UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[ X ]

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

For the fiscal year ended June 30, 2002
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: 000-31155

EVOLVE SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)

94-3219745
(I.R.S. Employer
Identification No.)

1400 65^th Street, Suite 100, Emeryville, CA
(Address of principal executive offices)

94608
(Zip Code)

Registrant's telephone number, including area code: (510) 428-6000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

___________________

       Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES [ X ] NO [ _ ]

                Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K.  [ _ ]

                The aggregate market value of the voting common stock held by non-affiliates of the registrant as of September 16, 2002, was approximately $5,712,434 based upon the closing sales price reported for that date on the NASDAQ SmallCap Market.  Shares of common stock held by each officer and director and by each person who owns more than 5% or more of the outstanding common stock have been excluded because such persons may be deemed to be affiliates.  This determination of affiliate status is not necessarily conclusive for other purposes.

                The number of shares outstanding of the registrant's common stock as of September 16, 2002, was 46,509,175.

Documents Incorporated by Reference

Portions of the Proxy Statement for registrant's 2002 Annual Meeting of Stockholders to be held in December 2002 are incorporated by reference in Part III of this Annual Report on Form 10-K.

EVOLVE SOFTWARE, INC.

FORM 10-K

For the Fiscal Year Ended June 30, 2002

TABLE OF CONTENTS

Page

PART I

Item 1.

Business

1

Item 2.

Properties

22

Item 3.

Legal Proceedings

22

Item 4.

Submission of Matters to a Vote of Security Holders

23

PART II

Item 5.

Market for Registrant's Common Equity and Related Stockholder Matters

24

Item 6.

Selected Consolidated Financial Data

25

Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

26

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

40

Item 8.

Financial Statements and Supplementary Data

40

Item 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosures

40

PART III

Item 10.

Directors and Executive Officers of the Registrant

41

Item 11.

Executive Compensation

41

Item 12.

Security Ownership of Certain Beneficial Owners and Management

41

Item 13.

Certain Relationships and Related Transactions

41

PART IV

Item 14.

Controls and Procedures

41

Item 15.

Exhibits, Financial Statement Schedules and Reports on Form 8-K

41

Signatures

44

Certifications

45

Financial Statements

F-1

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  A word such as "expects," "anticipates," "intends," "believes" or similar language identifies forward-looking statements.  These forward-looking statements include, among other things, statements about our anticipated growth strategies, the trends we see in our business and the markets in which we operate, the features and functionality of our products, our expectations for our future performance and the market acceptance of our products, and the status of evolving technologies and software architectures and their growth potential.  Forward-looking statements involve risks and uncertainties.  Our actual results may differ materially from those contemplated by the forward-looking statements.  Factors that might cause or contribute to these differences include, but are not limited to, those discussed in the section entitled "Item 1.  Business, Factors That May Affect Future Results."  You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report.  We undertake no obligation to publicly revise or update any forward-looking statements to reflect events or circumstances after the date of this report.

PART I

Item 1.  Business

Overview

Evolve Software, Inc. ("Evolve") provides enterprise software that optimizes the way organizations deliver services to their customers and employees.  Our service delivery software product is designed for service-oriented organizations where successful project delivery is vital to their business.  We primarily market our solution to professional services organizations (PSOs) and to corporate information technology (IT) departments in medium-to-large enterprises.  Within the PSO market segment, we sell to both consulting companies and services arms within high technology companies.  More recently, we have also acquired customers who are utilizing our products within corporate research and development or engineering environments.

Companies rely on our solution to automate and streamline the core business processes that are critical for delivering their services internally or externally on time and on budget.  Our solution allows customers to manage project portfolios, assess project opportunities, track professional resources, prepare budgets, monitor schedules, allocate resources, match specific skill sets to needs, drive efficiencies, and increase visibility, control and credibility within their operations.

Our strategy is to become the vendor of choice for enabling service-oriented organizations to manage their in-house and contracted professionals and projects.  We believe we are well positioned to capitalize on the market opportunity that exists through the development and sale of software to PSOs and corporate IT organizations, as well as other services-oriented businesses.  We believe we have the domain expertise, proven products and services, customer cases of return on investment (ROI) and the employees that will allow us to be successful in the marketplace.  Our target market is Fortune 1000 companies.

Our value proposition for corporate IT is that our solution transforms key business processes to enable all levels of the corporate IT organization to make better decisions, execute with confidence, and drive the following measurable results:

• Align technology investments to corporate strategy - pick the right projects, and have the right people ready to deliver;

• Reduce costs  - control budgetary spending, and do more with less; and

• Increase customer satisfaction - drive improved project quality with predictable, repeatable best practice processes and build effective collaboration throughout the project delivery cycle.

Our value proposition for professional services organizations is that our solution transforms key business processes to enable all levels of the professional services organization to make better decisions, execute with confidence, and drive the following measurable results:

• Drive revenue and maximize margins - optimize resource utilization to increase billable hours and margins;

• Increase customer satisfaction  - garner loyalty and win repeat business by assembling the optimal team, delivering with quality and exceeding expectations; and

• Strategically target and win the best business - sell profitable projects with the business plan and operational processes to win.

We believe our value proposition is compelling to many types of service-oriented organizations.  In addition to PSOs and corporate IT, other services-centric organizations in large companies, such as research and development (R&D) departments and field service teams, have become a natural market opportunity for the Evolve solution.

We have licensed our solution to a wide range of customers who have deployed our software to effectively deliver complex projects and better manage their operations and workforces.  Our customers include a diverse set of small, medium and large organizations across a number of industry segments including high tech, financial services, professional services, automotive, communications, consumer goods, transportation, manufacturing, utilities, government and pharmaceuticals.  A number of our customers have global presence and leverage the Evolve solution to manage their operations on a worldwide basis.

In August 2002, Evolve 5.5 became generally available.  This latest release is the most technologically- and feature-rich version of our product to date.  Our solution can interoperate and integrate with various in-house applications and legacy systems running in our customers' environments.  We continue to enhance the Evolve solution from a technology and functionality perspective in order to satisfy the needs of our target markets.  In addition to our application software, Evolve offers complementary services to our customers, including customer support, implementation consulting services and training.

Incorporated in Delaware, Evolve commenced operations in 1995.

We sell perpetual licenses of our software to be installed at the customer's premises or which can be operated in a third-party hosted environment.  We previously offered a hosted, ASP delivery option for customers.  However, an Evolve ASP offering is no longer necessary given the requirements of our target market and the size of installations we are selling into.  Of the customers who originally subscribed to our solution in a hosted ASP model, the majority have converted to a self-hosted licensed arrangement.  We will continue to support our remaining ASP customers contractually.  However, we do not intend to offer this service to new customers in the future.

Industry Background

Enterprise software applications during the past 15 years have focused on back-end financial processing, managing human resources, transacting business with customers, and the procurement, manufacturing and distribution of goods - but not necessarily services.  In the late 1990's, a new breed of enterprise application software emerged to automate the delivery of services, referred to as professional services automation (PSA) applications.  Initially, the greatest appeal for this type of application came from the technology consulting organizations that were growing at extraordinary rates, fueled by the Internet boom.  However, many of these firms had no, or very limited tools (such as spreadsheets, project management tools, report writers) to manage their consultants and the delivery of their services.  Very often, the data provided by their point solutions wasn't timely, accurate or integrated.  As a result, companies suffered from poor visibility, limited control and reduced credibility.  These companies required more sophisticated tools to gauge and manage their competitiveness and profitability.  Consulting companies readily appreciated the value of having a system to track and manage their business.  The return on investment was demonstrated to be rapid with results, including increased revenue, profit margins, project successes and customer satisfaction.

The key functional needs of the consulting services marketplace from which vendor applications were initially designed to address included:

• Resource Management - to ultimately increase utilization to increase revenues;

•  Opportunity Management - to track and manage project proposals in the pipeline; and

• Financial Management - to accurately invoice and account for the projects.

PSA applications were not only applicable for consulting companies.  They also fit naturally into the services organizations within high technology companies - the embedded professional services arms within enterprises.  Embedded PSOs share virtually the same system requirements as consulting firms.  They too strive to optimize the use of their resources, track and manage their projects and accurately bill their customers for the services rendered.

The market opportunity continued to grow as corporate IT organizations began to realize the value of PSA software.  Many of the general business processes and system requirements germane to corporate IT organizations are similar to those of PSOs.  Corporate IT is typically chartered with implementing and maintaining the technology, operational systems, enterprise applications and the systems infrastructure necessary to support their enterprises.  IT executives are often lacking comprehensive end-to-end solutions for managing their operations, their IT staff and the projects in their portfolio.  In many cases, corporate IT organizations rely on point solutions to manage their departments with tools that do not provide a complete, integrated solution, and have limited strategic value.  Therefore, these internally focused IT organizations have found that using PSA applications helps them align their technology initiatives with corporate strategy, make the right infrastructure investments, deliver ROI, control costs, optimize their limited budgets, manage their workforce and improve service quality.

A number of trends within corporate IT including an increasing amount of services provided with fewer resources and increased internal customer satisfaction, have emerged.  These trends bolster justification for an integrated service delivery solution to manage IT operations.  Many corporate IT organizations operate as shared service centers -- quasi-consulting businesses in which back-office support functions for a number of operating units are centralized at one or more specialist centers and assigned and "charged" to projects.  Shared service center models have further emphasized the parallels with professional services.  In addition, business process improvement methodologies, such as Six Sigma and the Capability Maturity Model (CMM) are being embraced by most Fortune 1000 companies to help guide them through a structured improvement process to increase efficiencies and the quality of deliverables.  This trend towards certification with CMM or Six Sigma make many corporate IT organizations receptive to applications that help enforce standardized, repeatable best practices.

To accommodate the system requirements and trends in corporate IT, second generation PSA solutions were released with additional functionality, including:

• Portfolio Management - to gain executive level project-wide operational visibility;

• Project Management - to better plan projects, resources, schedules and deliverables;

• Contractor Management - to gain control over contractor spend; and

• Knowledge Management - to collaborate and share information and best practices.

As a result of industry trends and the macroeconomic environment, an increasing number of corporate IT organizations are deploying service delivery applications.  As the benefits are realized and promoted, many more services-oriented organizations and companies are expected to adopt service delivery solutions.  A number of third party industry analysts, including The Gartner Group, Forrester, Aberdeen, AMR Research, META Group, IDC, and others, follow the service delivery market and have published reports that identify the size and growth opportunity for this area of enterprise applications.

