||
Options outstanding at December 31, 2007 |
|
4,534 |
|
$ |
3.02 |
|
|
|
|
|
|
Options granted |
|
80 |
|
$ |
2.06 |
|
|
|
|
|
|
Less options forfeited |
|
(69 |
) |
$ |
2.28 |
|
|
|
|
|
|
Less options expired |
|
(72 |
) |
$ |
4.53 |
|
|
|
|
|
|
Less options exercised |
|
(5 |
) |
$ |
0.76 |
|
|
|
|
|
|
Options outstanding at September 30, 2008 |
|
4,468 |
|
$ |
2.99 |
|
5.31 |
|
$ |
438 |
|
|
|
|
|
|
|
|
|
|
|
||
Options exercisable at September 30, 2008 |
|
3,719 |
|
$ |
3.16 |
|
4.68 |
|
$ |
438 |
|
The weighted-average grant-date fair value of stock options granted during the nine months ended September 30, 2008 was $1.67. No options were granted during the three months ended September 30, 2008.
As of September 30, 2008, there were approximately $1.4 million of total unrecognized compensation costs related to unvested stock options. These costs are expected to be recognized over a weighted average period of 1.3 years.
The total intrinsic value of stock option exercises for the three months ended September 30, 2008 and 2007 was $5,000 and $0, respectively. The total fair value of stock options vested during each of the three month periods ended September 30, 2008 and 2007 was $0.2 million.
The total intrinsic value of stock option exercises for the nine months ended September 30, 2008 and 2007 was $5,000 and $23,000, respectively. The total fair value of stock options vested during the nine months ended September 30, 2008 and 2007 was $0.7 million and $0.5 million, respectively.
The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $14,000 and $10,000 for the three months ended September 30, 2008 and 2007, respectively. The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $43,000 and $30,000 for the nine months ended September 30, 2008 and 2007, respectively.
Cash received from stock option exercises for the three months ended September 30, 2008 and 2007 was $4,000 and $0, respectively. Cash received from stock option exercises for the nine months ended September 30, 2008 and 2007 was $4,000 and $19,000, respectively.
Employee Stock Purchase Plan
Under the Employee Stock Purchase Plan (ESPP), we are authorized to issue up to 1,100,000 shares of our common stock to full-time employees, nearly all of whom are eligible to participate. Under the terms of the ESPP, employees may elect to have up to 15% of their gross compensation withheld through payroll deduction to purchase our common stock, capped at $25,000 annually. The purchase price of the stock is 85% of the lower of the closing price on the first day or the last day of each three-month participation period. As of September 30, 2008, there were 260,000 shares available for purchase. We recorded compensation expense of $6,000 for each of the three month periods ended September 30, 2008 and September 30, 2007 , and $17,000 for each of the nine month periods ended September 30, 2008 and September 30, 2007 associated with grants under the ESPP which includes the fair value of the look-back feature of each grant as well as the 15% discount on the purchase price.
The fair value of each grant made under our ESPP is estimated on the date of grant using the Black-Scholes model. The Black-Scholes model uses four assumptions to calculate the fair value of each option grant. The expected term of each grant is based upon the three-month participation period of each grant. The risk-free interest rate is based upon the rate currently available on zero-coupon U.S. Treasury instruments with a remaining term equal to the expected term of each grant. The expected volatility is based upon historical volatility of our common stock. The expected dividend yield is based upon historical and anticipated payment of dividends. The weighted average assumptions used in the fair value calculations are as follows:
12
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
Expected term (years) |
|
0.25 |
|
0.25 |
|
0.25 |
|
0.25 |
|
Risk-free interest rate |
|
1.15 |
% |
3.99 |
% |
1.40 |
% |
4.73 |
% |
Expected volatility |
|
65.87 |
% |
64.59 |
% |
68.22 |
% |
68.34 |
% |
Expected dividend yield |
|
0 |
% |
0 |
% |
0 |
% |
0 |
% |
Cash received from employee stock plan purchases for the three months ended September 30, 2008 and 2007 was approximately $16,000 and $19,000, respectively. Cash received from employee stock plan purchases for each of the nine months ended September 30, 2008 and 2007 was approximately $52,000.
NOTE 5 CONCENTRATION OF CREDIT RISK
For the three and nine months ended September 30, 2008, two significant customers (defined as contributing at least 10%) accounted for 33% (17% and 16%) and 29% (16% and 13%), respectively, of total revenue. These customers are large telecommunications operators located in the U.S. and U.K., respectively. For the three months ended September 30, 2007, three significant customers accounted for 44% (20%, 13%, and 11%) of total revenue. These customers are large telecommunications operators located in the U.S., U.K. and U.K., respectively. For the nine months ended September 30, 2007, two significant customers accounted for and 35% (21% and 14%) of total revenue. These customers are large telecommunications operators located in the U.S. and U.K., respectively.
As of September 30, 2008, three significant customers accounted for approximately 39% (16%, 13%, and 10%) of contract receivables. These customers are large telecommunications operators located in the U.K., Chile, and the U.S., respectively. At December 31, 2007, one significant customer accounted for approximately 42% of contract receivables. This customer is a large telecommunications operator located in the U.S.
