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** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **x**                                                                                                                                                                                              | ** ** | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                               |       |                                                                                                    |
| ** **                                                                                                                                                                                         | ** ** | **For the quarterly period ended June 30,  2008**                                                  |
|                                                                                                                                                                                               |       |                                                                                                    |
| ** **                                                                                                                                                                                         | ** ** | **OR**                                                                                                  |
| ** **                                                                                                                                                                                         | ** ** | ** **                                                                                              |
| **o**                                                                                                                                                                                              | ** ** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|                                                                                                                                                                                               |       |                                                                                                    |
| **For the  transition period  from             to             ** |

 

**Commission File Number: 0-24081**

 

**EVOLVING SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **84-1010843**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or  organization) |       | (I.R.S. Employer Identification No.) |
| ** **                                                      | ** ** | ** **                           |
| **9777 Pyramid Court, Suite 100 Englewood,  Colorado**     | ** ** | **80112**                            |
| (Address of principal executive offices)                        |       | (Zip Code)                           |

 

**(303) 802-1000**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes xNo o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definitions of “large accelerated filer,”“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one):

 

|   Large accelerated filer o                                              | Accelerated filer o         |
|------------------------------------------------------------------------------------|----------------------------------|
|                                                                               |                             |
|   Non-accelerated filer o  (Do not check if a smaller reporting company) | Smaller reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes o  No x

 

As of July 28, 2008 there were 19,383,018 shares outstanding ofRegistrant’s Common Stock (par value $0.001 per share).

 

 

 

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**EVOLVING SYSTEMS, INC.**

**Quarterly Report on Form 10-Q**

**June 30, 2008**

**Table of Contents**

 
| **PART I  – FINANCIAL INFORMATION** | ** **                                                                                                                                                    |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1                                        | Financial Statements                                                                                                                                          |   |
|                                          | Condensed Consolidated  Balance Sheets as of June 30, 2008 and December 31, 2007  (Unaudited)                                                       |   |
|                                          | Condensed  Consolidated Statements of Operations for the Three and Six Months Ended  June 30, 2008 and 2007 (Unaudited)                                  |   |
|                                          | Condensed  Consolidated Statements of Changes In  Stockholders’ Equity and Comprehensive Income for the Six Months Ended  June 30, 2008 (Unaudited) |   |
|                                          | Condensed Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007  (Unaudited)                                            |   |
|                                          | Notes to Unaudited Condensed  Consolidated Financial Statements                                                                                               |   |
| Item 2                                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                   |   |
| Item 3                                        | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                   |   |
| Item 4                                        | Controls and  Procedures                                                                                                                                      |   |
| ** **                                    | ** **                                                                                                                                                    |
| **PART II – OTHER  INFORMATION**    |
| Item 1                                        | Legal Proceedings                                                                                                                                             |   |
| Item 1A                                       | Risk Factors                                                                                                                                                  |   |
| Item 2                                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                  |   |
| Item 3                                        | Defaults  upon Senior Securities                                                                                                                              |   |
| Item 4                                        | Submission  of Matters to a Vote of Security Holders                                                                                                          |   |
| Item 5                                        | Other Information                                                                                                                                             |   |
| Item 6                                        | Exhibits                                                                                                                                                      |   |
|                                          |                                                                                                                                                          |   |
| Signature                                     |                                                                                                                                                          |   |