Evolve was a pioneer in PSA applications and we believe we remain a thought leader today.  In the late 1990s, we recognized the trend towards increased technology services and the gap in the marketplace for enterprise applications to serve consulting organizations.  We developed our solution to address the needs of the PSO market.  Our product was initially designed in partnership with a number of very prominent technology consulting companies who served as early adopters of the application.  In 1999, we began shipping our flagship product for PSA to benefit a wide range of professional services organizations.  With three major releases of our PSA application during the 1999-2000 time period, we gained significant market awareness and many successful customer implementations.  The next generation of our solution, Evolve 5.0 released in 2002, addressed many of the business requirements and trends in corporate IT.  We continue to release new versions of our product with incremental functionality and technology enhancements to remain competitive and deliver valuable capabilities to our customers.

The most current release of our application, Evolve 5.5, became generally available in August 2002 and is a leading edge Internet-based software solution for automating and integrating the core processes that are critical to project-based services organizations.  By integrating these processes, our solution provides enhanced visibility of business performance throughout the enterprise, allowing businesses to more effectively identify and pursue revenue opportunities, prioritize their internal and external projects, increase their operational efficiency and improve the productivity of their professionals.

Our software suite optimizes project planning and prioritization, improves resource utilization and demand forecasting, promotes career planning to develop valuable skills and retain top talent, and rapidly delivers return on investment while minimizing customers' total cost of ownership.  Our solution enables customers to integrate people and projects, and to align these to corporate strategy in order to remain competitive in today's changing market.

Our solution provides the following benefits to project-driven services organizations:

Increased Operational Efficiency.  The Evolve offering is designed to allow our customers to achieve significant cost savings and productivity enhancements by offering the ability to view and manage all of the core processes involved in providing services across an entire organization.  Our solution is accessible to professionals and managers across a project-driven services organization, allowing them to communicate and collaborate throughout a project.  Using our solution, services providers can rapidly match service professionals with projects to balance supply and demand for personnel resources within the extended enterprise.  Services providers can also quickly identify low utilization personnel and lower priority projects to intelligently shift the size and scope of the organization.  Our solution also automates and improves workflow processes and monitors key project parameters, allowing business managers to analyze and improve performance throughout the enterprise.

Increased Visibility.  With our service delivery solution, customers gain full visibility across the organization.  Through management dashboards and integrated online capabilities and reports, companies can view and analyze operational performance, manage the delivery of projects and services, forecast demand, measure actual performance and align spending with corporate and organizational goals.

Greater Control to Deliver Projects on Time and on Budget.  Our applications give organizations the power to execute consulting projects and IT investments with speed, precision, and cost efficiency.  Using online workflow systems and powerful capabilities, organizations can manage the workforce, avoid budget overruns and institute consistent business processes.

Enhanced Credibility.  With the Evolve solution, services organizations have the power to consistently deliver on their commitments and forge a strong partnership with both internal and external customers.  Our solution provides the comprehensive data to know where investments can pay off, and provides new ways to improve quality across the enterprise through best practices and knowledge collaboration.

Real-time Communication and Collaboration Across the Organization.  Our solution allows for the real-time, collaborative delivery of services and our knowledge repositories empower companies with reusable information and ideas.  With our sophisticated collaboration capabilities, companies can be more efficient, make better decisions, foster stronger relationships with customers and create quality deliverables. 

Stringent Qualification of Opportunities.  We believe our solution enables our customers to stringently qualify their project opportunities by prioritizing projects and enhancing the visibility of demand for services within a project, thereby allowing them to match their available resources to project opportunities.  Our solution provides functionality to significantly reduce the complexity inherent in assessing and matching resource capabilities and available revenue opportunities on a global basis and across organizational boundaries.  This helps companies focus on selecting the most valuable and strategic opportunities based on a limited or shrinking workforce.

Enhanced Client Satisfaction.  Our solution improves client satisfaction by more effectively matching client needs with the most knowledgeable and experienced available resources for their project.  In addition, our solution facilitates timely completion of projects by enabling project managers to collaborate with the service provider team and the client and make better decisions more quickly.  We believe that collaborative management is essential to increasing client satisfaction and generating repeat business.

Improved Retention of Service Professionals.  By enabling professionals to access and revise their skill profiles, staffing preferences and assignment schedules in real time, our software helps to close the gap between professional development and project staffing needs, improving service professionals' levels of satisfaction and retention.  Improving retention of service professionals reduces recruitment and training expenses, protects key knowledge assets and can have a significant impact on operating results of services providers.

The Evolve Strategy

We believe we can become the vendor of choice for how organizations manage their in-house and contracted professionals and projects.  We intend to achieve our objective by gaining wide market acceptance for our service delivery solution in each of our target market segments:  consulting companies, professional services divisions of technology companies and corporate IT organizations in Fortune 1000 companies.  In addition to gaining broad-based market acceptance, Evolve intends to systematically penetrate specific vertical markets based upon our success and the size and timing of the opportunities.

Our strategy may include acquisition of horizontal product offerings that strengthen our competitive position, vertical product offerings that complete an industry product footprint, or opportunities to expand our base and consolidate the market.

Key elements of our strategy include:

Extend Market Position Among Fortune 1000 Corporate IT Organizations and Leverage Leadership into Other Markets.  We have successfully leveraged our early success with PSOs to garner a number of Fortune 1000 corporate IT customers.  Similarly, we intend to leverage the domain expertise, understanding of the service delivery market and our referenceable customer base to acquire additional customers and expand our penetration into other segments.

Establish a Vertical Market Focus and Targeted Marketing Campaigns.  As the market awareness and adoption of Evolve increases, we anticipate being able to leverage successes in certain verticals to further our penetration.  Based upon the projected spending rates on IT applications within each of the vertical markets, we will systematically target and market to certain sectors such as financial services, pharmaceutical manufacturers, utilities and the public sector.

Expand Direct and Indirect Sales Channels to Gain Market Share.  We believe a significant component for our success will be the upgrading and expansion of our direct sales force to increase market coverage.  Many of our new sales representatives have a strong background in enterprise software and hardware sales and many have specific vertical market experience.  In addition to building a world-class direct sales organization, Evolve intends to secure indirect, or channel, sales relationships in order to further expand our market presence and access to decision makers.  We anticipate establishing channel partnerships to enhance our position in particular verticals in the U.S. and abroad.

Capitalize on Technology Leadership and Expand Product Offerings.  We have acquired substantial domain expertise in developing solutions addressing the core business process automation needs of services organizations.  We have implemented a technical architecture that meets the needs of services organizations for flexible solutions that can be configured rapidly to meet their individual requirements and can be expanded or scaled as their organizations grow.  We will continue to enhance our technology and expand our service offerings to meet the evolving needs of our customers and promote broad market adoption of our solution.  We expect to devote significant resources to developing product functionality and continuing to streamline the integration of our product and its data with other back-end and complementary systems.

Focus on Expanding Market Presence and Awareness in North America while Maintaining an International Presence.  For at least the next year, we are focusing our resources and efforts primarily on gaining market share in the U.S. and Canada.  We intend to continue to maintain a limited direct presence in Europe, and may enter into distribution or channel partner relationships to expand outside of the North American market.

Increase Additional Software Sales and Associated Services in our Existing Installed Base.  We aim to capitalize on the success of existing deployments to encourage adoption of Evolve across additional workgroups and divisions within our existing customers' enterprises.

Evolve Service Delivery Platform

The Evolve service delivery platform automates and integrates the key processes that are critical to the operational effectiveness of project-driven services organizations.  It is a proven end-to-end solution that can expand to address the needs of rapidly growing organizations.  Our products manage the inherently virtual, collaborative, project-oriented and people-centric characteristics of services organizations by employing the universal accessibility of the Internet, an intuitive user interface, and powerful applications functionality.

We provide an enterprise software application that is deployed primarily on a distributed basis across customers' computer networks.  Our solution also can be configured to operate on a hosted basis.  Through a sophisticated configuration and rules engine, our software can be deployed by a wide variety of customers with different business practices, without the need for costly customizations and source code changes.  This enables us to address the different needs of a diverse base of customers ranging from small emerging service firms to large complex global organizations across a variety of markets.

The Evolve solution can be licensed and deployed based upon pre-configured package options.  Specific features of the Evolve service delivery platform include:

Portfolio Management:  ensures that project investments are always aligned with corporate strategy through powerful, real-time executive scorecards and investment maps for tracking project key success factors, such as risk, value and performance. 

Opportunity Management:  controls and quantifies key front-end project planning activities, including modeling, evaluating and tracking individual project opportunities as well as forecasting, analyzing and managing the entire pipeline.  The demand planning and management capabilities supported by opportunity management provide the basis for successful portfolio management, capacity planning, resource management, project delivery and financial management.

Resource Management:  delivers enterprise-wide visibility into resource utilization and scheduling so that organizations can put the right people on the right projects at the right time.  Supported by a staffing workflow engine, Evolve's resource management capabilities drive timely resource assignment, project staffing and the efficient matching of the right workers, whether internal or outsourced, with the right projects in terms of skills, preferences, availability, resource costs and geographic locations.  In addition to these robust operational processes, these resource management capabilities extend to individual resource development with skill profiling & management, performance evaluations, and career planning & preferences while supporting matrixed resource relationships and personal profile management.

Project Delivery:  brings enterprise consistency and control to planning, estimating and delivering individual projects by leveraging hierarchical task management (work breakdown structures), estimate-to-complete processing, version controlled project budgeting, project performance scorecards, bi-directional synchronization with Microsoft Project, project collaboration spaces with deliverables management and project templates to support best practices.

Time & Expense Management:  enables fast, accurate time and expense entry and tracking based on project assignments and enables streamlined customer billing or chargebacks to corporate business units.  Our time & expense management capabilities are also available offline with work synchronized when reconnected to the Internet to effectively connect the mobile workforce.

Financial Management:  provides complete visibility and control over project budgets and financial performance across the global enterprise, with robust project budgeting, sophisticated project accounting, rich revenue recognition capabilities, invoicing, charge backs and expense reimbursement processing.  This financial information is made seamlessly available to enterprise accounting applications through delivered integration to accounts receivable, accounts payable and general ledger systems.