NOTE 6 LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
|
|
September 30, |
|
December 31, |
|
||
|
|
2008 |
|
2007 |
|
||
Senior term loan with financial institution, interest at a fixed rate of 8.25%, principal installments and interest payments are due monthly with final maturity on February 22, 2010. The loan is secured by substantially all of our assets. |
|
$ |
2,833 |
|
$ |
|
|
|
|
|
|
|
|
|
|
Senior note payable to financial institution, interest at the one-month London InterBank Offered Rate (LIBOR) plus a margin of 5.25% at December 31, 2007; however, the LIBOR rate cannot be less than 3.75%, interest rate was 10.25% at December 31, 2007. In February 2008, this note payable was replaced by our new $4.0 million senior term loan. |
|
|
|
4,419 |
|
||
|
|
|
|
|
|
||
$4.5 million senior revolving credit facility payable to financial institution, interest at one-month LIBOR plus 4.0%; however, the LIBOR rate cannot be less than 3.75%; interest rate was 9.00% at December 31, 2007. In February 2008, this revolver was replaced with our $6.0 million senior revolving credit facilities. |
|
|
|
2,000 |
|
||
|
|
|
|
|
|
||
Long-term unsecured subordinated notes payable, interest ranges from 11-14% with a weighted average rate of 12.60% and 12.82% at September 30, 2008 and December 31, 2007, respectively, accrued interest and principal are due in full May 16, 2011. |
|
4,550 |
|
4,767 |
|
||
Total debt |
|
7,383 |
|
11,186 |
|
||
Less current portion |
|
(2,000 |
) |
(2,500 |
) |
||
Long-term debt, excluding current portion |
|
$ |
5,383 |
|
$ |
8,686 |
|
13
On February 22, 2008, we replaced our existing senior term note and senior revolving facility with a new $4.0 million senior term loan, a $1.0 million U.S. revolving credit facility (U.S. Revolving Facility) and a $5.0 million U.K. revolving credit facility (U.K. Revolving Facility).
We used proceeds from the $4.0 million senior term loan to pay down our existing senior term note balance of approximately $3.8 million. The $4.0 million senior term loan bears interest at a fixed rate of 8.25% and is payable in 24 equal monthly installments of principal, plus all accrued interest, beginning March 10, 2008, with final maturity on February 22, 2010. The senior term loan is secured by substantially all assets of Evolving Systems, Inc. and subjects us to certain affirmative and negative covenants, including financial covenants related to maintaining a specified ratio of debt to EBITDA, as defined, minimum EBITDA, minimum liquidity, and a specified fixed charge ratio.
The remaining scheduled principal payments as of September 30, 2008 on our senior term loan are as follows (in thousands):
Year ending December 31, |
|
|
|
|
2008 |
|
$ |
500 |
|
2009 |
|
2,000 |
|
|
2010 |
|
333 |
|
|
|
|
$ |
2,833 |
|
Additionally, we obtained a new $1.0 million U.S. Revolving Facility that bears interest at Prime Rate plus 0.5%. Prime Rate was 5.00% as of September 30, 2008. Borrowings under the senior revolving facilities are limited to a percentage of our eligible accounts receivable and cash. The U.S. Revolving Facility is secured by all assets of Evolving Systems, Inc. and is subject to the same covenants as the senior term loan. All accrued interest on outstanding borrowings under the U.S. Revolving Facility is paid monthly, with any outstanding balance due with a final maturity of February 22, 2011. As of September 30, 2008, we had $1.0 million in availability, but no borrowing outstanding under this U.S. Revolving Facility.
We also entered into a $5.0 million U.K. Revolving Facility that bears interest at Prime Rate plus 0.5%. Prime Rate was 5.00% as of September 30, 2008. Borrowings under the U.K. Revolving Facility are limited to a percentage of our eligible accounts receivable and cash. The U.K. Revolving Facility is secured by all assets of Evolving Systems Holdings Limited and Evolving Systems Limited and is subject to the same covenants as the Senior Term Loan. All accrued interest on outstanding borrowings under the Senior Revolving Facility is paid monthly, with any outstanding balance due with a final maturity of February 22, 2011. As of September 30, 2008, we had $4.7 million in availability, but no borrowing outstanding under this U.K. Revolving Facility,
In connection with the replacement of our existing senior term note and senior revolving facility with the new senior term loan and U.S. Revolving Facility and the U.K. Revolving Facility, we recorded a write-off of debt issuance costs associated with the retired senior debt of approximately $0.3 million. Additionally, we capitalized debt issuance costs related to our new senior debt of approximately $0.3 million. These newly capitalized debt issuance costs will be amortized over the term of the new senior debt.
On February 22, 2008, we paid $272,000 to retire $279,000 of subordinated debt and related accrued interest held by two of our subordinated note holders. The retirements included principal of $217,000 and accrued interest of $62,000. The $7,000 gain on extinguishment of this debt is reflected within our other income (expense) on the consolidated statements of operations. On February 22, 2008, we also paid $728,000 in accrued interest to the remaining subordinated note holders.
We were in compliance with all of our debt covenants as of September 30, 2008.
NOTE 7 INCOME TAXES
We recorded net income tax expense of $122,000 and $345,000 for the three months ended September 30, 2008 and 2007, respectively. The net expense during the three months ended September 30, 2008 consisted of current income tax expense of $186,000, partially offset by a deferred tax benefit of $64,000, both of which were primarily related to our U.K.-based operations. The net expense during the three months ended September 30, 2007 consisted of current income tax expense of $407,000, partially offset by a deferred tax benefit of $62,000, both of which were primarily related to our U.K.-based operations.
We recorded net income tax expense of $161,000 and $569,000 for the nine months ended September 30, 2008 and 2007, respectively. The net expense during the nine months ended September 30, 2008 consisted of current income tax expense of $367,000, partially offset by a deferred tax benefit of $206,000, both of which were primarily related to our U.K.-based operations. The net expense during the nine months ended September 30, 2007 consisted of current income tax expense of $670,000, partially offset by a deferred tax benefit of $101,000, both of which were primarily related to our U.K.-based operations.
14
Effective April 2007, our Indian subsidiary was subject to a 10% minimum alternative tax. This tax did not have a material impact on our results for the three and nine months ended September 30, 2008, and we do not expect this tax to have a material impact on future results.
In conjunction with the acquisition of Evolving Systems U.K., we recorded certain identifiable intangible assets. Since the amortization of these identifiable intangibles is not deductible for income tax purposes, we established a long-term deferred tax liability of $4.6 million at the acquisition date for the expected difference between what would be expensed for financial reporting purposes and what would be deductible for income tax purposes. As of September 30, 2008 and December 31, 2007, this component of the deferred tax liability was $0.9 million and $1.2 million, respectively. This deferred tax liability relates to Evolving Systems U.K., and has no impact on our ability to recover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized.
