Symbolic Logic (EVOL) 10-Q 2001 Q3 Quarterly report

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EVOLVING SYSTEMS, INC.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)

/x/
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2001

OR

/ / 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	84-1010843
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
9777 Mt. Pyramid Court, Englewood, Colorado	80112
(Address of Principal Executive Offices)	(Zip Code)

(303) 802-1000
(Registrant's Telephone Number, Including Area Code)

    Indicate by check 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 filed such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes /x/  No / /

    As of October 31, 2001, there were outstanding 13,187,824 shares of Registrant's Common Stock (par value $0.001 per share).

EVOLVING SYSTEMS, INC.

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Balance Sheets September 30, 2001 and December 31, 2000 (unaudited)
	Statements of Operations for the three-month and nine-month periods ended September 30, 2001 and September 30, 2000 (unaudited)
	Condensed Statements of Cash Flow for the nine-month periods ended September 30, 2001 and September 30, 2000 (unaudited)
	Notes to Financial Statements (unaudited)
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities
Item 3.	Defaults on Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EVOLVING SYSTEMS, INC.

BALANCE SHEETS

(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

(unaudited)

				September 30, 2001			Dec. 31, 2000
ASSETS
Current assets:
	Cash and cash equivalents			$	7,250		$	4,382
	Short-term investments				0			5,931
	Contract receivables, net of allowance for doubtful accounts of $344 and $643 as of September 30, 2001 and December 31, 2000, respectively				11,770			15,202
	Unbilled work-in-progress				9,976			14,110
	Prepaid and other current assets				1,307			1,622
		Total current assets			30,303			41,247
Property and equipment, net					4,913			5,141
Long-term prepaids					305			0
Deferred tax assets					0			1,547
			Total assets	$	35,521		$	47,935
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term obligations			$	28		$	163
	Accounts payable and accrued liabilities				4,685			5,054
	Unearned revenue and customer deposits				3,751			5,880
		Total current liabilities			8,464			11,097
Long-term obligations					123			0
Stockholders' equity:
	Preferred stock, $.001 par value, 2,000,000 shares authorized, no shares issued				—			—
	Common stock, $.001 par value; 25,000,000 shares authorized; 13,187,824 and 12,950,620 shares issued and outstanding as of September 30, 2001 and December 31, 2000, respectively				13			13
	Additional paid-in-capital				53,552			53,063
	Deferred compensation				0			(37	)
	Accumulated deficit				(26,631	)		(16,201	)
			Total stockholders' equity		26,934			36,838
			Total liabilities and stockholders' equity	$	35,521		$	47,935

The accompanying notes are an integral part of the financial statements.

EVOLVING SYSTEMS, INC.

STATEMENTS OF OPERATIONS

(IN THOUSANDS EXCEPT PER SHARE DATA)

(unaudited)

			Three Months Ended September 30,						Nine Months Ended September 30,
			2001			2000			2001			2000
Revenue:
	License fees and related services		$	(74	)	$	3,496		$	11,140		$	12,214
	Other services			4,148			7,918			18,494			24,991
		Total revenue		4,074			11,414			29,634			37,205
Cost of revenue:
	License fees and related services			1,414			2,767			5,827			6,624
	Other services			6,221			6,570			17,290			18,395
		Total cost of revenue		7,635			9,337			23,117			25,019
	Gross margin			(3,561	)		2,077			6,517			12,186
Operating expenses:
	Sales and marketing			2,154			2,111			6,602			6,431
	General and administrative			2,329			3,115			6,894			8,445
	Research and development			1,177			130			2,239			130
		Total operating expenses		5,660			5,356			15,735			15,006
Loss from operations				(9,221	)		(3,279	)		(9,218	)		(2,820	)
Other income, net				59			113			335			567
Loss before income taxes				(9,162	)		(3,166	)		(8,883	)		(2,253	)
Provision for income taxes				1,485			18			1,547			18
Net loss			$	(10,647	)	$	(3,184	)	$	(10,430	)	$	(2,271	)
Basic and diluted earnings per common share:
Net loss per common share			$	(0.81	)	$	(0.25	)	$	(0.80	)	$	(0.18	)
Weighted average shares outstanding:
Basic and diluted shares outstanding				13,185			12,744			13,037			12,620

The accompanying notes are an integral part of the financial statements.