Knowledge Collaboration:  delivers convenient online and offline workspaces with knowledge management tools to help project teams collaborate on projects, boost quality, accelerate project delivery, and fully leverage the organization's intellectual assets and best practices.  The power of these collaborative workspaces are realized through discussion threads, topic subscription and notification, full text search with contextual search results and versioning, comments and approval for all project plans and deliverables.

Business Intelligence:  offers analytic capabilities into the wealth of information collected within the system to improve enterprise visibility and control over the service delivery process.  These capabilities include operational reporting, revenue and budget forecasting, performance and profitability reporting, resource utilization statistics, market segment analytics, capacity planning and project dashboards with key performance indicator trending. 

Professional Services

Our professional services organization has developed the RapidConnect implementation methodology to streamline implementations, institute best practices and allow our customers to rapidly configure and deploy our solution to  support their unique business needs.

We provide implementation consulting to ensure our customers receive the guidance and support they need to implement and operate our solution.  We have consultants who serve as engagement managers, project managers and technical and functional consultants during the deployment.  These professionals have domain expertise and can assist customers in planning, installing, configuring, deploying and upgrading their Evolve solution in order to achieve the greatest value and return on investment.  Depending on the complexity of the deployment with respect to the quantity of resources or projects to be managed, the level of integration with legacy systems, customer conversion requirements or operating environments, implementations of our software typically range from two to twelve months.

In addition to our internal professional services organization, we also have a network of business partners who are trained to implement the Evolve solution.  As a result, customers have available to them a broad offering of services to support successful Evolve implementations.

Education Services

We offer educational courses for product end-user training and technical training.  We provide instructor led offerings as well as train-the-trainer training.  We have standard course curricula and can also custom tailor classes to meet the needs of our customers.

We also provide product, technical and sales training for our alliance partners in order to educate them regarding our software.

Customer Support and Maintenance

We provide technical support and maintenance for our customers.  Customer support services are typically subject to an annual, renewable maintenance contract and are generally priced as a percentage of product license fees.  Customers current on maintenance contracts receive product upgrades or extensions and technical support without further cost.

We offer customer support services through a web-based on-line call tracking system that is accessible on a global 24x7 basis and is the primary access point for customers to log and track incidents.  Customers can also contact our Customer Support Center directly with priority, mission critical issues.  When a bug or issue is logged with Evolve Customer Support, it is assigned a priority level and an associated resolution response timeframe.

Technology

At the core of our service delivery platform is a highly adaptable, scalable, multi-tier, distributed, Internet-based architecture.  Our service delivery platform provides a common foundation on which Evolve products are built.  The underlying architecture is scalable to thousands of users and has been proven in large-scale enterprise rollouts.  Our platform includes support for the Microsoft Windows NT/2000/XP and Sun Solaris operating systems and Microsoft SQL Server and Oracle databases.

Our Service Delivery Platform includes the following components:

Evolve Server

Some of the key features of our Java-based application server include:

• the option of running multiple application servers to provide scalability for large sophisticated organizations;

• resource algorithms that reduce the time required to staff projects;

• a flexible object-based design allowing rapid incorporation of new features and functionality;

• java-based portability that provides flexibility to support multiple operating environments; and

• java-based presentation layer.

Configuration Application

Business Rules Repository

Our solution is designed to capture and store business information, rules and standards in a single, centralized repository that can be accessed by all functional modules.  This centralized information structure allows for rapid initial deployment and also facilitates adaptation to changes in the customer's organization and processes without source code modifications.  We believe this architecture will allow us to more easily extend our solution as we expand it to address specific vertical markets.

Web Services - Integration

Using Web services, we have begun to provide enhanced integration capabilities with enterprise applications within our customers' environments, such as sales force automation (SFA), customer relationship management (CRM), human resources (HR) and enterprise resource planning (ERP) systems.  We plan to focus on exposing the key business processes that most frequently interface with other enterprise applications.

Through Web services, customers will benefit from:

• simplified implementations;

• more ubiquitous interfaces and streamlined integration;

• rapid return on investment; and

• lower total cost of ownership. 

Web services are comprised of a set of open standards for implementing distributed applications, such as simple object access protocol (SOAP) and web service description language (WSDL).  These Web services standards and new services and protocols are being developed by a group of industry leaders who are spearheading their early creation and design efforts.  Evolve will adhere to the industry standards as they are registered and announced, mature and become universally adopted.

Evolve anticipates implementing and delivering Web services in a phased approach.  The first phase, offered in Evolve 5.5, focuses on interfaces with our customers' internal enterprise applications that are within the company firewall, and includes services for resource management, project management, client management, and opportunity management.  For this release, we delivered an Evolve web services programmatic interface based on open standards (SOAP, WSDL, XML) in order to address integration with HR, SFA, CRM and Project Accounting systems.  In future releases, Evolve expects to expand upon our Web services capabilities to enable further integration with third-party applications and supporting future Web services standards as they mature.

Connectors

Our solution provides connectors that support common industry standards and technologies such as Java database connectivity (JDBC), Open database Connectivity (ODBC), Structured Query Language (SQL) and Java.  These connectors allow for integration with:

• enterprise applications such as financial (e.g. accounts receivable, accounts payable, general ledger and project accounting), human resources and sales force automation systems;

• external databases or data marts.

Reporting & Analytics Engine

We have the ability to report on key data through our enterprise-class, web-based reporting engine.  Evolve bundles a leading report server in its service delivery platform in order to make sophisticated reporting available to our customers.  Reports are available through our browser-based client.  These reports provide views of the entire value chain, such as opportunity and revenue pipelines, utilization and profitability analysis, program/project performance and capacity planning.

Security Controller

Our integrated security and administration features store profiles and access rules within a centralized repository.  Customers can specify individual access rules for employees based on their position within their organization, as well as for customers, partners and other external parties.  Our systems support the lightweight directory access protocol (LDAP) security standard for universal sign-on and authentication functions.

Workflow Manager

Our platform provides sophisticated management of structured knowledge by capturing organizational processes and data in a notification-driven workflow management system.  Our platform incorporates an integrated messaging system that notifies users when actions, information or approvals are required.  Our Workflow Manager helps to streamline approval processes, monitor resources and facilitate collaboration among project team participants.

Knowledge Collaboration

A secure web-based workspace within our platform provides the ability to share information and work products among end users.  We provide a sophisticated database search and retrieval mechanism and the ability to submit information to the repository via an application user interface or via e-mail.

Global Support

Our product is globalized and is available in English, French, German, Italian and Spanish.  Evolve also provides multi-currency support for multinational enterprises, as well as globalization of date and number formats.

Research and Development

Since our inception in 1995, we have made substantial investments in research and product development.  We believe that our introduction of new and enhanced products will be a key factor for our future success.  Evolve engineering works closely with product management to formalize a product release plan.  The plan includes a roadmap for upcoming releases of Evolve based upon extensive input from current and prospective customers, industry analysts, partners and other industry thought leaders.  Through this intensive process we define the business requirements that each release of Evolve addresses.

Our solution consists of a combination of in-house developed software, embedded technology, and complementary third-party software products.  We've entered into certain OEM agreements to license and resell certain products to further our competitive advantage.  We also have platform and technology partnerships with Actuate, Microsoft, Oracle and Sun that are strategic to our research and development efforts.

Our engineering organization is grouped by focus area, including engineering development, architecture, engineering tools & services, functional testing, maintenance, technical publications and curriculum development, and program management.  We follow a product development lifecycle and release management methodology, including quality assurance processes.

After a critical review of our operations and cost structure, we closed our engineering development center in Chennai, India, in the quarter ending December 31, 2001.  We transferred all of the project work to our centralized engineering organization at Evolve headquarters.

We anticipate we will continue to commit substantial resources to research and development to respond quickly to rapid technological change, changing customer needs, frequent product introductions and evolving industry standards.  We expect to continue to invest our R&D resources to enhance our current solution, develop new products, and advance our underlying technology and architecture (e.g., expanded analytics, improved integration via Web services, etc.).  We cannot be certain, however, that these efforts or expenditures will result in existing or new customers embracing any enhancement or new release of our solution.

Sales and Marketing

Our primary target market is the Fortune 1000.  We sell our solution through our direct sales organization in both North America and the United Kingdom.  We are headquartered in Emeryville, CA, and have a small number of sales offices throughout the United States.

We also seek to augment our direct sales force with distribution channels to enhance our market presence.  The goal of our indirect sales efforts is to form alliances with partners who can introduce our solutions to their customer base, and to be able to offer to our customers additional software applications or consulting and support services from which they are likely to benefit.

To date, international sales have accounted for approximately two percent of our total revenues.  Our product is globalized and is available in English, French, German, Italian and Spanish.  Evolve also provides multi-currency support for multinational enterprises, as well as globalization of date and number formats.  To support our European customers, we maintain an office in the UK.  In the future, we anticipate strengthening our international presence through strategic alliances and new distribution channels.  In certain international markets, we may offer our products exclusively through resellers or distributors.

Evolve currently targets two primary market opportunities directly: (1) professional services organizations, including consulting companies and professional services divisions of technology companies, and (2) corporate IT organizations in Fortune 1000 companies.  These market segments can be further divided into vertical markets such as financial services, telecommunications, utilities, pharmaceuticals, healthcare, advertising and the public sector.

Our sales process includes an integrated team from our sales and professional services organizations.  An account executive is assigned to a prospect with responsibility for managing the account throughout the sales cycle.  We also have an experienced team of pre-sales solution architects who assist with product demonstrations and presentations and respond to customer requests for proposals.  Our solution architects work closely with prospects to understand their business environment and requirements and demonstrate how our solution addresses their needs.  In the lead generation stage of the sales cycle, we rely on our marketing and sales development professionals to perform prospecting and telesales.

The level of customer analysis and financial commitment required for many of our product implementations has caused our sales cycle to range from two to twelve months.  We follow a structured sales process beginning with lead qualification.  Initial sales activities typically include a high level overview of Evolve and our solution.  This is followed by a demonstration of our product capabilities and one or more detailed technical reviews.  Throughout the sales cycle, our sales team typically approaches management professionals within a prospect's organization, such as project managers, directors, or vice presidents.  We often also engage with prospects' senior management, including the chief executive officer, chief information officer, chief operating officer and chief financial officer.  We demonstrate our product to both functionally-oriented business users as well as to technically-focused information technology personnel.  Our sales process requires that we work closely with prospects to identify short-term needs and long-term goals.