As of September 30, 2008 and December 31, 2007 we continued to maintain a full valuation allowance on the domestic net deferred tax asset as we have determined it is more likely than not that we will not realize our domestic deferred tax assets. Such assets primarily consist of certain net operating loss carryforwards. We assessed the realizability of our domestic deferred tax assets using all available evidence. In particular, we considered both historical results and projections of profitability for the reasonably foreseeable future periods. We are required to reassess our conclusions regarding the realization of our deferred tax assets at each financial reporting date. A future evaluation could result in a conclusion that all or a portion of the valuation allowance is no longer necessary which could have a material impact on our results of operations and financial position.
Effective January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. There was not a material impact on our consolidated financial position and results of operations as a result of the adoption of the provisions of FIN 48.
On January 1, 2007, we recorded a FIN 48 transition adjustment consisting of a $0.4 million decrease in our deferred tax assets related to Research and Development Tax Credits that was offset by a corresponding decrease in our valuation allowance because we determined that it was not more likely than not that our deferred tax assets will be realized. As of September 30, 2008 and December 31, 2007, we had no liability for unrecognized tax benefits. We do not believe there will be any material changes our unrecognized tax positions over the next twelve months.
We conduct business globally and, as a result, Evolving Systems, Inc. or one or more of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including the U.S., the U.K., Germany and India.
NOTE 8 STOCKHOLDERS EQUITY
On February 25, 2008, holders of 461,758 shares of Series B Preferred Stock with a carrying value of $5.4 million, or approximately 96% of the outstanding preferred stock, converted their shares of preferred stock into 1,385,274 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock. On March 19, 2008, a holder of 16,992 shares of Series B Preferred Stock with a carrying value of $0.2 million, which represented the remainder of the outstanding preferred stock, converted his shares of preferred stock into 50,976 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock. As we previously included the Series B Convertible Preferred Stock as a participating security for basic EPS purposes, these conversions did not change our basic or diluted EPS calculations.
NOTE 9 SEGMENT INFORMATION
In accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, we define operating segments as components of an enterprise for which separate financial information is reviewed regularly by the chief operating decision-making group to evaluate performance and to make operating decisions. We have identified our Chief Executive Officer and Chief Financial Officer as our chief operating decision-makers (CODM). These chief operating decision makers review revenues by segment and review overall results of operations.
We currently operate business as two operating segments based on revenue type: license fees and services revenue and customer support revenue (as shown on the consolidated statements of operations). License fees and services (L&S) revenue represents the fees received from the license of software products and those services directly related to the delivery of the licensed products, as well as fees for custom development, integration services and time and materials work. Customer support (CS) revenue includes annual support fees, recurring maintenance fees, fees for maintenance upgrades and warranty services. Warranty services that are similar to software maintenance services are typically bundled with a license sale. Total assets by segment have not been disclosed as the information is not available to the chief operating decision-making group.
15
Segment information is as follows (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
||||
Revenue |
|
|
|
|
|
|
|
|
|
||||
License fees and services |
|
$ |
4,539 |
|
$ |
4,692 |
|
$ |
14,713 |
|
$ |
13,425 |
|
Customer support |
|
4,490 |
|
4,619 |
|
13,088 |
|
13,468 |
|
||||
|
|
9,029 |
|
9,311 |
|
27,801 |
|
26,893 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Revenue less cost of revenue, excluding depreciation and amortization |
|
|
|
|
|
|
|
|
|
||||
License fees and services |
|
2,562 |
|
2,595 |
|
8,610 |
|
7,463 |
|
||||
Customer support |
|
2,909 |
|
3,087 |
|
8,382 |
|
8,727 |
|
||||
|
|
5,471 |
|
5,682 |
|
16,992 |
|
16,190 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Unallocated costs |
|
|
|
|
|
|
|
|
|
||||
Other operating expenses |
|
4,077 |
|
4,018 |
|
13,137 |
|
12,349 |
|
||||
Depreciation and amortization |
|
560 |
|
585 |
|
1,801 |
|
1,905 |
|
||||
Restructuring and other |
|
|
|
|
|
|
|
(1 |
) |
||||
Interest income |
|
(29 |
) |
(86 |
) |
(146 |
) |
(231 |
) |
||||
Interest expense |
|
278 |
|
419 |
|
897 |
|
1,334 |
|
||||
(Gain) loss on debt extinguishment |
|
|
|
|
|
290 |
|
(42 |
) |
||||
Foreign currency exchange gain |
|
(130 |
) |
(168 |
) |
(272 |
) |
(7 |
) |
||||
Income before income taxes |
|
$ |
715 |
|
$ |
914 |
|
$ |
1,285 |
|
$ |
883 |
|
Geographic Regions
We are headquartered in Englewood, a suburb of Denver, Colorado. We use customer locations as the basis for attributing revenues to individual countries. We provide products and services on a global basis through our headquarters and our London-based Evolving Systems U.K. subsidiary. Additionally, personnel in Bangalore, India provide software development services to our global operations. Financial information relating to operations by geographic region is as follows (in thousands):
|
|
Three Months Ended September 30, |
|
||||||||||||||||
|
|
2008 |
|
2007 |
|
||||||||||||||
|
|
L&S |
|
CS |
|
Total |
|
L&S |
|
CS |
|
Total |
|
||||||
Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
318 |
|
$ |
2,561 |
|
$ |
2,879 |
|
$ |
221 |
|
$ |
2,772 |
|
$ |
2,993 |
|
United Kingdom |
|
1,527 |
|
641 |
|
2,168 |
|
1,868 |
|
654 |
|
2,522 |
|
||||||
Other |
|
2,694 |
|
1,288 |
|
3,982 |
|
2,603 |
|
1,193 |
|
3,796 |
|
||||||
Total Revenue |
|
$ |
4,539 |
|
$ |
4,490 |
|
$ |
9,029 |
|
$ |
4,692 |
|
$ |
4,619 |
|
$ |
9,311 |
|
|
|
Nine Months Ended September 30, |
|
||||||||||||||||
|
|
2008 |
|
2007 |
|
||||||||||||||
|
|
L&S |
|
CS |
|
Total |
|
L&S |
|
CS |
|
Total |
|
||||||
Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
1,539 |
|
$ |
7,470 |
|
$ |
9,009 |
|
$ |
1,169 |
|
$ |
7,929 |
|
$ |
9,098 |
|
United Kingdom |
|
3,914 |
|
1,958 |
|
5,872 |
|
4,625 |
|
2,001 |
|
6,626 |
|
||||||
Other |
|
9,260 |
|
3,660 |
|
12,920 |
|
7,631 |
|
3,538 |
|
11,169 |
|
||||||
Total Revenue |
|
$ |
14,713 |
|
$ |
13,088 |
|
$ |
27,801 |
|
$ |