EVOLVING SYSTEMS, INC.

CONDENSED STATEMENTS OF CASH FLOW

(IN THOUSANDS)

(unaudited)

				Nine Months Ended September 30,
				2001			2000
Operating activities:
	Net loss			$	(10,430	)	$	(2,271	)
	Adjustments to reconcile net income to net cash used in operating activities:
		Amortization of deferred compensation			37			33
		Depreciation, amortization and loss on disposal of property and equipment			1,948			2,574
		Bad debt expense			60			—
		Provision for deferred income taxes			1,547			—
		Change in operating assets and liabilities:
		Contract receivables			3,372			(7,515	)
		Unbilled work-in-progress			4,134			(2,703	)
		Prepaid and other assets			10			114
		Accounts payable and accrued liabilities			(369	)		926
		Unearned revenue and customer deposits			(2,129	)		(3,694	)
			Net cash used in operating activities		(1,820	)		(12,536	)
Investing activities:
		Purchases of property and equipment, net			(1,571	)		(1,875	)
		Sales of short-term investments, net			5,931			11,283
			Net cash provided by investing activities		4,360			9,408
Financing activities:
		Repayment of long-term obligations			(161	)		(491	)
		Proceeds from issuance of common stock			489			1,014
			Net cash provided by financing activities		328			523
	Net increase (decrease) in cash and cash equivalents				2,868			(2,605	)
	Cash and cash equivalents at beginning of period				4,382			4,266
	Cash and cash equivalents at end of period			$	7,250		$	1,661
	Supplemental disclosure of other cash and non-cash financing transactions:
	Assets acquired under capital lease			$	190			—

The accompanying notes are an integral part of the financial statements.

EVOLVING SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of Presentation

    Interim Financial Statements.  The accompanying financial statements of Evolving Systems, Inc. (the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to make the information presented not misleading. The unaudited financial statements included in this document have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation in accordance with generally accepted accounting principles. Our results for the period ended September 30, 2001 are not necessarily indicative of the results we will have for any subsequent quarter or full fiscal year. You should read these financial statements in conjunction with the audited financial statements and the notes to those statements for the year ended December 31, 2000 including Evolving Systems Form 10-K/A for the year ended December 31, 2000.

    Use of Estimates.  The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. During the third quarter of 2001, the Company increased its estimate to complete on a large fixed price contract with one customer. The additional estimated hours relate to increased testing requirements that expanded the scope of the project. This revision in estimated hours resulted in the reversal of approximately $350,000 in license fee and related revenue during the quarter.

(2) Earnings (Loss) Per Common Share

    Basic EPS was computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted EPS was computed using the weighted average number of common shares plus all dilutive potential common shares outstanding during the period unless the effect of the potential common shares is anti-dilutive.

    The following is the reconciliation of the numerators and denominators of the basic and diluted EPS computations (in thousands, except per share data):

		Three Months Ended September 30,						Nine Months Ended September 30,
		2001			2000			2001			2000
Basic earnings per share:
	Net loss	$	(10,467	)	$	(3,184	)	$	(10,430	)	$	(2,271	)
	Weighted average common shares outstanding		13,185			12,744			13,037			12,620
	Basic net income (loss) per common share	$	(.81	)	$	(.25	)	$	(.80	)	$	(.18	)
Effect of dilutive securities:
	Options and warrants		—			—			—			—
	Diluted weighted average common shares outstanding		13,185			12,744			13,037			12,620
	Diluted net income (loss) per common share	$	(.81	)	$	(.25	)	$	(.80	)	$	(.18	)

    Options to purchase 2,350,000 and 2,000,000 shares of common stock were excluded from dilutive stock option calculations for the three and nine month periods ended September 30, 2001 respectively because their exercise prices were greater than the average fair market value of the Company's stock for the period and as such, they would be anti-dilutive. Options to purchase an additional 1,297,000 shares of common stock whose exercise prices were below the average fair market value of the company's stock were excluded from the dilutive stock option calculation for the three month period ended September 30, 2001 due to the net loss.