We use a variety of marketing programs and campaigns to build awareness of our company, our brand and our products, as well as to attract potential customers.  These programs include advertising, seminars, trade shows, market research, analyst relations, public relations, product launch events, direct mail programs, telesales, speaking engagements and web-based marketing.  Our marketing organization also produces marketing collateral, including brochures, data sheets, white papers, presentations, customer case studies, ROI studies and demonstrations.

Customers

Our customers primarily include consulting firms, the services organizations of technology companies and the internal IT organizations within Fortune 1000 companies.  Our customers include a diverse set of small, medium and large organizations, ranging from high tech, financial services, professional services, automotive, communications, consumer goods, transportation, manufacturing, utilities, government and pharmaceuticals.  A number of our customers are global and leverage the Evolve solution to manage their operations on a worldwide basis.

Our solution has been readily adopted in each of the two primary market opportunities we target.  Representative professional services organizations include EDS, Sogeti (a wholly-owned subsidiary of Cap Gemini S.A.), IconMedialab and NCS Technologies.  Internal, or embedded service divisions of technology companies include Sun, Novell, Siemens, Ericsson and Autodesk.  Representative corporate IT customers include American Electric Power, Daimler Chrysler Services, Mattel, and Fleet Capital Leasing.

In the past, a small number of customers have contributed a substantial portion of our revenues in each fiscal period.  For each of the years ended June 30, 2002 and 2001, sales to one customer accounted for 14% of total revenues.  For the fiscal year ended June 30, 2000, sales to two customers accounted for 19% and 13% of our total revenues.  During the immediate near term, we expect that our concentration of customer sales will remain consistent with these levels.  Accordingly, the loss of a single customer or customer prospect may have a substantial impact on our operating results during a given fiscal period.  Over time, we anticipate increasing our overall customer base, which should reduce our reliance upon any one customer for revenues.

Business Partner Program

We seek to establish strategic relationships that can demonstrate tangible return on investment and provide direct business value for our customers.  We recently introduced our Business Partner Program targeted at four types of partners: solution, complementary software, platform and technology, and alliance partners.  Solution partners have systems integration expertise and manage customer implementations and supporting business process consulting.  Complementary software partners extend our core capabilities.  Platform and technology partners contribute tools, embedded functionality and platform technology that Evolve uses to develop product offerings.  Alliance partners join Evolve with the vision and equity needed to leverage new opportunities for mutual benefit.

Partners in the program commit to certifying a number of resources on Evolve solutions, and creating a co-branded practice based on Evolve's software and implementation methodology.

Partners participate in the program at one of three levels, based on their commitment.  Foundation partners receive training, certification and joint sales and marketing support.  Advanced partners receive additional training and engage in strategic selling opportunities with Evolve.  Premier partners receive a dedicated Evolve relationship manager and participate in yearly strategic planning meetings to target activity.  Advanced and premier membership is by invitation only.

Acquisitions

On June 29, 2001, we acquired the core assets of Vivant Corporation, a market leader in contingent workforce procurement software.  The acquisition positions us competitively to offer a comprehensive solution for staffing projects with both in-house resources and  contingent labor.

We paid $2.7 million in stock and cash plus certain future contingent payments to acquire Vivant's contractor management technology, including the Vivant Enterprise Service and the Vivant Marketplace Service.  We also hired several key Vivant employees.

Competition

The market for service delivery automation applications is intensively competitive and subject to rapid changes.  Competition could seriously harm our ability to sell additional software solutions on prices and terms favorable to us.  We currently compete with three primary types of software vendors:

• providers of enterprise application software such as PeopleSoft, Siebel, Lawson, Oracle and SAP;

• providers of professional services automation software such as Niku, Business Engine, Changepoint, Novient/Solution 6, PlanView; and

• providers of project management software such as Artemis, Microsoft and Primavera.

In addition to competing with independent software vendors, we also compete with the in-house IT departments of prospective customers that have developed "home grown" systems that substitute for some of the functionality of our solution.

At this time, there is no single dominant software provider in our market.  Some of our competitors' products may be more effective than our products at performing specific functions, or may be customized for particular vertical markets or tailored for certain business processes.  Even if a competitor's functionality is more limited or harder to use than what is provided by our products, our competitors' software could still discourage potential customers from purchasing our products if their solution offers other capabilities that are appealing to the customer.  Prospects may also decide to purchase the competition's product in order to reduce the number of different vendors of software necessary to effectively run their businesses.  Additionally, prospects may choose a competitor over Evolve as a result of their brand recognition, the size or quality of their existing customer base or other factors such as geographical location(s), company size or prior established relationships.

Any of our competitors may expand their technologies or product footprints, acquire companies, or develop partner relationships to obtain greater functionality and capability.  Some of our competitors have longer operating histories, greater name recognition and significantly greater financial, technical, marketing or other resources than we do.  Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements.  Many of our competitors have made and may continue to make strategic acquisitions or establish cooperative relationships among themselves or with other software vendors.  They may also establish or strengthen cooperative relationships with our current or future strategic partners, thereby limiting our competitive advantage or our ability to exclusively promote the value of the relationship.  There has been consolidation in the industry over the last year, which we expect will continue.

We believe that the primary competitive factors in our market include:

• a critical mass of brand name customers that have successfully implemented Evolve solutions and are referenceable;

• a robust software architecture that provides for enterprise scalability;

• breadth and depth of product functionality;

• superior  quality, performance and usability;

• best-in-class customer service and support;

• a highly skilled, seasoned and knowledgeable sales force;

• ease of integration with  customers' existing systems environment; and

• a competitive pricing and packaging model.

We cannot ensure our competitiveness in the face of significant current and future competition.  Many of our current competitors have more extensive customer bases, more financial resources, and longer operating histories that may be leveraged to gain market share that may adversely affect our position.  Competition may also result in pricing pressures that may affect gross margins to our detriment.

We believe our current solution competes favorably with respect to these factors, although our market is relatively new and evolving rapidly.  In order to sustain a market advantage and to compete effectively, we must continue to differentiate our products and services in the marketplace through best of breed technology leadership, development of comprehensive solution offerings, and highly effective sales and marketing execution.

Intellectual Property

Our success is dependent on our ability to develop and protect our proprietary technology and intellectual property rights.  We seek to protect our software, documentation and other written materials primarily through a combination of patent, trade secret, trademark and copyright laws, confidentiality procedures and contractual provisions.  For example, we license rather than sell our software and require licensees to enter into license agreements that impose certain restrictions on the licensees' ability to utilize the software.  In addition, we seek to avoid disclosure of our trade secrets by, among other things, requiring persons with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code.

We have two patent applications pending in the United States with respect to the "Team Builder" functionality in our Resource Manager module and the time and expense functionality of our Time and Expense module.  We have been issued a patent in the United States covering the enablement of dynamically configurable software systems by our Evolve software server.  We cannot assure you that the issued patent or either of the two applications would survive a legal challenge to its validity or provide significant protection to us.  Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary.  Policing unauthorized use of our products is difficult.  While we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem, particularly in foreign countries where the laws may not protect proprietary rights as fully as in the United States.  We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not reverse engineer or independently develop similar technology.

It is also possible that third parties will claim that we have infringed their current or future products or technologies.  We expect that enterprise application software developers will increasingly be subject to infringement claims as the number of products in different industry segments overlap.  Any claims, with or without merit, could be time-consuming, result in costly litigation, prevent product shipment, cause delays, or require us to enter into royalty or licensing agreements, any of which could harm our business.  Patent litigation, in particular, has complex technical issues and inherent uncertainties.  In the event an infringement claim against us was successful and we could not obtain a license on acceptable terms or license a substitute technology or redesign our product to avoid infringement, our business could be harmed.

We rely on software that we have licensed from third parties, including, but not limited to, Actuate, Allaire, Intraspect, and ProSight, to perform key functions of our solution and we rely on these and other third parties to support their products for our development and customer support efforts.  These companies could terminate our licenses if we breach our agreements with them, or they could discontinue support of the products we license from them.  This could result in delays or reductions of sales or shipments of our products until alternative software can be developed or licensed.

We indemnify some of our customers against claims that our products infringe upon the intellectual property rights of others.  We could incur substantial costs in defending our company and our customers against infringement claims.  In the event of a claim of infringement, we, or our customers, may be required to obtain one or more licenses from third parties.  We cannot assure you that such licenses could be obtained from third parties at a reasonable cost, or at all.  Defense of any lawsuit or failure to obtain any such required license could have a material adverse effect on our business.

Employees

As of June 30, 2002, we had a total of 130 full-time employees, including 63 in research and development, 36 in sales, marketing and business development, 15 in professional services and 16 in finance and administration.  None of our employees is subject to a collective bargaining agreement.  We consider our employee relations to be good.

FACTORS THAT MAY AFFECT FUTURE RESULTS

We may need additional capital to fund continued business operations at their current levels in fiscal 2003 and such financing may not be available on favorable terms, if at all.

The rate at which our capital is utilized is affected by the level of our fixed expenses, including employee related expenses and expenses relating to real estate and variable expenses.  We have used substantial capital to fund our operating losses.  Since inception, we have experienced negative cash flows from operations and expect to experience negative cash flows from operations for the foreseeable future.  Of our cash and cash equivalents balance of $8.7 million on June 30, 2002, $2.6 million is held under a term loan facility.  In August 2002, we completed a private placement of shares of Series B Preferred Stock for total proceeds of $7.5 million.  Additional capital may be required if one or more of the following occur:

• our revenues from the sale of our products fall below our current expectations because of the current economic slowdown or otherwise;

• forecasted cash collections from customers decline if some of our customers become insolvent or encounter financial difficulties;

• we are not able to significantly reduce our expenses or cannot reduce them in the timeframe required;

• we are unable to comply with the financial and other covenants required under our existing credit facilities causing us to be in default; or

• we encounter opportunities that we wish to pursue to acquire other businesses or technologies for cash.

We believe our capital resources are adequate for the 2003 fiscal year, however, if we need additional funds and cannot raise them in a timely manner or at all, we may not be able to continue our operations at our current level or at all.  If any additional equity financing is raised it would be dilutive to existing shareholders.

Our future operating results may fluctuate due to many factors, and any of these could cause our stock price to fall.