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                      | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                                      |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                 |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                      |       | $                       | 7,249      |                        | $          | 7,271 |   |
| Contract  receivables, net of allowance of $36 at June 30, 2008 and $66 at  December 31, 2007                                                                                                         |       | 6,004                   |       | 10,959                      |       |
| Unbilled  work-in-progress                                                                                                                                                                                      |       | 1,261                   |       | 922                         |       |
| Deferred income  taxes                                                                                                                                                                                          |       | 4                       |       | 4                           |       |
| Prepaid and  other current assets                                                                                                                                                                               |       | 1,752                   |       | 1,331                       |       |
| Total current  assets                                                                                                                                                                                           |       | 16,270                  |       | 20,487                      |       |
| Property and  equipment, net                                                                                                                                                                                    |       | 1,501                   |       | 1,677                       |       |
| Amortizable  intangible assets, net                                                                                                                                                                             |       | 3,920                   |       | 4,687                       |       |
| Goodwill                                                                                                                                                                                                        |       | 26,398                  |       | 26,417                      |       |
| Long-term  restricted cash                                                                                                                                                                                      |       | 100                     |       | 100                         |       |
| Other long-term  assets                                                                                                                                                                                         |       | 308                     |       | 359                         |       |
| Total assets                                                                                                                                                                                                    |       | $                       | 48,497     |                        | $          | 53,727 |   |
|                                                                                                                                                                                                            |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                   |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                                                                                           |       |                    |       |                        |       |
| Current portion  of capital lease obligations                                                                                                                                                                   |       | $                       | 20         |                        | $          | 20 |   |
| Current portion  of long-term debt                                                                                                                                                                              |       | 2,000                   |       | 2,500                       |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                       |       | 5,420                   |       | 5,903                       |       |
| Deferred income  taxes                                                                                                                                                                                          |       | 30                      |       | 34                          |       |
| Unearned revenue                                                                                                                                                                                                |       | 8,829                   |       | 10,635                      |       |
| Total current  liabilities                                                                                                                                                                                      |       | 16,299                  |       | 19,092                      |       |
| Long-term  liabilities:                                                                                                                                                                                         |       |                    |       |                        |       |
| Capital lease  obligations, net of current portion                                                                                                                                                              |       | 71                      |       | 79                          |       |
| Other long-term  obligations                                                                                                                                                                                    |       | 1,042                   |       | 1,477                       |       |
| Long-term debt,  net of current portion                                                                                                                                                                         |       | 5,883                   |       | 8,686                       |       |
| Deferred foreign  income taxes                                                                                                                                                                                  |       | 753                     |       | 878                         |       |
| Total  liabilities                                                                                                                                                                                              |       | 24,048                  |       | 30,212                      |       |
|                                                                                                                                                                                                            |       |                    |       |                        |       |
| Commitments and  contingencies (Note 10)                                                                                                                                                                        |       |                    |       |                        |       |
|                                                                                                                                                                                                            |       |                    |       |                        |       |
| Series B  convertible redeemable preferred stock                                                                                                                                                           |       | —                  |       | 5,587                       |       |
|                                                                                                                                                                                                            |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                     |       |                    |       |                        |       |
| Preferred stock,  $0.001 par value; 2,000,000 shares authorized; 0 and 478,750 shares of  Series B issued and outstanding as of June 30, 2008 and  December 31, 2007, respectively (shown above) |       | —                  |       | —                      |       |
| Common stock,  $0.001 par value; 40,000,000 shares authorized; 19,373,507 and 17,914,770  shares issued and outstanding as of June 30, 2008 and December 31,  2007, respectively                      |       | 19                      |       | 18                          |       |
| Additional  paid-in capital                                                                                                                                                                                     |       | 81,395                  |       | 75,317                      |       |
| Accumulated  other comprehensive income                                                                                                                                                                         |       | 2,055                   |       | 2,144                       |       |
| Accumulated deficit                                                                                                                                                                                             |       | (59,020                 | )          | (59,551                     | )          |
| Total  stockholders’ equity                                                                                                                                                                                |       | 24,449                  |       | 17,928                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                |       | $                       | 48,497     |                        | $          | 53,727 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(in thousands except per share data)**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and  services                                                   |       | $                                               | 5,342      |                                          | $          | 4,742 |   | $ | 10,174 |   | $ | 8,733 |   |
| Customer support                                                             |       | 4,303                                           |       | 4,380                                         |       | 8,598 |   | 8,850 |   |
| Total revenue                                                                |       | 9,645                                           |       | 9,122                                         |       | 18,772 |   | 17,583 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| **COSTS  OF REVENUE AND OPERATING EXPENSES**                                 |       |                                            |       |                                          |       |   |   |   |   |
| Costs of license  fees and services, excluding depreciation and amortization |       | 1,902                                           |       | 1,941                                         |       | 4,126 |   | 3,865 |   |
| Costs of  customer support, excluding depreciation and amortization          |       | 1,632                                           |       | 1,716                                         |       | 3,125 |   | 3,209 |   |
| Sales and  marketing                                                         |       | 2,194                                           |       | 2,186                                         |       | 4,381 |   | 4,225 |   |
| General and  administrative                                                  |       | 1,236                                           |       | 1,648                                         |       | 2,661 |   | 3,199 |   |
| Product  development                                                         |       | 950                                             |       | 358                                           |       | 2,018 |   | 907 |   |
| Depreciation                                                                 |       | 252                                             |       | 252                                           |       | 482 |   | 540 |   |
| Amortization                                                                 |       | 379                                             |       | 392                                           |       | 759 |   | 780 |   |
| Restructuring  and other expense (recovery)                                  |       | —                                          |       | —                                        |       | — |   | (1 | ) |
| Total costs of  revenue and operating expenses                               |       | 8,545                                           |       | 8,493                                         |       | 17,552 |   | 16,724 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations                                                      |       | 1,100                                           |       | 629                                           |       | 1,220 |   | 859 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Other income  (expense):                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Interest income                                                              |       | 39                                              |       | 81                                            |       | 117 |   | 145 |   |
| Interest expense                                                             |       | (283                                            | )          | (451                                          | )          | (619 | ) | (915 | ) |
| Gain (loss) on  extinguishment of debt                                       |       | —                                          |       | —                                        |       | (290 | ) | 42 |   |
| Foreign currency  exchange gain (loss)                                       |       | 32                                              |       | (104                                          | )          | 142 |   | (162 | ) |
| Other expense,  net                                                          |       | (212                                            | )          | (474                                          | )          | (650 | ) | (890 | ) |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss)  before income taxes                                           |       | 888                                             |       | 155                                           |       | 570 |   | (31 | ) |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income tax  expense                                                          |       | 113                                             |       | 83                                            |       | 39 |   | 223 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss)                                                           |       | $                                               | 775        |                                          | $          | 72 |   | $ | 531 |   | $ | (254 | ) |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Basic and  diluted income (loss) per common share                            |       | $                                               | 0.04       |                                          | $          | 0.00 |   | $ | 0.03 |   | $ | (0.01 | ) |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  basic shares outstanding                                   |       | 19,374                                          |       | 19,180                                        |       | 19,368 |   | 19,167 |   |
| Weighted average  diluted shares outstanding                                 |       | 19,845                                          |       | 19,604                                        |       | 19,840 |   | 19,167 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EVOLVINGSYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCHANGES IN STOCKHOLDERS’ EQUITY**