(3) 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 discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. We identified our chief operating decision-makers as three key executives-the Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer. This chief operating decision-making group reviews the revenue and overall results of operations by the nature of the products and services provided. The accounting policies of the operating segments below are the same as those described in the summary of significant accounting policies included in our Annual Report on Form 10-K/A for the year ended December 31, 2000. We develop products and solutions for the telecommunications industry and provide a broad range of both fixed-price and time-and-materials software solutions.

    The groupings presented below represent an aggregation of financial information for business segments meeting certain criteria, including economic characteristics, similar customers, and the same products and services. The OSS Products Group encompasses a broad array of software and systems that perform critical functions for telecommunications carriers, including ordering, provisioning, service assurance and billing. The Wireless Data Group provides custom software infrastructure products for Lucent, and other infrastructure suppliers. New proprietary wireless data products include the OMNIPresence Server™ and related products under development. We provide services and products solely within the United States geographic area. Total assets have not been specified by segment, as it is

impractical to do so. The following table provides revenue and gross margin by segment for the three and nine month periods ended September 30, 2001 and September 30, 2000, respectively:

			Three Months Ended September 30,						Nine Months Ended September 30,
			2001			2000			2001		2000
REVENUE
OSS Products Group:
	LNP		$	1,465		$	4,831		$	15,425	$	16,427
	NPAC			1,198			1,710			4,318		6,034
	OSS Solutions			430			1,589			2,996		5,998
Wireless Data Group:
	Wireless			981			3,284			6,895		8,746
		Total Revenue	$	4,074		$	11,414		$	29,634	$	37,205
GROSS MARGIN
OSS Products Group:
	LNP		$	(3,827	)	$	695		$	720	$	5,833
	NPAC			641			740			2,273		3,102
	OSS Solutions			(259	)		(85	)		342		853
Wireless Data Group:
	Wireless			(116	)		727			3,182		2,398
		Total Gross Margin	$	(3,561	)	$	2,077		$	6,517	$	12,186

(4) Income Taxes

    As of the third quarter of 2001, the Company recorded a deferred tax Valuation allowance equal to 100% of the total deferred tax assets. Management considered a number of factors, including the Company's cumulative operating losses over the prior three years, near-term projected losses due to the impact of delays in customer purchasing decisions and the state of the economy, as well as certain offsetting positive factors. Management concluded that a valuation allowance was required for 100% of the total deferred tax assets as it is more likely than not that the deferred tax assets will not be realized.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

    Evolving Systems provides the telecommunications industry with solutions comprised of software products and systems integration services for a full range of operational support systems, network element software and wireless data applications.

    We derive revenue from license fees and services under the terms of both fixed price and time-and-materials contracts. License fees and related services revenue consists of revenue from contracts that generally provide for both licenses and services related to our standard software products. Other services revenue consists of revenue from custom programming, systems integration of third-party products, annual maintenance contracts and training.

    License fees and related services revenue is generated from fixed price contracts that provide for both licenses and services. Where the services are essential to the functionality of the delivered software, we generally recognize revenue using the percentage-of-completion method of accounting. We determine the percentage of completion for each contract based on the ratio of direct labor hours incurred to total estimated direct labor hours. We record amounts billed in advance of services being performed 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 during the succeeding 12 months.

    In arrangements where the services are not essential to the functionality of the delivered software, we recognize license revenue when a license agreement has been signed, delivery has occurred, the fee is fixed or determinable, collectibility is probable and the customer has accepted the software. Where applicable, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered to the extent that vendor specific objective evidence ("VSOE") of fair value exists. If VSOE does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist or all of the elements are delivered.

    We generally recognize services revenue provided under fixed price contracts using the percentage-of-completion method of accounting described above. We recognize revenue from other services provided pursuant to time-and-materials contracts as the services are performed.

    We record annual maintenance revenue as deferred revenue and recognize it ratably over the service period, which is generally 12 months. We recognize revenue from training services as the training services are performed. When maintenance or training services are bundled with the original license fee arrangement, we defer their fair value and recognize it during the periods in which we provide the services.

    We may encounter budget and schedule overruns on fixed price contracts caused by increased material, labor or overhead costs. We make adjustments to cost estimates in the periods in which the facts requiring such revisions become known to us. We record estimated losses, if any, in the period in which current estimates of total contract revenue and contract costs indicate a loss.