13,425 |
|
$ |
13,468 |
|
$ |
26,893 |
|
|
|
September 30, |
|
December 31, |
|
||
|
|
2008 |
|
2007 |
|
||
Long-lived assets, net |
|
|
|
|
|
||
United States |
|
$ |
7,134 |
|
$ |
7,814 |
|
United Kingdom |
|
21,971 |
|
24,883 |
|
||
Other |
|
77 |
|
84 |
|
||
Total long-lived assets, net |
|
$ |
29,182 |
|
$ |
32,781 |
|
16
Financial information relating to product groupings was as follows (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
||||
Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
Activation |
|
$ |
5,457 |
|
$ |
5,309 |
|
$ |
15,475 |
|
$ |
14,787 |
|
Numbering solutions |
|
2,825 |
|
2,678 |
|
9,249 |
|
8,759 |
|
||||
Mediation |
|
747 |
|
1,324 |
|
3,077 |
|
3,347 |
|
||||
|
|
$ |
9,029 |
|
$ |
9,311 |
|
$ |
27,801 |
|
$ |
26,893 |
|
NOTE 10 COMMITMENTS AND CONTINGENCIES
(a) Other Commitments
As permitted under Delaware law, we have agreements with officers and directors under which we agree to indemnify them for certain events or occurrences while the officer or director is, or was serving, at our request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments we could be required to make under these indemnification agreements; however, we maintain Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2008 or December 31, 2007.
We enter into standard indemnification terms with customers and suppliers, as discussed below, in the ordinary course of business. As we may subcontract the development of deliverables under customer contracts, we could be required to indemnify customers for work performed by subcontractors. Depending upon the nature of the customer indemnification, the potential amount of future payments we could be required to make under these indemnification agreements may be unlimited. We may be able to recover damages from a subcontractor if the indemnification to customers results from the subcontractors failure to perform. To the extent we are unable to recover damages from a subcontractor, we could be required to reimburse the indemnified party for the full amount. We have never incurred costs to defend lawsuits or settle claims relating to indemnification arising out of subcontractors failure to perform. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2008 or December 31, 2007.
Our standard license agreements contain product warranties that the software will be free of material defects and will operate in accordance with the stated requirements for a limited period of time. The product warranty provisions require us to cure any defects through any reasonable means. We believe the estimated fair value of the product warranty provisions in the license agreements in place with our customers is minimal. Accordingly, there were no liabilities recorded for these product warranty provisions as of September 30, 2008 or December 31, 2007.
Our software arrangements generally include a product indemnification provision whereby we will indemnify and defend a customer in actions brought against the customer for claims that our products infringe upon a copyright, trade secret, or valid patent. We have not historically incurred any significant costs related to product indemnification claims. Accordingly, there were no liabilities recorded for these indemnification provisions as of September 30, 2008 or December 31, 2007.
In relation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreed to indemnify certain parties from any losses, actions, claims, damages or liabilities (or actions in respect thereof) resulting from any claim raised by a third party. We do not believe that there will be any claims related to these indemnifications. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2008 or December 31, 2007.
(b) Litigation
During the fourth quarter of 2006, a previous vendor filed a complaint in the Superior Court of New Jersey against us asserting we breached certain provisions of a license agreement. While the outcome of this matter is uncertain, we believe we have paid all fees due under our license agreement and we are vigorously defending this claim.
We are involved in various other legal matters arising in the normal course of business. Losses, including estimated costs to defend, were recorded for these matters to the extent they were probable of loss and the amount of loss could be reasonably estimated.
NOTE 11 RELATED PARTY TRANSACTIONS
Effective January 1, 2008, we entered into a consulting agreement with Stephen K. Gartside, Jr., our previous President and CEO and current Chairman of the Board. Under the agreement, we will pay Mr. Gartside a fee of $20,000 for consulting services provided to us during 2008. We had current obligations in the consolidated balance sheets, under the agreement, of $5,000 and $0 as of September 30, 2008 and December 31, 2007, respectively. We recorded $5,000 and $0 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three months ended September 30, 2008 and 2007, respectively.
17
We recorded $15,000 and $0 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the nine months ended September 30, 2008 and 2007, respectively.
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about Evolving Systems industry, managements beliefs, and certain assumptions made by management. Forward-looking statements include our expectations regarding product, services, and maintenance revenue, annual savings associated with the organizational changes effected in prior years, and short- and long-term cash needs. In some cases, words such as anticipates, expects, intends, plans, believes, estimates, variations of these words, and similar expressions are intended to identify forward-looking statements. The statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any forward-looking statements. Risks and uncertainties of our business include those set forth in our Annual Report on Form 10-K for the year ended December 31, 2007 under Item 1A. Risk Factors as well as additional risks described in this Form 10-Q. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. However, readers should carefully review the risk factors set forth in other reports or documents we file from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
OVERVIEW
We are a worldwide provider of software solutions and services to telecommunications carriers, with more than 70 network operators in over 40 countries. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (OSS). Our Tertio solution is a leading packaged solution for service activation in the wireless industry.
We recognize revenue in accordance with the prescribed accounting standards for software revenue recognition under generally accepted accounting principles. Our license fees and services revenues fluctuate from period to period as a result of the timing of revenue recognition on existing projects.
18
RESULTS OF OPERATIONS
The following table presents the unaudited consolidated statements of operations reflected as a percentage of total revenue.