**ANDCOMPREHENSIVE INCOME**

**(inthousands, except share data)**

**(unaudited)**

 
| ** **                                                        | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**       | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**      | ** ** | **Deficit**            | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2007**                            |       | 17,914,770            |       | $           | 18         |              | $          | 75,317          |       | $                      | 2,144      |       | $          | (59,551 | ) | $ | 17,928 |   |
| Common stock  issued pursuant to the Employee Stock Purchase Plan |       | 22,487                |       | —      |       | 36                |       | —          |       | —                 |       | 36         |       |
| Stock-based  compensation expense                                 |       | —                |       | —      |       | 456               |       | —          |       | —                 |       | 456        |       |
| Preferred stock  conversion                                       |       | 1,436,250             |       | 1           |       | 5,586             |       | —          |       | —                 |       | 5,587      |       |
| Comprehensive  income:                                            |       |                  |       |        |       |              |       |            |       |                   |       |       |       |
| Net income                                                        |       | —                |       | —      |       | —            |       | —          |       | 531                    |       |       |       |
| Foreign currency  translation adjustment                          |       | —                |       | —      |       | —            |       | (89             | )          | —                 |       |       |       |
| Comprehensive  income                                             |       |                  |       |        |       |              |       |            |       |                   |       | 442        |       |
| **Balance  at June 30, 2008**                                |       | 19,373,507            |       | $           | 19         |              | $          | 81,395          |       | $                      | 2,055      |       | $          | (59,020 | ) | $ | 24,449 |   |

 

The accompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                                | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                |       |                                          |       |   |   |
| Net income  (loss)                                                                        |       | $                                             | 531        |   | $ | (254 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                          |       |   |   |
| Depreciation                                                                              |       | 482                                           |       | 540 |   |
| Amortization of  intangible assets                                                        |       | 759                                           |       | 780 |   |
| Amortization of  debt issuance costs                                                      |       | 78                                            |       | 125 |   |
| Equity  compensation                                                                      |       | 456                                           |       | 381 |   |
| Gain on disposal  of property and equipment                                               |       | —                                        |       | (1 | ) |
| (Gain) loss on  extinguishment of debt                                                    |       | 290                                           |       | (42 | ) |
| Foreign currency  transaction (gains) losses, net                                         |       | (142                                          | )          | 162 |   |
| Benefit from  foreign deferred income taxes                                               |       | (127                                          | )          | (65 | ) |
| Change in  operating assets and liabilities:                                              |       |                                          |       |   |   |
| Contract  receivables                                                                     |       | 5,054                                         |       | 4,502 |   |
| Unbilled  work-in-progress                                                                |       | (339                                          | )          | 109 |   |
| Prepaid and  other current assets                                                         |       | (479                                          | )          | (16 | ) |
| Accounts payable  and accrued liabilities                                                 |       | (386                                          | )          | 197 |   |
| Unearned revenue                                                                          |       | (1,807                                        | )          | (657 | ) |
| Other                                                                                     |       | (433                                          | )          | 343 |   |
| Net cash  provided by operating activities                                                |       | 3,937                                         |       | 6,104 |   |
|                                                                                      |       |                                          |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                                          |       |   |   |
| Purchases of  property and equipment                                                      |       | (393                                          | )          | (322 | ) |
| Reduction in  restricted cash                                                             |       | —                                        |       | 200 |   |
| Proceeds from  sale of property and equipment                                             |       | —                                        |       | 1 |   |
| Earnout payments  from business combinations                                              |       | —                                        |       | (24 | ) |
| Net cash used in  investing activities                                                    |       | (393                                          | )          | (145 | ) |
|                                                                                      |       |                                          |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                                          |       |   |   |
| Capital lease  payments                                                                   |       | (9                                            | )          | (12 | ) |
| Principal  payments on long-term debt                                                     |       | (7,298                                        | )          | (1,141 | ) |
| Proceeds from  issuance of long-term debt                                                 |       | 4,000                                         |       | — |   |
| Payments for  debt issuance costs                                                         |       | (282                                          | )          | — |   |
| Proceeds from  issuance of common stock                                                   |       | 36                                            |       | 55 |   |
| Net cash used in  financing activities                                                    |       | (3,553                                        | )          | (1,098 | ) |
|                                                                                      |       |                                          |       |   |   |
| Effect of  foreign exchange rate changes on cash                                          |       | (13                                           | )          | (39 | ) |
|                                                                                      |       |                                          |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | (22                                           | )          | 4,822 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 7,271                                         |       | 5,076 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                             | 7,249      |   | $ | 9,898 |   |
|                                                                                      |       |                                          |       |   |   |
| Supplemental  disclosure of other cash and non-cash transactions:                         |       |                                          |       |   |   |
| Interest paid                                                                             |       | $                                             | 1,095      |   | $ | 460 |   |
| Income taxes  paid                                                                        |       | $                                             | 294        |   | $ | 27 |   |
| Conversion of  preferred stock into common stock                                          |       | $                                             | 5,587      |   | $ | 5,389 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

**Organization –**Weare a provider of software solutions and services to the wireless, wireline andIP carrier markets with long-standing relationships with many of the largestcarriers worldwide. Our customers rely on us to develop, deploy, enhance,maintain and integrate complex, highly reliable software solutions for a rangeof Operations Support Systems (“OSS”). We offer software products and solutions in three core areas:  service activation solutions used toactivate complex bundles of voice, video and data services for traditional andnext generation wireless and wireline networks; numbering solutions that enable carriers to comply withgovernment-mandated requirements regarding number portability as well asproviding phone number management and assignment capabilities; and mediationsolutions supporting data collection for both service assurance and billingapplications.

 

**InterimConsolidated Financial Statements** – The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) and in conformity with the instructions to Form 10-Qand Article 10 of Regulation S-X and the related rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and notedisclosures normally included in financial statements prepared in accordancewith GAAP have been condensed or omitted pursuant to such rules andregulations. However, we believe that the disclosures included in thesefinancial statements are adequate to make the information presented notmisleading. The unaudited condensed consolidated financial statements includedin this document have been prepared on the same basis as the annualconsolidated financial statements, and in our opinion, reflect all adjustments,which include normal recurring adjustments necessary for a fair presentation inaccordance with GAAP and SEC regulations for interim financial statements. Theresults for the three and six months ended June 30, 2008 are not necessarilyindicative of the results that we will have for any subsequent period.  These unaudited condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and the notes to those statements for theyear ended December 31, 2007 included in our Annual Report on Form 10-K.

 

**Use ofEstimates –**The preparation of financial statements inconformity with accounting principles generally accepted in the U.S. requiresus to make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities, at thedate of the financial statements, as well as the reported amounts of revenueand expenses during the reporting period. We made estimates with respect torevenue recognition for estimated hours to complete projects accounted forusing the percentage of completion method, allowance for doubtful accounts,income tax valuation allowance, fair values of long-lived assets, valuation ofintangible assets and goodwill, useful lives for property, equipment andintangible assets, business combinations, capitalization of internal softwaredevelopment costs and fair value of stock-based compensation amounts.  Actual results could differ from these estimates.

 

**ForeignCurrency Translation –**Our functional currency is the U.S.dollar.  The functional currency of ourforeign operations, generally, is the respective local currency for eachforeign subsidiary.  Assets andliabilities of foreign operations denominated in local currencies aretranslated at the spot rate in effect at the applicable reporting date.  Our consolidated statements of operations aretranslated at the weighted average rate of exchange during the applicableperiod.  The resulting unrealizedcumulative translation adjustment, net of applicable income taxes, is recordedas a component of accumulated other comprehensive income (loss) in stockholders’equity.  Realized and unrealizedtransaction gains and losses generated by transactions denominated in acurrency different from the functional currency of the applicable entity arerecorded in other income (loss) in the period in which they occur.