    Based on our recent financial results we implemented a work force reduction of approximately 10%, or 24 people, that is expected to result in estimated annualized savings of $2.0 million. We recognized approximately $220,000 in severance expense related to this headcount reduction in this year's third quarter. We are also continuing to control fixed asset purchases and general expenditures throughout all levels of the organization.

RESULTS OF OPERATIONS

    The following table presents, for the periods indicated, certain items in the Company's statement of operations reflected as a percentage of total revenue.

			Three Months Ended September 30,				Nine Months Ended September 30,
			2001		2000		2001		2000
Revenue:
	License fees and related services		(1.8	)%	30.6	%	37.6	%	32.8	%
	Other services		101.8		69.4		62.4		67.2
		Total revenue	100.0		100.0		100.0		100.0
Cost of revenue:
	License fees and related services		34.7		24.2		19.7		17.8
	Other services		152.7		57.6		58.3		49.4
		Total cost of revenue	187.4		81.8		78.0		67.2
	Gross margin		(87.4	)	18.2		22.0		32.8
Operating expenses:
	Sales and marketing		52.9		18.5		22.3		17.3
	General and administrative		57.2		27.3		23.3		22.7
	Research and development		28.9		1.1		7.6		0.3
		Total operating expenses	139.0		46.9		53.2		40.3
Loss from operations			(226.4	)	(28.7	)	(31.2	)	(7.5	)
Other income, net			1.6		1.0		1.2		1.5
Loss before income taxes			(224.8	)	(27.7	)	(30.0	)	(6.0	)
Provision for income taxes			36.5		0.2		5.2		0.1
Net loss			(261.3	)%	(27.9	)%	(35.2	)%	(6.1	)%

The three months ended September 30, 2001 compared to the three months ended September 30, 2000

    Revenue.  Total revenue decreased approximately $7.3 million or 64% to $4.1 million in the three months ended September 30, 2001 from $11.4 million in the three months ended September 30, 2000. License fees and related services revenue decreased by $3.6 million or 102% to $(74,000) in the three months ended September 30, 2001 from $3.5 million in the three months ended September 30, 2000, reflecting the downturn in the US economy and increased delays in customer purchasing decisions in the aftermath of the September 11, 2001 terrorist attacks. Immediately following the attacks, the major carriers, who are our customers, turned their short-term focus to network security and stability. Transactions for wireless LNP software also have been delayed pending a decision by the FCC on a petition filed by a wireless carrier requesting either full or partial forbearance from the FCC's requirement for wireless number portability by November 2002. The negative license fee revenue for the three months ended September 30, 2001 was the result of increased testing requirements on a large contract that caused an increase in estimated hours that expanded the scope of the project. This caused the percentage-of-completion to decline and revenue to be reversed. This revenue will be recognized in the fourth quarter of 2001 with the delivery of the software to the customer. Other services revenue decreased by $3.8 million or 48% to $4.1 million in the three months ended September 30, 2001 from $7.9 million in the three months ended September 30, 2000, which is also a reflection of increased delays in customer purchasing decisions. As a percentage of total revenue, license fees and related services revenue decreased to (2)% for the three months ended September 30, 2001 from 31% for the three months ended September 30, 2000. License fees have decreased at a

higher proportionate rate in the three months ended September 30, 2001 compared to September 30, 2000 because of the reduced volume of license sales and the impact on revenues of increased estimated hours on one large project during the three months ended September 30, 2001. Other services revenue increased to 102% of total revenue for the three months ended September 30, 2001 because of the previously mentioned negative license fees and related services revenue.

    Cost of revenue.  Total cost of revenue decreased by $1.7 million or 18% to $7.6 million in the three months ended September 30, 2001 from $9.3 million in the three months ended September 30, 2000. Cost of revenue has decreased compared to the three months ended September 30, 2000 due to management focus on cost control and staff reductions in response to the current economic conditions in the three months ended September 30, 2001. As a percentage of total revenue, costs increased to 187% of revenue for the three months ended September 30, 2001 from 82% of revenue in the three months ended September 30, 2000. The percentage increase in costs relative to revenues from the three months ended September 30, 2000 is a result of the previously discussed delayed purchasing decisions and revenue reversal. While cost controls have been implemented that have reduced costs from the three months ended September 30, 2000, a minimum cost structure remains necessary to support the business in anticipation of future customer demand.