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
REVENUE |
|
|
|
|
|
|
|
|
|
License fees and services |
|
50 |
% |
50 |
% |
53 |
% |
50 |
% |
Customer support |
|
50 |
% |
50 |
% |
47 |
% |
50 |
% |
Total revenue |
|
100 |
% |
100 |
% |
100 |
% |
100 |
% |
|
|
|
|
|
|
|
|
|
|
COSTS OF REVENUE AND OPERATING EXPENSES |
|
|
|
|
|
|
|
|
|
Costs of license fees and services, excluding depreciation and amortization |
|
22 |
% |
23 |
% |
22 |
% |
22 |
% |
Costs of customer support, excluding depreciation and amortization |
|
18 |
% |
16 |
% |
17 |
% |
18 |
% |
Sales and marketing |
|
22 |
% |
22 |
% |
23 |
% |
23 |
% |
General and administrative |
|
14 |
% |
14 |
% |
14 |
% |
17 |
% |
Product development |
|
9 |
% |
7 |
% |
10 |
% |
6 |
% |
Depreciation |
|
2 |
% |
2 |
% |
3 |
% |
3 |
% |
Amortization |
|
4 |
% |
4 |
% |
4 |
% |
4 |
% |
Restructuring and other |
|
|
% |
|
% |
|
% |
|
% |
Total costs of revenue and operating expenses |
|
91 |
% |
88 |
% |
93 |
% |
93 |
% |
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
9 |
% |
12 |
% |
7 |
% |
7 |
% |
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
% |
1 |
% |
1 |
% |
1 |
% |
Interest expense |
|
(3 |
)% |
(5 |
)% |
(3 |
)% |
(5 |
)% |
Loss on debt extinguishment |
|
|
% |
|
% |
(1 |
)% |
|
% |
Foreign currency exchange gain |
|
2 |
% |
2 |
% |
1 |
% |
|
% |
Other expense, net |
|
(1 |
)% |
(2 |
)% |
(2 |
)% |
(4 |
)% |
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
8 |
% |
10 |
% |
5 |
% |
3 |
% |
|
|
|
|
|
|
|
|
|
|
Income tax expense |
|
1 |
% |
4 |
% |
1 |
% |
2 |
% |
|
|
|
|
|
|
|
|
|
|
Net income |
|
7 |
% |
6 |
% |
4 |
% |
1 |
% |
Revenue
Revenue is comprised of license fees/services and customer support. License fees and services revenue represent the fees we receive from the licensing of our software products and those services directly related to the delivery of the licensed product as well as integration services and time and materials work. Customer support revenue includes annual support, recurring maintenance, maintenance upgrades and warranty services. Warranty services consist of maintenance services and are typically bundled with a license sale and the related revenue, based on Vendor-Specific Objective Evidence (VSOE), is deferred and recognized ratably over the warranty period. The following table presents our revenue by product group (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
||||
Activation |
|
$ |
5,457 |
|
$ |
5,309 |
|
$ |
15,475 |
|
$ |
14,787 |
|
Numbering solutions |
|
2,825 |
|
2,678 |
|
9,249 |
|
8,759 |
|
||||
Mediation |
|
747 |
|
1,324 |
|
3,077 |
|
3,347 |
|
||||
|
|
$ |
9,029 |
|
$ |
9,311 |
|
$ |
27,801 |
|
$ |
26,893 |
|
19
License Fees and Services
License fees and services revenue decreased 3%, or $0.2 million, to $4.5 million for the three months ended September 30, 2008 from $4.7 million for the three months ended September 30, 2007. This decrease in license fees and services revenue was composed of a $0.5 million decrease in revenue from our mediation products, partially offset by an increase of $0.2 million in revenue from our numbering solutions products and an increase of $0.1 million in revenue from our activation products. The decrease in our mediation product revenue is the result of a decline in sales to our existing customer base. The increase in our numbering solutions product revenue is the result of our expansion into international markets with our NumeriTrack® and our Dynamic SIM Allocation solutions. Our Dynamic SIM Allocation solution uses core technology from both our service activation products and our numbering solutions NumeriTrack product. When reporting revenue results we apportion the revenue associated with Dynamic SIM Allocation solution evenly across our activation and numbering solutions product revenue groups. The increase in our activation product revenue is the result of growth in the activation customer account base as well as to revenue from our Dynamic SIM Allocation solution.
License fees and services revenue increased 10%, or $1.3 million, to $14.7 million for the nine months ended September 30, 2008 from $13.4 million for the nine months ended September 30, 2007. This increase in license fees and services revenue was composed of an increase of $0.6 million in revenue from our activation products, an increase of $0.6 million in revenue from our numbering solutions products and an increase of $0.1 million in revenue from our mediation products. The increase in our activation product revenue is the result of growth in the activation customer account base as well as to revenue from our Dynamic SIM Allocation solution. The increase in our numbering solutions product revenue is the result of our expansion into international markets with our NumeriTrack and our Dynamic SIM Allocation solutions. The increase in our mediation product revenue is the result of follow on sales from our existing mediation account base.
Customer Support
Customer support revenue decreased $0.1 million, or 3%, to $4.5 million for the three months ended September 30, 2008 from $4.6 million for the three months ended September 30, 2007. The decrease in customer support revenue resulted from a decrease of $0.1 million in our numbering solutions customer support revenue and a decrease of $0.1 million in our mediation customer support revenue, partially offset by an increase of $0.1 million in activation customer support revenue. The decrease in numbering solutions customer support revenue is due to a decline in the numbering solutions support account base. The decrease in mediation customer support revenue is the result of a decline in our network mediation account base. The increase in activation customer support revenue is due to new customer sales.
Customer support revenue decreased $0.4 million, or 3%, to $13.1 million for the nine months ended September 30, 2008 from $13.5 million for the nine months ended September 30, 2007. The decrease in customer support revenue resulted from a decrease of $0.3 million in our mediation products customer support revenue and a decrease of $0.1 million in numbering solutions customer support revenue. The decrease in mediation customer support revenue is the result of a decline in our network mediation account base.