We believe that year-over-year comparisons of our operating results are not a good indication of future performance.  Our operating results may fluctuate due to factors beyond our control and, as a result, the price of our common stock may fall.  Factors that may cause our future operating results to be below our expectations and cause our stock price to fall include:

• the lack of demand for and acceptance of our products, product enhancements and services;

• unexpected changes in the development, introduction, timing and competitive pricing of our products and services or those of our competitors;

• any inability to expand our direct sales force and indirect marketing channels both domestically and internationally;

• difficulties in recruiting and retaining key personnel;

• lengthening of our sales cycles;

• unforeseen reductions or reallocations of our customers' information technology infrastructure budgets; and

• any delays or unforeseen costs incurred in integrating technologies and businesses we may acquire.

We plan to aggressively and prudently manage our operating expenses with a focus on our research and development organization and our direct sales group.  Our operating expenses are based on our expectations of future revenues and are relatively fixed in the short-term.  If revenues fall below our expectations in any quarter, and we are not able to quickly reduce our spending in response, our operating results for that quarter will be harmed.

We have incurred losses since inception, and we may never become profitable.

We have incurred net losses and losses from operations since our inception in 1995, and we may never be profitable.  As of June 30, 2002, we had an accumulated deficit of approximately $255 million.  Since inception, we have funded our business primarily from the sale of our stock and by borrowing funds, not from cash generated by our business.  Despite recent cost reductions, we expect to continue to incur significant sales and marketing, research and development, and general and administrative expenses.  As is the case with many enterprise software companies, our revenues declined during the 2002 fiscal year and we may experience further declines or insufficient revenue growth in future periods.  As a result, we expect to experience continued losses and negative cash flows from operations.  If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future.

Reductions in capital spending by corporations could reduce demand for our products.

Historically, corporations and other organizations have tended to reduce or defer major capital expenditures in response to slower economic growth or recession.  Market analysts have observed a significant reduction in the growth of corporate spending on information technology projects in response to the current economic slowdown.  To the extent that current economic uncertainty persists, some of the prospective customers in our current sales pipeline could choose to postpone or reduce orders for our products, or may delay implementing our solutions within their organizations.  In addition, existing customers seeking to reduce capital expenditures may cancel or postpone plans to expand the use of our products in additional operating divisions, or may defer plans to purchase additional modules of our solutions.  Any of the foregoing would have an adverse impact on our revenues and our operating results.

We may lose existing customers or be unable to attract new customers if we do not develop new products or enhance our existing products.

If we are not able to maintain and improve our existing products and develop new products, we may lose existing customers or be unable to attract new customers.  We may not be successful in developing and marketing product enhancements or new products on a timely or cost-effective basis.  These products, if developed, may not achieve market acceptance.

A limited number of our customers expect us to develop product enhancements that address their specific needs.  If we fail to deliver these enhancements on a timely basis, we risk damaging our relationship with these customers.  We have experienced delays in the past in releasing new products and product enhancements and may experience similar delays in the future.  These delays or problems in the installation or implementation of our new releases may cause some of these customers to forego additional purchases of our products or to purchase those of our competitors.

Significant turnovers in senior management and sales force could affect our ability to successfully grow our business.

We have experienced significant turnover in our senior management in the last fiscal year and may continue to experience changes in our management team.  In March 2002, we hired a new Chief Executive Officer.  In April 2002, we hired new Vice Presidents of Sales, Marketing and Business Development.  In July 2002, we hired a new Chief Financial Officer.  We believe that retention of qualified senior management is essential to our success.  Our business could be seriously harmed if we are not successful in integrating the recently appointed executives into our company.  To integrate into our company, new senior management personnel must spend a significant amount of time learning our business model and management system, in addition to performing their regular duties.  Accordingly, until these individuals have become familiar with our business model and systems, their integration may result in some disruption to our ongoing operations.  The departure of senior management personnel could result in a loss of confidence in our company by customers, suppliers and partners. 

We also have experienced significant turnover in our sales force in the last fiscal year and may continue to experience turnover in our sales force.  In order to reduce expenses, we reduced our sales force headcount significantly in the last fiscal year.  Our success has always depended in large part on our ability to attract and retain highly skilled sales personnel.  Loss of sales representatives could harm our relationship with the customers they serve.  Reduction in sales force may impact our revenue growth.  Further, new sales personnel require extensive training to become fully productive.  If we are unable to hire, retain and continue to develop our sales force, it could have a material adverse effect on our business.

Financial difficulties of some of our customers may adversely affect our operating results.

As public valuations for many businesses have declined substantially in recent months, some of our customers may encounter difficulties in securing additional financing to meet their obligations, or may seek to limit expenditures to conserve their cash resources.  As a result, we may encounter difficulties in securing payment of certain customer obligations, when due, and may be compelled to increase our bad debt reserves.  Any difficulties encountered in collections from customers would also adversely affect our cash flow and our operating results.

If the market for service delivery solutions for internal IT, professional services and other strategic workforces within the Fortune 1000 companies does not continue to grow, the growth of our business will not be sustainable.

The future growth and success of our business is contingent on the growing acceptance of, and demand for, service delivery automation solutions for internal IT, professional services and other strategic workforces within Fortune 1000 companies.  A significant portion of our historical revenues have been attributable to the sale of automation solutions for professional services organizations.  This is a relatively new enterprise application solution category, and it is uncertain whether major services organizations as well as service departments and internal departments of major corporations will choose to adopt service delivery automation systems.  While we have devoted significant resources to promoting market awareness of our products and the problems our products address, we do not know whether these efforts will be sufficient to engender significant demand in the market for our products.  Accordingly, the market for our products may not grow or, even if the market does grow in the near term, that growth may not be sustainable.

Our inability to attract and retain qualified personnel could affect our ability to successfully grow our business.

If we are unable to hire and retain a sufficient number of qualified personnel, particularly in sales, marketing, research and development, services and support, our ability to grow our business could be affected.  The loss of the services of our key engineering, sales, services or marketing personnel would harm our operations.  For instance, loss of sales and customer service representatives could harm our relationship with the customers they serve, loss of engineers and development personnel could impede the development of product releases and enhancements and decrease our competitiveness, and departure of senior management personnel could result in a loss of confidence in our company by customers, suppliers and partners.  None of our key personnel is bound by an employment agreement, and we do not maintain key person insurance on any of our employees.  Because we, like many other technology companies, rely on stock options as a key component of our employee compensation, if the market price of our common stock decreases or increases substantially, some current or potential employees may perceive our equity incentives as less attractive.  In that case, our ability to attract and retain employees may be adversely affected.

If we fail to expand our relationships with third-party resellers and integrators, our ability to grow revenues could be harmed.

In order to grow our business, we must establish, maintain and strengthen relationships with third-parties, such as information technology consultants and systems integrators as implementation partners, and hardware and software vendors as marketing partners.  If these parties do not provide sufficient, high-quality service or integrate and support our software correctly, our revenues may be harmed.  In addition, these parties may offer products of other companies, including products that compete with our products.  Our contracts with third parties may not require these third parties to devote resources to promoting, selling and supporting our solutions, or may be terminated by either party with little or no penalty or prior notice and do not provide for minimum payments to us.  These companies may not devote adequate resources to selling or promoting our products and services and may promote the products or services of several different companies, including, in some cases, products or services that compete with our products and services.  We may not be able to maintain these relationships or enter into additional relationships in the future.  Therefore, we may have little control over these third parties.  We cannot assure you that we can generate and maintain relationships that offset the significant time and effort that are necessary to develop these relationships, or that, even if we are able to develop such relationships, these third-parties will perform adequately.

We may not be able to increase our revenues or manage our operating expenditures as planned and we may need to implement additional restructuring activities.

We are attempting to increase our revenues through marketing initiatives as well as increase the scope of our customer base to include Fortune 1000 companies and internal IT organizations.  We will need this revenue growth to meet our positive cash flow from operations targets.  Because of market uncertainties and a highly competitive environment, we cannot be certain we will achieve these targets.  In order to achieve positive cash flows from operations, we will also need to achieve our revenue growth targets and maintain our operating cost structure in future quarters.  In response to the current uncertain economic environment and volatility in the public equity markets, we implemented significant measures designed to reduce our operating expenses and enhance our ability to attain operating profitability.  In addition, if our revenue growth targets cannot be achieved, we would be forced to seek expense reductions in excess of our current plans, which may not be achievable.

The lengthy and unpredictable sales cycles for our products and resistance to adoption of our software could cause our operating results to suffer.

Our operating results for future periods could be adversely affected because of  the unpredictability of our sales cycles.  Our products and services have lengthy and unpredictable sales cycles varying from as little as two months to as much as twelve months.  Because we are unable to control many of the factors that will influence our customers' buying decisions, it is difficult for us to forecast the timing and recognition of revenues from sales of our software solutions.

Customers in our target market often take an extended time evaluating our products before purchasing them.  Our products may have an even longer sales cycle in international markets.  During the evaluation period, a variety of factors, including the introduction of new products or aggressive discounting by competitors and changes in our customers' budgets and purchasing priorities, may lead customers to not purchase or to scale down orders for our products.

Because we are pioneering a new solution category, we often must educate our prospective customers on the use and benefit of our solutions, which may cause delays during the product evaluation process.  Prospective companies may be reluctant to abandon investments they have made in other systems in favor of our solution.  In addition, IT departments of potential customers may resist purchasing our solutions for a variety of other reasons, particularly the potential displacement of their historical role in creating and running software, and concerns that packaged software products are not sufficiently customizable for their enterprises.

Our services revenues have a substantially lower margin than our software license revenues, and an increase in the proportion of services revenues relative to license revenues will harm our gross margin.

A significant shift in our revenue mix away from license revenues to services revenues would adversely affect our gross margins.  Revenues derived from the services we provide have substantially lower gross margins than revenues we derive from licensing our software.  The relative contribution of services we provide to our overall revenues is subject to significant variation based on the structure and pricing of arrangements we enter into with customers in the future, and the extent to which our partners provide implementation, integration, training and maintenance services required by our customers.  An increase in the percentage of total revenues generated by the services we provide will adversely affect our overall gross margins.

Our markets are highly competitive, and competition could harm our ability to sell products and services and reduce our market share.