    Cost of license fees and related services decreased by $1.4 million or 49% to $1.4 million for the three months ended September 30, 2001 from $2.8 million for the three months ended September 30, 2000, due to management's focus on cost control. As a percentage of total revenue, cost of license fees and related services increased to 35% for the three months ended September 30, 2001 from 24% in the three months ended September 30, 2000. The percentage increase in costs is a reflection of the reduced revenues from the three months ended September 30, 2001. Cost of other services decreased by $349,000 or 5% to $6.2 million for the three months ended September 30, 2001 from $6.6 million for the three months ended September 30, 2000. Cost of other services revenue similarly has decreased from the three months ended September 30, 2000 due to management focus on cost control in response to market conditions. Cost of other services as a percent of revenue increased from 58% in the three-month period ended September 30, 2000 to 153% in the three month period ended September 30, 2001 because of the previously mentioned reduction in revenues.

    We experienced a negative gross margin in the three months ended September 30, 2001. This is a 106% decrease in total gross margin compared to the three months ended September 30, 2000. The change can be attributed to the lower revenue in the three months ended September 30, 2001 compared to September 30, 2000. When short-term revenue declines, the fixed cost nature of staffing costs will result in lower or negative gross margins.

    Our expense levels are based in significant part on our expectations regarding future revenues. Our revenue is difficult to forecast because the market for the Company's products and services is rapidly evolving, and our sales cycle and the size and timing of significant contracts vary substantially among customers.

    Sales and marketing.  Sales and marketing expenses increased by $43,000 or 2% to $2.2 million in the three months ended September 30, 2001 from $2.1 million in the three months ended September 30, 2000. The increase in costs from the three months ending September 30, 2000 is due to our participation in more trade shows in the three months ended September 30, 2001. As a percentage of revenue, sales and marketing expense increased to 53% of revenue in the three months ended September 30, 2001 from 19% in the three months ended September 30, 2000. The increase in sales and marketing costs as a percentage of revenue from the three months ended September 30, 2000 is a result of the lower revenue earned in the three months ended September 30, 2001 as discussed above.

    General and administrative.  General and administrative expenses decreased by $786,000 or 25% to $2.3 million in the three months ended September 30, 2001 from $3.1 million in the three months

ended September 30, 2000. As a percentage of revenue, general and administrative expenses increased to 57% in the three months ended September 30, 2001 from 27% in the three months ended September 30, 2000. The decrease in dollars is a result of management cost controls and efficiencies implemented since the three months ended September 30, 2000, including a reduction of headcount,. due to attrition. In addition, due to lower than expected revenues, there was a reduction in bonus expense for the three months ended September 30, 2001 compared to September 30, 2000. General and administrative expenses increased as a percentage of revenue because of the lower revenue level in the three month period ended September 30, 2001.

    Research and development.  Research and development expenses increased by $1.0 million or 805% to $1.2 million in the three months ended September 30, 2001 from $130,000 in the three months ended September 30, 2000, reflecting our strategic decision to begin investing in new wireless products and additional LNP features. As a percentage of revenue, research and development expenses increased to 29% in the three months ended September 30, 2001 from 1% in the three months ended September 30, 2000.

    Other income, net.  Other income, net, decreased $54,000, or 48%, to $59,000 in the three months ended September 30, 2001 from $113,000 in the three months ended September 30, 2000 due to lower interest income. While interest expense declined as debt was paid down, interest income also declined for the three months ended September 30, 2001 compared to the three months ended September 30, 2000, primarily due to decreased investment balances and interest rates.

    Provision for income taxes.  Prior to the third quarter we had recorded a partial valuation allowance against carryforward tax benefits to the extent we believed that it was more likely than not that all of such benefits would not be realized in the foreseeable future. For the three months ended September 30, 2001, we increased the valuation allowance to fully reserve against the deferred tax asset and have recorded a provision for income taxes of $1.5 million, based on our assessment that it is more likely than not that we will not realize the deferred tax assets that were recorded on the balance sheet at June 30, 2001. Our assessment of this valuation allowance was made using all available evidence, both positive and negative. In particular, we considered both historical results and our projections of profitability for only reasonably foreseeable future periods. Our realization of our recorded net deferred tax assets is dependent on future taxable income and therefore, we are not assured that such benefits will be realized.