Costs of Revenue, Excluding Depreciation and Amortization
Costs of revenue, excluding depreciation and amortization, consist primarily of personnel costs and other direct costs associated with these personnel, facilities costs, cost of third-party software and partner commissions. Costs of revenue, excluding depreciation and amortization, were $3.6 million for each of the three month periods ended September 30, 2008 and 2007. Costs of revenue, excluding depreciation and amortization, were $10.8 million and $10.7 million for the nine months ended September 30, 2008 and 2007, respectively. These costs are discussed further below.
Costs of License Fees and Services, Excluding Depreciation and Amortization
Costs of license fees and services, excluding depreciation and amortization, decreased $0.1 million, or 6%, to $2.0 million for the three months ended September 30, 2008 from $2.1 million for the three months ended September 30, 2007. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 44% for the three months ended September 30, 2008 from 45% for the three months ended September 30, 2007. These decreases are due to lower costs needed to support lower customer support revenue.
Costs of license fees and services, excluding depreciation and amortization, increased $0.1 million, or 2%, to $6.1 million for the nine months ended September 30, 2008 from $6.0 million for the nine months ended September 30, 2007. The increase in costs is attributed to increased customer support revenues and to the higher cost of international business. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 42% for the nine months ended September 30, 2008 from 44% for the nine months ended September 30, 2007, due to the increased utilization of our lower cost offshore development resources in India.
Costs of Customer Support, Excluding Depreciation and Amortization
Costs of customer support, excluding depreciation and amortization, increased $0.1 million, or 3%, to $1.6 million for the three months ended September 30, 2008 from $1.5 million for the three months ended September 30, 2007. As a percentage of
20
customer support revenue, costs of customer support revenue, excluding depreciation and amortization, increased to 35% for the three months ended September 30, 2008 from 33% for the three months ended September 30, 2007. These increases are due to increased employee efforts needed to support the existing and new customer account base.
Costs of customer support, excluding depreciation and amortization, remained constant at $4.7 million for each of the nine month periods ended September 30, 2008 and 2007. As a percentage of customer support revenue, costs of customer support revenue, excluding depreciation and amortization, increased to 36% for the nine months ended September 30, 2008 from 35% for the nine months ended September 30, 2007. This percentage increase is due to increased employee efforts needed to support the existing and new customer account base.
Sales and Marketing
Sales and marketing expenses primarily consist of compensation costs, including bonuses and commissions, travel expenses, advertising, marketing and facilities expenses. Sales and marketing expenses remained constant at $2.0 million for each of the three month periods ended September 30, 2008 and 2007. As a percentage of total revenue, sales and marketing expenses remained constant at 22% for each of the three month periods ended September 30, 2008 and 2007.
Sales and marketing expenses increased $0.2 million, or 3%, to $6.4 million for the nine months ended September 30, 2008 from $6.2 million for the nine months ended September 30, 2007. As a percentage of total revenue, sales and marketing expenses remained constant at 23% for each of the nine month periods ended September 30, 2008 and 2007. The increase in the expense base is the result of increased travel costs associated with our expansion into new international markets, as well as to higher incentive compensation related to our improved financial results.
General and Administrative
General and administrative expenses consist principally of employee related costs and professional fees for the following departments: facilities, finance, legal, human resources, and certain executive management. General and administrative expenses decreased $0.1 million, or 5%, to $1.3 million from $1.4 million for the three months ended September 30, 2008 and 2007, respectively. This decrease was a result of decreased professional fees. As a percentage of total revenue, general and administrative expenses remained constant for the three months ended September 30, 2008 and 2007 at 14%.
General and administrative expenses decreased $0.6 million, or 13%, to $3.9 million from $4.5 million for the nine months ended September 30, 2008 and 2007, respectively. As a percentage of total revenue, general and administrative expenses for the nine months ended September 30, 2008 and 2007, decreased to 14% from 17%, respectively. These decreases were a result of decreased professional fees as well as to lower landlord costs related to our headquarters facility lease.
Product Development
Product development expenses consist primarily of employee related costs and subcontractor expenses. Product development expenses increased $0.1 million, or 19%, to $0.8 million from $0.7 million for the three months ended September 30, 2008 and 2007, respectively. As a percentage of revenue, product development expenses for the three months ended September 30, 2008 and 2007, increased to 9% from 7%, respectively. These increases are the result of increased investments made in our activation products, including, the development of Tertio Service Verification and Tertio Service Activation. In addition, we have invested in the development of our Dynamic SIM Allocation product.
Product development expenses increased $1.2 million, or 79%, to $2.8 million from $1.6 million for the nine months ended September 30, 2008 and 2007, respectively. As a percentage of revenue, product development expenses for the nine months ended September 30, 2008 and 2007, increased to 10% from 6%, respectively. These increases are the result of increased investments made in our activation products, including, but not limited to, the development of our Tertio Service Verification, Tertio Service Activation and Tertio Process Management products. In addition, we have invested in the development of our Dynamic SIM Allocation product.
Depreciation
Depreciation expense consists of depreciation of long-lived property and equipment. Depreciation expense was $0.2 million for each of the three month periods ended September 30, 2008 and 2007, respectively, and $0.7 million for each of the nine month periods ended September 30, 2008 and 2007, respectively.
Amortization
Amortization expense consists of amortization of identifiable intangible assets acquired through our acquisitions of CMS, TSE and Evolving Systems U.K. Amortization expense remained constant at $0.4 million for each of the three month periods ended September 30, 2008 and 2007.
Amortization expense decreased $0.1 million, or 4%, to $1.1 million from $1.2 million for the nine months ended September 30, 2008 and 2007, respectively. This decrease was primarily the result of certain intangible assets reaching their end of life.
21
Interest Expense
Interest expense includes interest expense on our long-term debt and capital lease obligations as well as amortization of debt issuance costs. Interest expense was $0.3 million and $0.4 million for the three months ended September 30, 2008 and 2007, respectively, and interest expense was $0.9 million and $1.3 million for the nine months ended September 30, 2008 and 2007, respectively. These decreases of $0.1 million and $0.4 million, for the three and nine months ended September 30, 2008, respectively, were the result of reduced levels of debt and to lower interest rates on our senior debt.