 

**Principlesof Consolidation –**The consolidated financial statementsinclude the accounts of Evolving Systems and subsidiaries, all of which arewholly owned.  All significantintercompany transactions and balances have been eliminated in consolidation.

 

**Goodwill –**Goodwill is the excess of acquisition cost of an acquiredentity over the fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested forimpairment annually or whenever indicators of impairment exist. Theseindicators may include a significant change in the business climate, legalfactors, operating performance indicators, competition, sale or disposition ofa significant portion of the business or other factors. For purposes of thegoodwill evaluation, we compare the fair value of each of our reporting unitsto its respective carrying amount. If the carrying value of a reporting unitwere to exceed its fair value, we would then compare the fair value of thereporting unit’s goodwill to its carrying amount, and any excess of thecarrying amount over the fair value would be charged to operations as animpairment loss.

 

**IntangibleAssets –**Amortizable intangible assets consist primarily ofpurchased software and licenses, customer contracts and relationships,trademark and tradenames, and business partnerships acquired in conjunctionwith our purchases of CMS Communications, Inc. (“CMS”), Telecom SoftwareEnterprises, LLC (“TSE”) and Tertio Telecoms Ltd. (“Evolving Systems U.K.”).  These finite life assets are amortized usingthe straight-line method over their estimated lives.

 

We assess theimpairment of identifiable intangibles if events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable. Factorsthat we consider significant which could trigger an impairment analysis includethe following:

 

·                  Significantunder-performance relative to historical or projected future operating results;

 

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·                  Significant changes in the manner ofuse of the acquired assets or the strategy of the overall business;

 

·                  Significant negative industry oreconomic trends; and/or

 

·                  Significant decline in our stockprice for a sustained period.

 

If, as a result ofthe existence of one or more of the above indicators of impairment, wedetermine that the carrying value of intangibles and/or long-lived assets maynot be recoverable, we compare the estimated undiscounted cash flows expectedto result from the use of the asset and its eventual disposition to the asset’scarrying amount. If an amortizable intangible or long-lived asset is not deemedto be recoverable, we will recognize an impairment loss representing the excessof the asset’s carrying value over its estimated fair value.

 

**RevenueRecognition –**We recognize revenue from two primary sources:license fees and services, and customer support, in accordance with Statementof Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended andinterpreted by SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions.”  Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition,” provides further interpretive guidance for publiccompanies on the recognition, presentation and disclosure of revenue infinancial statements.  In addition to thecriteria described below, we generally recognize revenue when an agreement issigned, the fee is fixed or determinable and collectibility is reasonablyassured.

 

The majority of ourlicense fees and services revenue is generated from fixed-price contracts,which provide for licenses to our software products and services to customizesuch software to meet our customers’ use.  When the services are determined to be essential to the functionality ofthe delivered software, we recognize revenue using the percentage-of-completionmethod of accounting, in accordance with SOP 97-2 and SOP 81-1, “Accounting forLong-Term Construction Type Contracts.” The percentage of completion for each contract is estimated based on theratio of direct labor hours incurred to total estimated direct laborhours.  Since estimated direct laborhours, and changes thereto, can have a significant impact on revenuerecognition, these estimates are critical and are reviewed regularly.  Amounts billed in advance of services beingperformed are recorded as unearned revenue. Unbilled work-in-progressrepresents revenue earned but not yet billable under the terms of thefixed-price contracts. All such amounts are expected to be billed and collectedwithin 12 months.

 

We may encounter budgetand schedule overruns on fixed price contracts caused by increased laboror overhead costs. Adjustments to cost estimates are made in the periods inwhich the facts requiring such revisions become known. Estimated losses, if any,are recorded in the period in which current estimates of total contract revenueand contract costs indicate a loss.

 

In arrangements where theservices are not essential to the functionality of the software, we recognizelicense revenue upon delivery.  To theextent that Vendor-Specific Objective Evidence (“VSOE”) of the fair value ofundelivered elements exists, fees from multiple element arrangements areunbundled and recorded as revenue as the elements are delivered.  If VSOE for the undelivered elements does notexist, fees from such arrangements are deferred until the earlier of the datethat VSOE does exist on the undelivered elements or all of the elements havebeen delivered.

 

We recognize servicesrevenue from fixed-price contracts using the proportional performance method ofaccounting, which is similar to the percentage of completion method describedabove. Revenue from professional services provided pursuant totime-and-materials based contracts and training services are recognized as theservices are performed, as that is when our obligation to our customers undersuch arrangements is fulfilled.