The nine months ended September 30, 2001 compared to the nine months ended September 30, 2000

    Revenue.  Total revenue decreased approximately $7.6 million or 20% to $29.6 million in the nine months ended September 30, 2001 from $37.2 million in the nine months ended September 30, 2000. License fees and related services revenue decreased by $1.1 million or 9% to $11.1 million in the nine months ended September 30, 2001 from $12.2 million in the nine months ended September 30, 2000, reflecting the downturn in the US economy and increased delays in customer purchasing decisions in the aftermath of the September 11, 2001 terrorist attacks. Following the attacks, the major carriers, who are our customers, turned their short-term focus to network security and stability. Transactions for wireless LNP software also have been delayed pending a decision by the FCC on a petition filed by a wireless carrier requesting either full or partial forbearance from the FCC's requirement for wireless number portability by November 2002. Other services revenue decreased by $6.5 million or 26% to $18.5 million in the nine months ended September 30, 2001 from $25.0 million in the nine months ended September 30, 2000, also a reflection of increased delays in customer purchasing decisions. As a percentage of total revenue, license fees increased to 38% for the nine months ended September 30, 2001 from 33% for the nine months ended September 30, 2000 because license fees decreased at a slower rate than our overall revenue decline. As a percentage of total revenue, other services revenue decreased to 62% for the nine months ended September 30, 2001

from 67% for the nine months ended September 30, 2000 because custom software development revenue declined as we focus our marketing efforts on our standard products.

    Cost of revenue.  Cost of revenue decreased $1.9 million or 8% to $23.1 million in the nine months ended September 30, 2001 from $25.0 million in the nine months ended September 30, 2000. License fees and related services cost decreased by $797,000 or 12% to $5.8 million for the nine months ended September 30, 2001 from $6.6 million for the nine months ended September 30, 2000. Other services cost decreased $1.1 million or 6% to $17.3 million in the nine months ended September 30, 2001 from $18.4 million in the nine months ended September 30, 2000. The decreases in costs is due to management's focus on cost controls and a reduction in staffing given the market conditions previously mentioned in the nine months ended September 30, 2001.

    Sales and marketing.  Sales and marketing expenses increased by $171,000 or 3% to $6.6 million in the nine months ended September 30, 2001 from $6.4 million in the nine months ended September 30, 2000. This increase in costs is due to gradually increased sales staff in 2001 and increased costs related to participation in more industry trade shows. As a percentage of revenue, sales and marketing expenses increased to 22% of revenue in the nine months ended September 30, 2001 from 17% in the nine months ended September 30, 2000.

    General and administrative.  General and administrative expenses decreased by $1.6 million or 18% to $6.9 million in the nine months ended September 30, 2001 from $8.4 million in the nine months ended September 30, 2000. As a percentage of revenue, general and administrative expenses remained constant at 23% in the nine months ended September 30, 2001 from the nine months ended September 30, 2000. The decrease in general and administrative costs is due to a decrease in headcount from 65 at September 30, 2000 compared to 51 at September 30, 2001 and substantially declined bonus payments to employees from the nine months period ending September 30, 2000.

    Research and development.  Research and development expenses increased by $2.1 million, or 1,622%, to $2.2 million in the nine months ended September 30, 2001 from $130,000 in the nine months ended September 30, 2000, reflecting our strategic decision to begin investing in new wireless products and additional LNP features. As a percentage of revenue, research and development expenses increased to 8% in the nine months ended September 30, 2001 from 0% in the nine months ended September 30, 2000.

    Other income, net.  Other income, net decreased by $232,000 or 41%, to $335,000 in the nine months ended September 30, 2001 from 567,000 in the nine months ended September 30, 2000. As a percentage of revenue, other income, net decreased to 1% of income in the nine months ended September 30, 2001 from 2% of expense in the nine months ended September 30, 2000. This change resulted from reduced interest income due to lower interest rates and a decline in interest expense as debt continued to decline.