Gain (Loss) on Debt Extinguishment
In February 2008, we wrote-off the remaining debt issuance costs of $297,000 related to our senior term note payable that was replaced during the three months ended March 31, 2008. This loss related to the debt issuance cost write-off was partially offset by a $7,000 gain resulting from us paying $272,000 to retire $279,000 of subordinated debt and related accrued interest held by two of our subordinated note holders. The retirements included principal of $217,000 and accrued interest of $62,000.
In March 2007, we paid $77,000 to retire $119,000 of subordinated debt and related accrued interest held by one of our subordinated note holders, resulting in a $42,000 gain on debt extinguishment. The retired debt included principal of $103,000 and accrued interest of $16,000.
Foreign Currency Exchange Gain
Foreign currency transaction gains resulted from transactions denominated in a currency other than the functional currency of the respective subsidiary and were $130,000 and $168,000 for the three months ended September 30, 2008 and 2007, respectively, and $272,000 and $7,000 for the nine months ended September 30, 2008 and 2007, respectively. The gains were generated primarily through the remeasurement of certain non-functional currency denominated financial assets and liabilities of our Evolving Systems U.K. subsidiary.
Income Taxes
We recorded net income tax expense of $122,000 and $345,000 for the three months ended September 30, 2008 and 2007, respectively. The net expense during the three months ended September 30, 2008 consisted of current income tax expense of $186,000, partially offset by a deferred tax benefit of $64,000, both of which were primarily related to our U.K.-based operations. The net expense during the three months ended September 30, 2007 consisted of current income tax expense of $407,000, partially offset by a deferred tax benefit of $62,000, both of which were primarily related to our U.K.-based operations. Our effective tax rate of 17% for the three months ended September 30, 2008 was down from an effective rate of 38% for the three months ended September 30, 2007. This reduction in our effective tax rate relates to a change in earnings mix amongst our tax jurisdictions. We also had an increased benefit from research and development tax credits for our U.K.-based operations. Additionally, the U.K. corporate tax rate decreased from 30% to 28% effective April 1, 2008.
We recorded net income tax expense of $161,000 and $569,000 for the nine months ended September 30, 2008 and 2007, respectively. The net expense during the nine months ended September 30, 2008 consisted of current income tax expense of $367,000, partially offset by a deferred tax benefit of $206,000, both of which were primarily related to our U.K.-based operations. The net expense during the nine months ended September 30, 2007 consisted of current income tax expense of $670,000, partially offset by a deferred tax benefit of $101,000, both of which were primarily related to our U.K.-based operations. Our effective tax rate of 13% for the nine months ended September 30, 2008 was down from an effective rate of 64% for the nine months ended September 30, 2007. This reduction in our effective tax rate relates to a change in earnings mix amongst our tax jurisdictions. We also had an increased benefit from research and development tax credits for our U.K.-based operations. Additionally, the U.K. corporate tax rate decreased from 30% to 28% effective April 1, 2008.
In conjunction with the acquisition of Evolving Systems U.K., we recorded certain identifiable intangible assets. Since the amortization of these identifiable intangibles is not deductible for income tax purposes, we established a long-term deferred tax liability of $4.6 million at the acquisition date for the expected difference between what would be expensed for financial reporting purposes and what would be deductible for income tax purposes. As of September 30, 2008 and December 31, 2007, this component of the deferred tax liability was $0.9 million and $1.2 million, respectively. This deferred tax liability relates to Evolving Systems U.K., and has no impact on our ability to recover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized.
FINANCIAL CONDITION
Our working capital position decreased $0.8 million to $0.6 million as of September 30, 2008 from $1.4 million as of December 31, 2007. The decrease in our working capital position is primarily attributable to $3.0 million in existing cash used to retire our $2.0 million revolving credit facility and to retire $1.0 million related to our subordinated notes, including accrued non-current interest. These debt payments were unscheduled payments and reduced balances classified as long-term as of December 31, 2007. This decrease in our working capital position due to early debt payments and capital expenditures was partially offset by cash received as part of our debt refinance of $4.0 million, of which $2.0 million is classified as current. See also, Liquidity and Capital
22
Resources, for further discussion of our working capital.
CONTRACTUAL OBLIGATIONS
There have been no material changes to the contractual obligations as disclosed in our 2007 Annual Report on Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed operations through cash flows from operations as well as debt and equity transactions. At September 30, 2008, our principal source of liquidity was $5.6 million in cash and cash equivalents as well as $5.7 million available under our revolving lines of credit. The following table summarizes our statements of cash flows (in thousands):
|
|
Nine Months Ended |
|
||||
|
|
2008 |
|
2007 |
|
||
Cash provided (used) by: |
|
|
|
|
|
||
Operating activities |
|
$ |
3,287 |
|
$ |
4,413 |
|
Investing activities |
|
(481 |
) |
(268 |
) |
||
Financing activities |
|
(4,105 |
) |
(1,586 |
) |
||
Effect of exchange rates |
|
(343 |
) |
(28 |
) |
||
Net cash provided (used) |
|
$ |
(1,642 |
) |
$ |
2,531 |
|
Net cash provided by operating activities for the nine months ended September 30, 2008 and 2007 was $3.3 million and $4.4 million, respectively. This $1.1 million decrease in cash provided by operating activities is primarily attributable to $0.8 million in unscheduled interest payments made on our subordinated notes during the nine months ended September 30, 2008.
Net cash used by investing activities for the nine months ended September 30, 2008 and 2007 was $0.5 million and $0.3 million. The cash used for the nine months ended September 30, 2008 related entirely to purchases of property and equipment of $0.5 million. The cash used for the nine months ended September 30, 2007 related primarily to purchases of property and equipment of $0.5 million, partially offset by reductions in restricted cash of $0.2 million.
Net cash used in financing activities for the nine months ended September 30, 2008 and 2007 was $4.1 million and $1.6 million, respectively. Financing activities for the nine months ended September 30, 2008 consisted of principal payments on existing debt of approximately $7.8 million, partially offset by borrowings related to our new senior term loan of approximately $3.7 million, net of issuance costs. Financing activities in the nine months ended September 30, 2007 consisted of principal payments on notes payable of $1.6 million.