 

We recognize customersupport, including maintenance revenue, ratably over the service contractperiod. When maintenance is bundled with the original license fee arrangement,its fair value, based upon VSOE, is deferred and recognized during the periodswhen services are provided.

 

**Stock-basedCompensation –** We account for stock-based compensation underStatement of Financial Accounting Standards No. 123(Revised), “Share-BasedPayment” (“SFAS 123R”).  This statementreplaced SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS123”) and superseded APB Opinion No. 25, “Accounting for Stock Issued toEmployees.”  Under SFAS 123R, we apply afair-value-based measurement method to account for share-based paymenttransactions with employees and directors and record compensation cost for allstock awards granted after January 1, 2006 and awards modified,repurchased, or cancelled after that date. In addition, we record compensationcosts associated with the vesting of unvested options outstanding at January 1,2006 using the guidance under SFAS 123. Stock-based compensation is a non-cash expense because we settle theseobligations by issuing shares of our common stock instead of settling suchobligations with cash payments.  Werecognized compensation cost for options on a straight-line basis over thevesting period using an estimated forfeiture rate.   Effective January 1, 2006, stock optiongrants and employee stock purchase plan purchases were accounted for under SFAS123R.  We used the Black-Scholes model toestimate the fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**Reclassifications –**Certainprior period balances have been reclassified to conform to the current year’spresentation.

 

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**Recent Accounting Pronouncements –**InDecember 2007, the SEC issued Staff Accounting Bulletin 110, *Share-Based Payment* (“SAB 110”), which amends StaffAccounting Bulleting 107 (“SAB 107”), *Share-Based Payment*,to permit public companies, under certain circumstances, to use the simplifiedmethod of SAB 107 for employee option grants after December 31, 2007.  Use of the simplified method after December 31,2007 is permitted only for companies whose historical data about theiremployees’ exercise behavior does not provide a reasonable basis for estimatingthe expected term of the options.  Wecurrently use the simplified method to estimate expected term for employeeoption grants as adequate historical experience is not available to provide areasonable estimate.  SAB 110 iseffective for employee options granted after December 31, 2007.  We adopted SAB 110 effective January 1,2008 and will continue to apply the simplified method until adequate historicalexperience is readily available to provide a reasonable estimate of theexpected term for employee option grants.

 

In February 2007,the FASB issued SFAS No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities - Including anAmendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 permits entities to choose to measureeligible items at fair value at specific election dates (the ‘‘fair valueoption’’). Unrealized gains and losses on items for which the fair value optionhas been elected are reported in earnings at each subsequent reporting period.This accounting standard is effective for us beginning January 1,2008.  We have elected not to apply thefair value option allowed under SFAS 159.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value under generally accepted accounting principles, andexpands disclosures about fair value measurements. In February 2008, theFASB issued Staff Position No. 157-2, which delayed the effective date ofSFAS 157 to fiscal years ending after November 15, 2008 for non-financialassets and liabilities, except for items that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually).  The adoption of SFAS 157 didnot have a material effect on our consolidated financial statements.

 

**NOTE 2 –GOODWILL AND INTANGIBLE ASSETS**

 

We recordedgoodwill as a result of three acquisitions which occurred over the period from November 2003to November 2004. We acquired CMS in November 2003, TSE in October 2004and Evolving Systems U.K. in November 2004.

 

Changes in the carrying amount of goodwill by reporting unit are asfollows (in thousands):

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|---------------------------|------------|-----------|------------|
| ** **                                             | ** ** | **U.S.**                           | ** ** | **U.K.**                  | ** ** | **U.S.**  | ** ** | **U.K.** | ** ** | **Goodwill** | ** ** |
| Balance as of  December 31, 2007                  |       | $                                  | —     |                      | $          | 9,118     |       | $ | 6,033 |   | $ | 11,266 |   | $ | 26,417 |   |
| Effects of  changes in foreign currency exchange rates |       | —                             |       | (8                        | )          | —    |       | (11 | ) | (19 | ) |
| Balance as of  June 30, 2008                      |       | $                                  | —     |                      | $          | 9,110     |       | $ | 6,033 |   | $ | 11,255 |   | $ | 26,398 |   |

 

We conducted our annual goodwill impairment test as of July 31,2007, and we determined that goodwill was not impaired as of the testdate.  From July 31, 2007 through June 30,2008, no events have occurred that we believe may have impaired goodwill.