    Provision for income taxes.  Prior to 2001 we had recorded a partial valuation allowance against carryforward tax benefits to the extent we believe that it was more likely than not that all of such benefits would not be realized in the foreseeable future. For the nine months ended September 30, 2001, we increased the valuation allowance to fully reserve against the deferred tax asset and have recorded a provision for income taxes of $1.5 million, based on our assessment that it is more likely than not that we will not realize the deferred tax assets that were recorded on the balance sheet at December 31, 2001. Our assessment of this valuation allowance was made using all available evidence, both positive and negative. In particular, we considered both historical results and our projections of profitability for only reasonably foreseeable future periods. Our realization of our recorded net deferred tax assets is dependent on future taxable income and therefore, we are not assured that such benefits will be realized.

Liquidity and Capital Resources.

    We have financed our operations through a combination of cash from operations, borrowings and funds received in our initial public offering in May 1998. At September 30, 2001, the Company's principal sources of liquidity included $7.3 million in cash and cash equivalents.

    Net cash used in operating activities was $1.8 million in the nine months ended September 30, 2001 compared to $12.5 million in the nine months ended September 30, 2000. The primary sources of cash from operations in the nine months ended September 30, 2001 were increased collection on major accounts, reflected in decreased contract receivables of $3.4 million and decreased unbilled work-in-progress of $4.1 million, partially offset by a $2.1 million decrease in unearned revenue and customer deposits.

    Net cash provided by investing activities during the nine months ended September 30, 2001 was $4.4 million compared to $9.4 million in the nine months ended September 30, 2000. Purchases of property and equipment to support operations accounted for $1.6 million in the nine months ended September 30, 2001 compared to $1.9 million for the nine months ended September 30, 2000. The sale of $5.9 million in short-term investments provided cash during the nine months ended September 30, 2001 compared to $11.3 million in sales during the nine months ended September 30, 2000.

    Net cash provided by financing activities was $328,000 resulting from the sale of common stock upon the exercise of $489,000 in stock options offset by $161,000 in capital lease obligation repayments for the nine months ended September 30, 2001. This compares to $523,000 provided by financing activities in the nine months ended September 30, 2000 resulting from the sale of common stock upon the exercise of $1.0 million in stock options offset by $491,000 in capital lease obligation repayments for the nine months ended September 30, 2001.

    We believe that our current cash and short-term investments, together with anticipated cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. Thereafter, the Company may require additional funds to support such activity through public or private equity financing or from other sources. There can be no assurance that additional financing will be available at all or that if available, such financing will be obtainable on terms favorable to the Company and would not be dilutive.

Recent accounting pronouncements.

    In June 2001, the FASB issued SFAS No. 141, "Business Combinations". SFAS No. 141 establishes methods of accounting for business combinations using the purchase method of accounting with goodwill initially recognized as an asset in the financial statements. The provisions of SFAS No. 141 will apply to all business combinations initiated after June 30, 2001. To date, we have not entered into any business combination activities.

    In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 eliminates the requirement to amortize goodwill and provides for testing the value of the Goodwill for impairment at least annually. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 with initial impairment tests performed on all goodwill within six months of adoption. We anticipate that SFAS No. 142 will have no impact on our financial condition or results of operations due to our lack of business combination activity.

    On October 3, 2001, the FASB issued Statement of Accounting Standards No.144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 supercedes FAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." FAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30), Reporting Results of Operations -Reporting the Effects of Disposal of a Division of a Business. FAS 144 develops one accounting model for

long-lived assets that are to be disposed of by sale. FAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, FAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. FAS 144 is effective for fiscal years beginning after December 15, 2001. We are in the process of evaluating the effect of FAS 144 on our financial statements.

Factors that might affect operating results.