Competition could seriously harm our ability to sell additional software solutions and subscriptions on prices and terms favorable to us.  The markets for our products are intensely competitive and subject to rapidly changing technology.  We currently compete against providers of automation solutions for professional services organizations, such as Changepoint, Niku, Business Engine and Planview.  In addition, we are facing increasing competition from providers of enterprise application software vendors such as Peoplesoft, Siebel and SAP.  Companies in each of these areas may expand their technologies or acquire companies to support greater professional services automation functionality and capabilities.  In addition, "in-house" information technology departments of potential customers have developed or may develop systems that substitute for some of the functionality of our product line.

Some of our competitors' products may be more effective than our products at performing particular functions or be more customized for particular customer needs.  Even if these functions are more limited than those provided by our products, our competitors' software products could discourage potential customers from purchasing our products.  A software product that provides some of the functions of our software solutions, but also performs other tasks may be appealing to these vendors' customers because it would reduce the number of different types of software necessary to effectively run their businesses.  Further, many of our competitors may be able to respond more quickly than we can to changes in customer requirements.

Some of our competitors have longer operating histories, significantly greater financial, technical, marketing or other resources, or greater name recognition.  This may cause potential customers to purchase their products even if their products provide inferior features or functionality.  Customers seeking financial stability in a vendor may select one of our more established competitors.  In addition, competitors with greater resources may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements.  Our competitors have made and may also continue to make strategic acquisitions or establish cooperative relationships among themselves or with other software vendors.  They may also establish or strengthen cooperative relationships with our current or future partners, limiting our ability to promote our products through these partners and limiting the number of consultants available to implement our software.

Our revenues depend on orders from our top customers, and if we fail to secure one or more orders, our revenues will be reduced.

Historically, we have received a significant portion of our revenues in each fiscal period from a small number of customers.  Accordingly, the loss of a single customer or customer prospect may have an impact on our operating results if we depended on the sale of our products to that customer to meet our financial performance targets during a given fiscal period.  Our agreements with existing customers often do not include long-term commitments from customers to continue to purchase our products.  Moreover, a substantial percentage of new customer contracts are typically signed in the last few weeks of each fiscal quarter, and prospects we are pursuing have often made a decision not to purchase our products in the final stages of the sales cycle.  Accordingly, our ability to meet our financial targets during each fiscal period is subject to substantial variation and uncertainty, and the loss of one or more customers or customer prospects can cause our operating results to fall below the expectations of investors and adversely affect our stock price.

If our products do not stay compatible with widely used software programs, our revenues may be adversely affected.

Our software products must work with widely used software programs.  If these software programs and operating environments do not remain widely used, or we do not update our software to be compatible with newer versions of these programs and systems, we may lose customers.

Our software operates only on a computer server running both the Microsoft Windows NT or Sun Solaris operating system and database software from Microsoft or Oracle.  In order to increase the flexibility of our solution and expand our client base, we must be able to successfully adapt our software to work with other applications and operating systems. 

Our software connects to and uses data from a variety of our customers' existing software systems, including systems from Oracle and SAP.  If we fail to enhance our software to connect to and use data from new versions of these products, we may lose potential customers.

The cost and difficulties of implementing our products could significantly harm our reputation with customers and harm our future sales.

If our customers encounter unforeseen difficulties or delays in deploying our products and integrating them with their other systems, they may reverse their decision to use our solutions, which would reduce our future revenues, could impact the collection of outstanding receivables, and damage our reputation.  Factors that could delay or complicate the process of deploying our solutions include customers:

• needing to modify significant elements of their existing IT systems in order to effectively integrate them with our solutions;

• needing to establish and implement internal business processes within their organizations before they can make effective use of our software;

• needing to purchase and deploy significant additional hardware and software resources and to make significant investments in consulting and training services; and

• relying on third-party systems integrators to perform all or a portion of the deployment and integration work, reducing the control we have over the implementation process and the quality of customer service provided to the customer.

If our products contain significant defects or our services are not perceived as high quality, we could lose potential customers or be subject to liability.

Our products are complex and may contain errors, defects, integration problems or other types of failures, particularly when new versions are released.  In the past we have discovered software errors in some of our products after introduction.  We may not be able to detect and correct errors before releasing our products commercially.  If our commercial products contain errors, we may:

• need to expend significant resources to locate and correct the errors;

• be required to delay introduction of new products or commercial shipment of products; or

• experience reduced sales and harm to our reputation from dissatisfied customers.

Our customers also may encounter system configuration problems that require us to spend additional consulting or support resources to resolve these problems.

Because our customers use our software products for critical operational and decision-making processes, product defects may also give rise to product liability claims.  Although our license agreements with customers typically contain provisions designed to limit our exposure, some courts may not enforce all or part of these limitations.  We may encounter product liability claims in the future which, whether or not they have merit, could:

• divert the attention of our management and key personnel from our business;

• be expensive to defend; and

• result in large damage awards.

Defects or errors could also result in tort or warranty claims.  Warranty disclaimers and liability limitation clauses in our customer agreements may not be enforceable.  Furthermore, our errors and omissions insurance may not adequately cover us for claims.  If a court were to refuse to enforce the liability-limiting provisions of our contracts for any reason, or if liabilities arose that were not contractually limited or adequately covered by insurance, our business could be harmed.

Our business may suffer if we are not able to protect our intellectual property.

Our success is dependent on our ability to develop and protect our proprietary technology and intellectual property rights.  We seek to protect our software, documentation and other written materials primarily through a combination of patent, trade secret, trademark and copyright laws, confidentiality procedures and contractual provisions.  While we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be completely successful in doing so.  Further, our competitors may independently develop or patent technologies that are equivalent or superior to ours.

We have been issued a patent in the United States covering the enablement of dynamically configurable software systems by our Evolve software server.  We also have two patent applications pending in the United States with respect to the "Team Builder" functionality in our Resource Manager module and the time and expense functionality of our Time and Expense module.  We cannot assure you that either of these two applications would survive a legal challenge to its validity or provide significant protection to us.  Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary.  Policing unauthorized use of our products is difficult.  While we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem, particularly in foreign countries where the laws may not protect proprietary rights as fully as in the United States.  We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not reverse engineer or independently develop similar technology.

If others claim that we are infringing their intellectual property, we could incur significant expenses or be prevented from selling our products.

We cannot assure you that others will not claim that we are infringing their intellectual property rights or that we do not infringe those intellectual property rights.  We have not conducted a search for existing intellectual property registrations, and we may be unaware of intellectual property rights of others that may cover some of our technology.

Any litigation regarding intellectual property rights could be costly and time-consuming and divert the attention of our management and key personnel from our business operations.  The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks.  Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements.

We may not be able to obtain royalty or license agreements on terms acceptable to us, or at all.  We also may be subject to significant damages or an injunction against the use of our products.  A successful claim of patent or other intellectual property infringement against us could have an immediate material adverse effect on our business and financial condition.

We continue to operate internationally, but we may encounter a number of problems in doing so which could limit our future growth.

We may not be able to successfully market, sell, deliver and support our products and services internationally.  Any failure to grow and manage effective international operations could limit the future growth of our business.  Expansion into international markets would require significant management attention and financial resources to open additional international offices and hire international sales and support personnel.  Doing business internationally involves greater expense and many additional risks, particularly:

• differences and unexpected changes in regulatory requirements, taxes, trade laws, tariffs, intellectual property rights and labor regulations;

• changes in a specific country's or region's political or economic conditions;

• greater difficulty in establishing, staffing and managing foreign operations; and

• fluctuating exchange rates.

Security concerns, particularly related to the use of our software on the Internet, may limit the effectiveness of and reduce the demand for our products.

Despite our efforts to protect the confidential and proprietary information of our customers, there is a risk that this information will be disclosed to unintended third-party recipients.  To the extent our ability to implement a secure application environment is impaired by technical problems, or by improper or incomplete procedural diligence by either ourselves or our customers, sensitive information could be exposed to inappropriate third parties such as competitors of our customers, which may in turn expose us to liability and detrimentally impact our customers' confidence in our software.

Resistance to online use of personal information regarding employees and consultants may hinder the effectiveness of and reduce demand for our products and services.

Companies store information on our application service provider offering and on online networks created by our customers, which may include personal information of their employees, including employee backgrounds, skills, and other details.  These employees may object to online compilation, transmission and storage of such information.  To the extent that European companies and customers will have access to it (given the global nature of the Internet), and to the extent that our services are utilized by Europeans, legal action grounded in European privacy laws could prevent our solution from succeeding in the European market.

RISKS RELATED TO OUR STOCK

Our officers, directors and affiliated entities have significant control over us and may approve or reject matters contrary to your vote or interests.

Our executive officers and directors together with their affiliates beneficially own, or have rights to acquire, an aggregate of approximately 76% of our outstanding capital stock.  These stockholders, if acting together, will be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or similar transactions, even if other stockholders disagree.  In particular, Warburg Pincus Private Equity VIII, L.P.  ("Warburg") owns or has the right to acquire securities with voting power equivalent to 67% of our outstanding capital stock.  Furthermore, certain actions that we may wish to undertake require the consent of holders of a majority of our outstanding shares of our preferred stock.  These actions include authorization and sale of certain senior securities, certain transactions involving a change of control of Evolve, the incurrence of significant indebtedness and the payment of dividends.  With respect to these and other matters, the interests of the holders of our Series A and Series B Preferred Stock will not necessarily be identical to those of holders of our common stock.  For instance, in the event of certain change of control transactions, the holders of Series A and Series B Preferred Stock are entitled to payment of a liquidation preference prior to payment of any consideration to the holders of our common stock.  This may cause the holders of Series A and Series B Preferred Stock generally, and Warburg in particular, to favor or oppose a merger or sale of Evolve or its assets in circumstances where many holders of common stock have a conflicting interest.  In such an instance, we may not be able to pursue a transaction even if it is supported by many or most holders of our common stock.  Alternatively, we may pursue a transaction that is not supported by, or may be detrimental to, the holders of our common stock.

The sale of a substantial number of shares of common stock or preferred stock could cause the market price of our common stock to decline.