 

Identifiable intangible assets are amortized on a straight-line basisover estimated lives ranging from one to seven years and include the cumulativeeffects of foreign currency exchange rates. As of June 30, 2008 and December 31, 2007, identifiableintangibles are as follows (in thousands):

 
| ** **                 | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** | **Weighted-**             | ** ** |
|----------------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **(1)  Gross  Amount**      | ** ** | **Accumulated  Amortization**   | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average  Amortization  Period** | ** ** |
| Purchased  software        |       | $                           | 2,070      |                            | $          | 929                       |       | $ | 1,141 |   | $ | 2,072 |   | $ | 700 |   | $ | 1,372 |   | 4.7 yrs |   |
| Purchased  licenses        |       | 227                         |       | 194                             |       | 33                        |       | 227 |   | 146 |   | 81 |   | 2.3 yrs |   |
| Trademarks and  tradenames |       | 895                         |       | 256                             |       | 639                       |       | 896 |   | 192 |   | 704 |   | 7.0 yrs |   |
| Business  partnerships     |       | 146                         |       | 58                              |       | 88                        |       | 146 |   | 44 |   | 102 |   | 5.0 yrs |   |
| Customer  relationships    |       | 3,705                       |       | 1,686                           |       | 2,019                     |       | 3,707 |   | 1,279 |   | 2,428 |   | 5.6 yrs |   |
|                       |       | $                           | 7,043      |                            | $          | 3,123                     |       | $ | 3,920 |   | $ | 7,048 |   | $ | 2,361 |   | $ | 4,687 |   | 5.4 yrs |   |

 

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(1)  Changesin intangible values as of June 30, 2008 compared to December 31,2007 are the direct result of changes in foreign currency exchange rates forthe periods then ended.

 

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Amortizationexpense of identifiable intangible assets was $0.4 million and $0.8 million foreach of the three and six month periods ended June 30, 2008 and 2007,respectively.  As Evolving Systems U.K.uses the Great British pound as its functional currency, the amount of futureamortization actually recorded will be based upon exchange rates in effect atthat time. Expected future amortization expense related to identifiableintangibles based on our carrying amount as of June 30, 2008 is as follows(in thousands):

 
| **Twelve months ending June 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|
| 2009                                                  |       | $          | 1,129      |   |
| 2010                                                  |       | 900        |       |
| 2011                                                  |       | 887        |       |
| 2012                                                  |       | 502        |       |
| 2013                                                  |       | 502        |       |
| Thereafter                                            |       | —     |       |
|                                                  |       | $          | 3,920      |   |

 

**NOTE 3 –EARNINGS PER COMMON SHARE**

 

Basicearnings per share (“EPS”) is computed by dividing net income or loss availableto common stockholders by the weighted average number of shares outstandingduring the period, including common stock issuable under participating securities,such as the Series B Convertible Redeemable Preferred Stock (“Series BPreferred Stock”). Diluted EPS is computed using the weighted average number ofshares outstanding, including participating securities, plus all potentiallydilutive common stock equivalents. Common stock equivalents consist of stockoptions and shares held in escrow. The following is the reconciliation of thedenominator of the basic and diluted EPS computations (in thousands):

 
| ** **                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted average  common shares outstanding         |       | 19,374                                          |       | 17,665                                        |       | 19,120 |   | 17,180 |   |
| Participating  securities                           |       | —                                          |       | 1,515                                         |       | 248 |   | 1,987 |   |
| Basic weighted  average shares outstanding          |       | 19,374                                          |       | 19,180                                        |       | 19,368 |   | 19,167 |   |
| Effect of  dilutive securities                      |       | 471                                             |       | 424                                           |       | 472 |   | — |   |
| Diluted weighted  average common shares outstanding |       | 19,845                                          |       | 19,604                                        |       | 19,840 |   | 19,167 |   |

 

Weighted average options to purchase 2.7 million shares of common stockwere excluded from the dilutive stock calculation for each of the three and sixmonth periods ended June 30, 2008 because their exercise prices weregreater than the average fair value of our common stock for the period.

 

Weighted average options to purchase 1.1 million shares of common stockwere excluded from the dilutive stock calculation for the six months ended June 30,2007, as their effect would have been anti-dilutive as a result of the net lossfor the period.  Weighted average optionsto purchase 2.3 million and 2.9 million shares of common stock were excludedfrom the dilutive stock calculation for the three and six months ended June 30,2007 because their exercise prices were greater than the average fair value ofour common stock for the period.