    Our operating results have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future. Fluctuations in operating results may continue to result in volatility in the price of our Common Stock. We cannot provide assurance that we will be profitable in the future or that our level of profitability will not vary significantly between quarters. These quarterly fluctuations may result from a number of factors, including the magnitude, timing and signing of new contracts; our rate of progress under such contracts; the timing of customer and market acceptance of our product and service offerings; actual or anticipated changes in government laws and regulations related to the telecommunications market or judicial or administrative actions with respect to such laws or regulations; the nature and pace of enforcement of the Telecommunications Act of 1996 including, but not limited to the FCC's position on wireless number portability; the impact of changes to revenue recognition rules; changes in management; sale of our software in an application service provider (ASP) model; product lifecycles; our success in building a product-based business and developing and marketing new products; the mix of products and services sold; changes in demand for our products and services; the timing of third-party contractors' delivery of software and hardware; budgeting cycles of our customers; changes in the renewal rate of support agreements; the timing and amount of our expenditures for research and development sales, general and administrative expenses; competition by existing and emerging competitors in the telecommunications software markets; controlling costs, attracting and retaining qualified personnel and expanding our sales and marketing programs; regional office expansion; software defects and other product quality problems; changes in our strategy; the extent of industry consolidation; expansion into international markets, and general economic conditions.

    A significant portion of our revenue has been and is expected to continue to be derived from a small number of customers. Accordingly, the loss of any significant customer, delays in delivery or acceptance of any of our products or delays in the performance of services could have a material adverse effect on our business, financial condition and results of operations. Historically, we have generally recognized both license fees and service fee revenue under our customer contracts using the percentage-of-completion method. We have broadened our strategy to include the development and sale of standard, packaged software products and we also offer our software under ASP arrangements. To the extent that we are successful in our strategy, we expect that we may record future revenue from license fees upon the acceptance of a software product by customers, or as monthly payments are invoiced under an ASP arrangement. Software companies that account for revenue from license fees upon acceptance of software products may be exposed to increased risk of quarterly fluctuations. Likewise, software companies that adopt an ASP licensing model, in lieu of recording revenue upon acceptance, may have temporary revenue reductions until the ASP licensing model is fully realized. To the extent that this pattern develops, any failure or delay in the delivery and acceptance of orders during any given quarter, or any signing of an ASP licensing arrangement in lieu of receiving payment of the packaged software up front, could have a material adverse effect on our business, financial condition and results of operations. The timing of revenue recognition from our contracts has caused, and may continue to cause, material fluctuations in our operating results, particularly on a quarterly basis.

    Our expense levels are based in significant part on our expectations regarding future revenue. Our revenue is difficult to forecast because the market for our products and services is rapidly evolving, and our sales cycle and the size and timing of significant contracts vary substantially among customers. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenue. Any significant shortfall from anticipated levels of demand for our products and services could have a material adverse effect on our business, financial condition and results of operations.

    Based on all of the foregoing, we believe that future revenue, expenses and operating results are likely to vary significantly from quarter to quarter. As a result, quarter-to-quarter comparisons of operating results are not necessarily meaningful or indicative of future performance. Furthermore, we believe that it is likely that in some future quarter our operating results will be below the expectations of public market analysts or investors. In such event, or in the event that adverse conditions prevail, or are perceived to prevail, with respect to our business or generally, the market price of our Common Stock would likely go down.

    These results should be read in conjunction with the risk factors defined in the Company's Amended Form 10-K/A for the year ended December 31, 2000. Statements contained in this Form 10-Q with respect to future revenue and expenses are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ. Among the factors that could cause actual results to differ are those described above and in more detail in our Amended Form 10-K/A.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

    From time to time we are involved in various legal proceedings arising in the normal course of business operations. We do not expect that any such proceedings will have a material adverse effect on our financial position, results of operations or cash flows.

Item 2. Changes in Securities

    None

Item 3. Defaults on Senior Securities

    None

Item 4. Submission of Matters to a Vote of Security Holders

    On March 23, 2001, the Company solicited the written consent of its security holders with respect to (a) Election of Directors; (b) Amendment of the Company's Stock Option Plan; (c) Amendment to the Company's Employee Stock Purchase Plan; and (d) Ratification of PricewaterhouseCoopers LLP as the independent auditors of the Company. These matters were voted on and approved by the shareholders on April 25, 2001.

Item 5. Other Information

    None

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits



(b)

Reports on Form 8-K

    None

SIGNATURES

    Pursuant to the requirements of the Securities exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: 11/14/2001
By:
/s/ DAVID R. JOHNSON   David R. Johnson
Senior Vice President of Finance, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial and Accounting Officer)