We believe that our current cash and cash equivalents, together with anticipated cash flow from operations and availability under our revolving lines of credit will be sufficient to meet our working capital, capital expenditure and financing requirements for at least the next twelve months. In making this assessment we considered the following:
· Our cash and cash equivalents balance at September 30, 2008 of $5.6 million;
· The availability under our revolving credit facilities of $5.7 million at September 30, 2008;
· Our demonstrated ability to generate positive cash flows from operations;
· Our backlog as of September 30, 2008 of approximately $13.7 million, including $6.5 million in license fees and services and $7.2 million in customer support;
· Our planned capital expenditures; and
· Our cash forecast which indicates that we will have sufficient liquidity to cover anticipated operating costs and capital expenditures as well as debt service payments.
We are exposed to foreign currency rate risks which impact the carrying amount of our foreign subsidiaries and our consolidated equity, as well as our consolidated cash position due to translation adjustments. For the nine months ended September 30, 2008, the effect of exchange rate changes resulted in a $344,000 decrease to consolidated cash. During the nine months ended September 30, 2007, the effect of exchange rate changes resulted in a $28,000 decrease in consolidated cash. We do not currently hedge our foreign currency exposure, but we monitor rate changes and may hedge our exposures if we see significant negative trends in exchange rates.
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OFF-BALANCE SHEET ARRANGEMENTS
We have no off-balance sheet arrangements that have a material current effect or that are reasonably likely to have a material future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES
In the ordinary course of business, we are exposed to certain market risks, including changes in interest rates and foreign currency exchange rates. Uncertainties that are either non-financial or non-quantifiable such as political, economic, tax, other regulatory, or credit risks are not included in the following assessment of market risks.
Interest Rate Risks
Our cash balances are subject to interest rate fluctuations and as a result, interest income amounts may fluctuate from current levels. We are exposed to interest rate risk related to our senior revolving credit facilities entered into in February 2008. These obligations are variable interest rate notes based on Prime Rate. Fluctuations in Prime Rate affect our interest rates.
Foreign Currency Risk
We are exposed to favorable and unfavorable fluctuations of the U.S. dollar (our functional currency) against the currencies of our operating subsidiaries. Any increase (decrease) in the value of the U.S. dollar against any foreign currency that is the functional currency of one of our operating subsidiaries will cause the parent company to experience unrealized foreign currency translation losses (gains) with respect to amounts already invested in such foreign currencies. In addition, we and our operating subsidiaries are exposed to foreign currency risk to the extent that we enter into transactions denominated in currencies other than our respective functional currencies, such as accounts receivable (including intercompany amounts) that are denominated in a currency other than their own functional currency. Changes in exchange rates with respect to these items will result in unrealized (based upon period-end exchange rates) or realized foreign currency transaction gains and losses upon settlement of the transactions. In addition, we are exposed to foreign exchange rate fluctuations related to our operating subsidiaries monetary assets and liabilities and the financial results of foreign subsidiaries and affiliates when their respective financial statements are translated into U.S. dollars for inclusion in our consolidated financial statements. Cumulative translation adjustments are recorded in accumulated other comprehensive income (loss) as a separate component of equity. As a result of foreign currency risk, we have and may continue to experience economic loss and negative impacts on earnings and equity with respect to our holdings solely as a result of foreign currency exchange rate fluctuations.
The relationship between the Great British pound, Indian rupee and the U.S. dollar, which is our functional currency, is shown below, per one U.S. dollar:
Spot rates: |
|
September 30, |
|
December 31, 2007 |
|
Great British Pound |
|
0.55038 |
|
0.50092 |
|
Indian Rupee |
|
47.25898 |
|
39.43218 |
|
|
|
Three months ended |
|
Nine months ended |
|
||||
Average rates: |
|
September 30, |
|
September 30, |
|
September 30, |
|
September 30, |
|
Great British Pound |
|
0.52865 |
|
0.49494 |
|
0.51390 |
|
0.50352 |
|
Indian Rupee |
|
43.72414 |
|
40.52512 |
|
41.62863 |
|
41.91718 |
|
At the present time, we do not hedge our foreign currency exposure or use derivative financial instruments that are designed to reduce our long-term exposure to foreign currency exchange risk. To the extent that translation and transaction gain and losses become significant, we will consider various options to reduce this risk.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act), that are designed to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
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Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of such period.
In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
During the three and nine months ended September 30, 2008, there were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) or in other factors that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
During the fourth quarter of 2006, a previous vendor filed a complaint in the Superior Court of New Jersey against us asserting we breached certain provisions of a license agreement. While the outcome of this matter is uncertain, we believe we have paid all fees due under our license agreement and we are vigorously defending this claim.
We are involved in various other legal matters arising in the normal course of business. Losses, including estimated costs to defend, were recorded for these matters to the extent they were probable of loss and the amount of loss could be reasonably estimated.
This Quarterly Report on Form 10-Q should be read in conjunction with the risk factors defined in our Annual Report on Form 10-K for the year ended December 31, 2007 under Item 1A. Risk Factors.
The Current Economic Environment and Fluctuations in Currency Exchange Rates Could Adversely Impact Our Business.
In recent months, domestic and global economies have experienced significant difficulties within the financial and credit markets, and these adverse economic conditions are predicted to continue into the foreseeable future. The current unfavorable economic conditions as well as fluctuations in currency exchange rates could adversely affect our business, financial condition, operating results and cash flows. Because of the severity and the far-reaching impacts of the situation, all companies could be adversely affected by the current economic conditions to a certain degree, including us and our customers. There can be no assurances regarding the performance of our business, and the potential impact to our customers and the markets they serve, resulting from the current economic conditions.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
None
(a) Exhibits
Exhibit 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
25
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.
Date: November 12, 2008 |
/s/ BRIAN R. ERVINE |
|
Brian R. Ervine |
|
Executive Vice President, Chief |
|
Financial and Administrative Officer, |
|
Treasurer and Assistant Secretary |
|
(Principal Financial and Accounting Officer) |
26