Sales of a substantial number of shares of our common stock in the public market, or the appearance that such shares are available for sale, could adversely affect the market price for our common stock.  The market price of our stock could also decline if one or more of our significant stockholders decided for any reason to sell substantial amounts of our stock in the public market.  As of June 30, 2002, we had 44,836,414 shares of common stock outstanding.  Of these shares, 44,278,571 were freely tradable in the public market, either without restriction or subject, in some cases, only to S-3 prospectus delivery requirements, and, in other cases, only to either manner of sale, volume, or notice requirements of Rule 144 under the Securities Act of 1933.  An additional 557,843 shares will become eligible for sale, subject only to the manner of sale requirements of Rule 144, as our right to repurchase these shares lapses over time with the continued employment by Evolve of these stockholders.  As of June 30, 2002, we also had 12,788,396 shares subject to outstanding options under our stock option plans (plus 4,006,875 shares subject to options and warrants issued outside of any plan), and 7,110,542 shares are available for future issuance under these plans.  We also have 1,875,000 shares of Series A Preferred Stock outstanding, which as of August 31, 2002, were convertible into 53,454,064 shares of common stock.  We also have 750,000 shares of Series B Preferred Stock outstanding, which as of August 31, 2002, were convertible into 39,473,684 shares of common stock.  As of June 30, 2002, we also had warrants outstanding to purchase a total of 9,375,000 of our common stock and warrants to purchase up to 575,000 shares of Series A Preferred Stock, which as of August 31, 2002, were convertible to up to 15.5 million shares of common stock.  If all the warrants for the Series A Preferred Stock are exercised in full, additional common stock warrants for up to 3,885,135 shares of our common stock will be issued.

Nasdaq listing may be at risk.

On July 10, 2002, we transferred our stock listing from the Nasdaq National Market to the Nasdaq SmallCap Market.  On August 21, 2002, we received a letter from the Nasdaq Stock Market indicating that we had until February 10, 2003, to maintain a minimum closing bid price of $1.00 or more over ten consecutive trading days as required by the Nasdaq SmallCap Market.  In order to maintain compliance with the Nasdaq listing requirements, we may be required to take various measures including raising additional capital and effecting a reverse split of our common stock.  Certain of such measures, including any reverse stock split, would require stockholder approval.  If we are unable to demonstrate compliance with any Nasdaq requirement, we may be delisted from the Nasdaq SmallCap Market.  In such event, trading volumes in our stock may be significantly diminished and a market for our stock may not develop.

Item 2. Properties

As of June 30, 2002, Evolve's headquarters and principal research and development, finance and administrative and marketing operations were located in approximately 35,000 square feet of office space in Emeryville, California.  In September 2002, we entered into an agreement to move our headquarters to 25,000 square feet of leased office space in San Francisco, California.  This new property is adequately sized for our current organization and we expect it to provide a more efficient working environment.  This transition is expected to be substantially complete by October 31, 2002.  We also maintain sales organizations in various locations around the United States and the United Kingdom, none of which is significant individually or in the aggregate.

Item 3.  Legal Proceedings

From time to time, we become involved in litigation relating to claims arising from the ordinary course of business.  At June 30, 2002, we were defending a claim filed by an early customer in the federal district court in Massachusetts.  The customer has alleged a variety of claims including that the software and services purchased from us did not satisfy certain contractual obligations, and that we engaged in practices that they allege were unfair.  The court granted our motion to dismiss several of the claims.  We believe that the plaintiff's claims are without merit, and we intend to defend vigorously against them.

In November 2001, a complaint seeking class action status was filed against us in the United States District Court for the Southern District of New York.  The complaint is purportedly brought on behalf of all persons who purchased our common stock from August 9, 2000, through December 6, 2000.  The complaint names as defendants some of our former and current officers and several investment banking firms that served as managing underwriters of our initial public offering.  Among other claims, the complaint alleges liability under the Securities Act of 1933 and the Securities Exchange Act of 1934, on the grounds that the registration statement for our initial public offering did not disclose that:  (1) the underwriters had allegedly agreed to allow certain of their customers to purchase shares in the offering in exchange for alleged excess commissions paid to the underwriters; and (2) the underwriters had allegedly arranged for certain of their customers to purchase additional shares in the aftermarket at pre-determined prices under alleged arrangements to manipulate the price of the stock in aftermarket trading.  We are aware that similar allegations have been made in numerous other lawsuits challenging initial public offerings conducted in 1998, 1999 and 2000.  No specific amount of damages is claimed in the complaint involving the initial public offering.  We intend to contest the claims vigorously.  We are unable, at this time, to determine whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period. 

We believe that there are no other claims or actions pending or threatened against us, the ultimate disposition of which would have a material adverse effect on us or our reported financial results.

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

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2002.

PART II

Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters

Our common stock is listed on the Nasdaq SmallCap Market under the symbol "EVLV."  The price range per share reflected in the table below represents the highest and lowest bid prices for our stock as reported by the Nasdaq SmallCap Market or the Nasdaq National Market, as the case may be, during each quarter the stock has been publicly traded since August 10, 2000, the date of our initial public offering:

High

Low 

The number of holders of record of the shares of our common stock was 746 as of August 31, 2002.  There are approximately 3,100 additional beneficial owners of our common stock.

We have not paid any cash dividends on our capital stock.  We currently intend to retain any earnings to fund the development and growth of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future as our bank credit agreements prohibit payment of cash dividends. 

Recent Sales of Unregistered Securities

On April 3, 2002, an investor acquired 25,000 shares of our Series A Preferred Stock at a price of $10 per share, for total proceeds to us of $250,000 via the exercise of preferred stock warrants.

In August 2002, we completed a private placement of shares of Series B Preferred Stock pursuant to a Series B Preferred Stock Purchase Agreement, with existing investors.  We sold an aggregate of 750,000 shares of Series B Preferred Stock at $10.00 per share for total proceeds of $7.5 million. 

Item 6.  Selected Consolidated Financial Data

The selected consolidated financial data presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" presented in Item 7 and more detailed financial statements presented in Item 15(a)(1) of this Form 10-K.  The consolidated statement of operations data set forth below for the years ended June 30, 2000, 2001 and 2002, and the consolidated balance sheet data as of June 30, 2001 and 2002, are derived from and qualified by reference to, our audited financial statements included in Item 8 of this Form 10-K.  The consolidated financial data for periods or at dates prior to the financial statements presented in Item 8 of this Form 10-K are derived from audited consolidated financial statements not included herein.  Historical results are not necessarily indicative of results that may be expected for any future period.

Summary Consolidated Financial Data

(In thousands, except per share amounts)

Years Ended June 30,

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Except for historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our future financing needs, our future revenue growth prospects and our expense projections for future periods.  Our actual results may differ significantly from those projected in the forward-looking statements.  Factors that might cause or contribute to these differences include, but are not limited to, those discussed in the section below entitled "Factors That May Affect Future Results of Operations" and other documents we file with the Securities and Exchange Commission ("SEC").  You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K.  We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect subsequent events or circumstances after the date of this document.

Overview

Evolve provides enterprise software that optimizes the way organizations deliver services to their customers and employees.  Our service delivery software products are designed for service-oriented organizations where successful project delivery is vital to their business.  We primarily market our solution to professional services organizations and to corporate information technology departments in medium-to-large enterprises.

Evolve was founded in February 1995.  From our inception through December 1998, our activities, funded by the venture capital we raised, consisted primarily of building our business infrastructure, recruiting personnel and developing software and service offerings.  Our Evolve solution was first made commercially available the quarter ended March 31, 1999.  We have incurred net losses and negative cash flows from operations since inception.  Our accumulated deficit at June 30, 2002, was $254.9 million.

In August 2000, we completed an initial public offering of 5,750,000 shares of common stock, resulting in proceeds of $46.5 million, net of offering costs.  From October 2001 through August 2002, we raised an additional  $25.5 million in financing from the issuance of Series A and Series B Preferred Stock to new and existing investors.

Sources of Revenue and Revenue Recognition

We derive revenues from fees for licenses, implementation services and maintenance, and hosted license agreements.  We recognize revenues in accordance with the provisions of the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended and SOP 81-1, "Accounting for Performance of Construction-type and Certain Production-type Contracts."  We also follow the provisions of the Securities and Exchange Commission's Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements."

Under SOP 97-2 as amended, SOP 81-1 and SAB 101, we recognize revenues when all of the following conditions are met:

• when persuasive evidence of a customer agreement exists;

• the delivery of the product or service subject to the agreement has occurred;

• the associated fees are fixed or determinable; and

• we believe that collection of these fees is reasonably assured.

We have established vendor specific objective evidence of fair value for certain services.  For these contracts, which involve significant implementation or other services which are essential to the functionality of the software and which are reasonably estimable, the license and services revenue is recognized over the period of each implementation, primarily using the percentage-of-completion method.  Labor hours incurred are used as the measure of progress towards completion.  A provision for estimated losses on engagements is made in the period in which the loss becomes probable and can be reasonably estimated.  In cases where a sale of a license does not include implementation services, as in the sale of additional seats, revenue is recorded upon delivery with an appropriate deferral for maintenance services, if applicable, provided all of the other relevant conditions have been met.

Our services revenue includes reimbursement for travel expenses incurred by our consultants and reimbursed by our customers.  These revenues are recognized in the period in which they are incurred.  The associated expenses are included as a cost of revenue.

Our customer agreements typically include arrangements for maintenance services to be provided by us.  Generally, we have vendor specific objective evidence of fair value for the maintenance element of software arrangements based on the renewal rates for maintenance in future years as specified in our contracts.  In those cases where first year maintenance revenue is included in the license fee, we defer the fair value of the first year maintenance revenue at the outset of the arrangement and recognize it ratably over the period during which the maintenance is to be provided, which normally commences on the date the software is delivered.

We generate revenue from our hosted license business by hosting the software and making the solution available to customers via the Internet, as well as by providing maintenance and other services to the customer.  In such situations, customers pay a monthly fee for the term of the contract in return for access to our software, maintenance and other services such as implementation, training, consulting and hosting.  For certain hosted software arrangements for which we do not have vendor specific objective evidence of fair value for the elements of the contract, fees are recognized on a monthly basis as the hosting service is provided.  In other circumstances where the customer has the right to take delivery of the software and we have vendor specific objective evidence of fair value for the hosting element of the contract, fees are allocated between the elements based on the vendor specific objective evidence.  We have discontinued offering new hosting contracts to our customers and will no longer provide hosting licenses and related services when our current hosting obligations expire.

License revenue includes product licenses to companies from which we have purchased products and services under separate arrangements executed within a short period of time ("reciprocal arrangements").  Products and services purchased in reciprocal arrangements include:  (1) software licensed for internal use; (2) software licensed for resale or incorporation into our products; and (3) development or implementation services.  For reciprocal arrangements, we follow the AICPA's Technical Practice Aid ("TPA") No. 5100.56 and 5100.57 "Non-Monetary Exchanges of Software" and SOP 97-2 "Software Revenue Recognition."  In determining these fair values, we consider the recent history of cash sales of the same products or services in similar sized transactions.  Revenues recognized under reciprocal arrangements were $966,000, $2.1 million, and $369,000 for the fiscal years ended June 30, 2002, 2001 and 2000, respectively.

Deferred revenue represents amounts billed to customers under license and service arrangements in excess of amounts recognized as revenue to-date from those arrangements.  Deferred revenue also represents fees derived from maintenance and hosting agreements that are being recognized ratably over the unexpired portion of the underlying period of the agreements.  As work progresses towards completion of these arrangements, a portion of the deferred revenue will be recognized.  Certain revenues will also be deferred, if other revenue recognition criteria have not been met.

Stock-Based Compensation

We incurred stock-based compensation charges in connection with stock option grants and sales of restricted stock to employees at exercise or sales prices below the deemed fair market value of our common stock for accounting purposes.  The cumulative difference between the deemed fair value of the underlying stock at the date the options were granted and the exercise price of the granted options was $40.3 million as of August 9, 2000, the date of our Initial Public Offering.  We use the accelerated method of the Financial Account Standards Board ("FASB") Interpretation ("FIN") No. 28, "Accounting for Stock Appreciation Rights and Other Variable or Award Plans," over the four-year vesting period of the granted options.  During fiscal 2001 and 2002, the effects of systematic amortization, employee terminations and modifications of stock-based awards reduced our remaining unearned stock-based compensation balance to $1.5 million.  We expect that our results from operations will include stock-based compensation expense, at a maximum, through 2004.  Future terminations or modifications to existing awards will impact future stock-based compensation expense.   We have recorded stock-based charges of $12.4 million, $17.9 million and $19.3 million for the years ended June 30, 2002, 2001 and 2000, respectively.

As a result of employee terminations and the implementation of a stock option swap program during the year ended June 30, 2002, and as a result of employee terminations during the year ended June 30, 2001, we recorded a reduction of additional paid-in capital and unearned stock-based compensation of $5.6 million for each of these two years.  For many terminated employees and swapped options, we had incurred significant deferred stock-based charges on the original option grants in previous years.  The reversed amounts represent the additional paid-in capital and stock-based compensation amounts associated with the unvested options and stock awards.

In connection with the termination of employment of certain executive officers in fiscal 2001, we entered into arrangements with those executive officers to provide consulting services.  For accounting purposes, this was deemed to be a change in status of the employee and resulted in a new measurement date for the amended equity awards in accordance with FIN No. 44, "Accounting for Certain Transactions Involving Stock Compensation."  As a result of these arrangements, during the year ended June 30, 2001, we reduced additional paid-in capital, reduced unearned stock-based compensation and reversed stock-based charges of $2.7 million, $1.5 million and $1.2 million, respectively, related to previously recognized stock-based compensation.  The revised value of the modified awards, using the Black-Scholes option pricing model affected additional paid-in capital and unearned stock-based compensation by a credit of $40,000 and a charge of $400,000 for the years ended June 30, 2002 and 2001, respectively.  The related amortization was a credit of $40,000 and a charge of $391,000 for the years ended June 30, 2002 and 2001, respectively.

In addition, for other executive officers whose employment was terminated in fiscal 2001 and who had purchased restricted stock with full recourse notes, we agreed, as part of their termination settlements, to allow them to sell back to us their restricted shares in exchange for cancellation of the notes.  Accordingly, these notes are accounted for as non-recourse notes on a variable basis such that the charge or credit arising from these notes will fluctuate from period to period based on our stock price.  As a result of these arrangements, during the year ended June 30, 2001, we recorded a reduction in additional paid-in capital, a reduction in unearned stock-based compensation and a reversal of stock-based charges of $6.0 million, $3.1 million and $2.9 million, respectively, related to previously recognized stock-based compensation associated with the unvested portion of the original award.  During the year ended June 30, 2001, the value of the modified awards, using the Black-Scholes option pricing model, decreased stockholder notes receivable by $3.0 million, increased unearned stock-based compensation by $3.2 million and decreased interest receivable by $243,000.  During the year ended June 30, 2002, the revised value of the awards decreased stockholder notes receivable and additional paid-in capital by $385,000 and $40,000, respectively, and increased unearned stock-based compensation by $345,000.  The related amortization was $2.3 million and $1.1 million for the years ended June 30, 2002 and 2001, respectively.

In October 2001, the Board of Directors voted to modify existing stockholder loans, which were issued to allow board members, officers and selected employees to exercise stock options and purchase restricted stock, from full-recourse to non-recourse and to extend their due dates, in the event of termination, from thirty days to fifteen months after the date of termination.  The loans are secured only by the underlying stock, which they were used to purchase.  As a result, the loans became subject to variable accounting and the outstanding stockholder loans and related interest were revalued to their net realizable value of $0.13 per share at June 30, 2002, resulting in a reduction of stockholders' loans and related interest and an increase in expenses of $7.5 million for fiscal 2002.  Until they are due or repaid, if earlier, the loans will be revalued each quarter to their net realizable value as determined by the stock price at that time.

The financial impact on operating results of these arrangements is included within stock-based compensation expense.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.

We believe that the following are critical accounting policies and estimates used in the preparation of our consolidated financial statements.

We derive revenues from fees for licenses, implementation services and maintenance, and hosted license agreements.  We recognize revenues in accordance with the provisions of the AICPA SOP 97-2, "Software Revenue Recognition," as amended and SOP 81-1, "Accounting for Performance of Construction-type and Certain Production-type Contracts."  We also follow the provisions of the Securities and Exchange Commission's SAB 101, "Revenue Recognition in Financial Statements."

Under SOP 97-2 as amended, SOP 81-1 and SAB 101, we recognize revenues when all of the following conditions are met:

• when persuasive evidence of a customer agreement exists;

• the delivery of the product or service subject to the agreement has occurred;

• the associated fees are fixed or determinable; and

• we believe that collection of these fees is reasonably assured.

We have established vendor specific objective evidence of fair value for certain services.  Our implementation services are considered essential to the functionality of our software primarily because we do not have significant experience of third party consultants implementing our software at customer sites.  We are investing in our partner strategy and expect, in the near future, that customers will have the ability to purchase implementation services from trained and certified partners.  In the meantime, our implementation services are essential to the functionality of the software and, for those contracts where the services are reasonably estimable, the license and services revenue is recognized over the period of each implementation, primarily using the percentage-of-completion method.  Labor hours incurred are used as the measure of progress towards completion.  A provision for estimated losses on engagements is made in the period in which the loss becomes probable and can be reasonably estimated.  In the future, if our implementation services are no longer considered essential to the functionality of the license, our revenue recognition will be accelerated under these arrangements with license revenue being recorded upon delivery assuming all other criteria are met.  In cases where a sale of a license does not include implementation services, as in the sale of additional seats, revenue is recorded upon delivery with an appropriate deferral for maintenance services, if applicable, provided all of the other relevant conditions have been met.

We do not recognize revenue for refundable fees or agreements with cancellation rights until such rights to refund or cancel have expired. 

Our customer agreements typically include arrangements for maintenance services to be provided by us.  Generally, we have vendor specific objective evidence of fair value for the maintenance element of software arrangements based on the renewal rates for maintenance in future years as specified in the contracts.  In those cases where first year maintenance revenue is included in the license fee, we defer the fair value of the first year maintenance revenue at the outset of the arrangement and recognize it ratably over the period during which the maintenance is to be provided, which is generally twelve months.

Allowance for Doubtful Accounts

We make estimates as to the overall collectibility of accounts receivable and provide an allowance for amounts deemed to be uncollectible.  Specifically, we analyze our accounts receivable and historical bad debt pattern, customer concentrations, customer credit-worthiness, current economic and industry trends and changes in our customer payment terms when evaluating the adequacy of our allowance for doubtful accounts.  We will continue to monitor our customers' ability to pay throughout the term of the applicable arrangements and will adjust the provision for bad debt allowance or defer revenue recognition, as appropriate.  These estimates could change if actual results differ materially from those estimates based on more accurate information in the future.

Contingencies

Because of the uncertainties related to both the amount and range of loss on the remaining pending litigation we are unable, at this time, to determine whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period.  As additional information becomes available, we will assess the potential liability related to our pending litigation.

Goodwill and Other Intangible Assets

We are required to regularly review all of our long-lived assets, including goodwill and other intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  Factors we consider important which could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our market capitalization relative to net book value for a sustained period.  When we determine that an impairment review is necessary based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in our current business model.  Significant judgment is required in the development of projected cash flows for these purposes including assumptions regarding the appropriate level of aggregation of cash flows, their term and discount rate as well as the underlying forecasts of expected future revenue and expense.  We have recorded significant impairment charges for goodwill and intangible assets in the past and to the extent that events or circumstances cause our assumptions to change, additional charges may be required which could be material.  At June 30, 2002, we determined that our balances of $478,000 relating to goodwill and $1.7 million relating to acquired technologies were not impaired.

We will adopt Statement of Financial Accounting Standards ("SFAS") No. 142 effective July 1, 2002, which will result, among other items, in no longer amortizing our existing goodwill.  Other than goodwill and acquired workforce in place, which will be subsumed into goodwill on adoption, all identifiable intangible assets will continue to be amortized in accordance with SFAS No. 142.  We are currently reviewing the impact of the adoption of SFAS No. 142, including the transition impairment tests.  The impairment, if any, resulting from these transition tests will be recorded in the period it is determined and will be recognized as the cumulative effect of a change in accounting principle. 

Accounting for Income Taxes

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets.  We have recorded a valuation allowance due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward, before they expire.  The valuation allowance is based on estimates of taxable income by jurisdiction in which we operate and the period over which these deferred tax assets will be recoverable.  Should we determine that we would be able to realize our deferred tax asset in the foreseeable future, an adjustment to the deferred tax asset would increase income in the period such determination was made.

The following table sets forth certain statements of operations data in absolute dollars for the periods indicated.  The data has been derived from the audited consolidated financial statements contained in this report.