 

**NOTE 4 – SHARE-BASED COMPENSATION**

 

We adopted SFAS 123R effective January 1, 2006 usingthe modified prospective method.  Werecognized $0.2 million and $0.5 million of compensation expense in theconsolidated statements of operations for the three and six months ended June 30,2008, respectively, with respect to our stock-based compensation plans.  We recognized $0.1 million and $0.4 millionof compensation expense in the consolidated statements of operations for thethree and six months ended June 30, 2007, respectively, with respect toour stock-based compensation plans.  Thefollowing table summarizes stock-based compensation expenses recorded in thestatement of operations (in thousands):

 

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| ** **                                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Cost of license  fee and services, excluding depreciation and amortization |       | $                                               | 13         |                                          | $          | 12 |   | $ | 30 |   | $ | 34 |   |
| Cost of customer  support, excluding depreciation and amortization         |       | 2                                               |       | 1                                             |       | 4 |   | (1 | ) |
| Sales and  marketing                                                       |       | 41                                              |       | 29                                            |       | 83 |   | 67 |   |
| General and  administrative                                                |       | 152                                             |       | 84                                            |       | 298 |   | 268 |   |
| Product  development                                                       |       | 20                                              |       | 6                                             |       | 41 |   | 13 |   |
|                                                                       |       | $                                               | 228        |                                          | $          | 132 |   | $ | 456 |   | $ | 381 |   |

 

Thenegative amount in the table above for the six months ended June 30, 2007resulted from the true-up of estimated forfeitures to actual forfeitures.

 

**StockOption Plan**

 

In January 1996,our stockholders approved an Amended and Restated Stock Option Plan (the “OptionPlan”).  Under the Option Plan, asamended, 8,350,000 shares were reserved for issuance.  Options issued under the Option Plan were atthe discretion of the Board of Directors, including the vesting provisions ofeach stock option granted. Options were granted with an exercise price equal tothe closing price of our common stock on the date of grant, generally vest overfour years and expire no more than ten years from the date of grant. The OptionPlan terminated on January 18, 2006; options granted before that date werenot affected by the plan termination.  AtJune 30, 2008, 3,855,198 options remained outstanding under the OptionPlan.

 

In March 2007,upon the hiring of our Vice President of World Wide Sales and Marketing, inaccordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv), the board ofdirectors approved an inducement award under a stand-alone equity incentiveplan.  We granted 100,000 non-qualifiedoptions to purchase shares of our common stock at an exercise price equal tothe closing price of our common stock on the date of grant.  The options vest over four years and expireten years from the date of grant.

 

In June 2007,our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”).  A maximum of 2,000,000 shares may be issuedunder the 2007 Stock Plan.  Awardspermitted under the 2007 Stock Plan include: Stock Options, Stock Appreciation Rights, Restricted Stock, RestrictedStock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan areat the discretion of the Board of Directors. As applicable, awards are granted with an exercise price equal to theclosing price of our common stock on the date of grant, generally vest overfour years and expire no more than ten years from the date of grant.

 

In December 2007,under the 2007 Stock Plan, we awarded a total of 137,500 shares of restrictedstock to members of our board of directors and senior management.  The fair market value for share-basedcompensation expensing is equal to the closing price of our common stock on thedate of grant.  The restrictions on thestock award are released over four years for awards granted to employees andover one year for awards granted to members of the board of directors.

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesmodel.  The Black-Scholes model uses fourassumptions to calculate the fair value of each option grant.  The expected term of share options granted isderived using the simplified method as prescribed by the SEC Staff AccountingBulletin 107 (“SAB 107”), “Share-Based Payment.”  In January 2008, we adopted theprovisions of Staff Accounting Bulletin 110, “Share-Based Payment,” whichallows us to continue to calculate the expected term of share options grantedusing the simplified method as prescribed under SAB 107. The risk-free interestrate is based upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of the stockoptions.  The expected volatility isbased upon historical volatility of our common stock over a period equal to theexpected term of the stock options.  Theexpected dividend yield is zero and is based upon historical and anticipatedpayment of dividends.  Theweighted-average assumptions used in the fair value calculations are asfollows:

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected term  (years)   |       | *                                               |       | 6.3                                           |       | 6.2 |   | 6.2 |   |
| Risk-free  interest rate |       | *                                               |       | 5.03                                          | %          | 2.7 | % | 4.71 | % |
| Expected volatility      |       | *                                               |       | 108.1                                         | %          | 101.9 | % | 108.0 | % |
| Expected  dividend yield |       | *                                               |       | 0                                             | %          | 0 | % | 0 | % |

 

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*   None granted.

 

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The following is asummary of stock option activity under the three stock incentive plans for thesix months ended June 30, 2008:

 
| ** **                                     | ** ** | **Number of  Shares  (in  thousands)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Options  outstanding at December 31, 2007 |       | 4,534                                       |       | $                                       | 3.02       |                                                          |       |                                                 |       |   |
| Options granted                                |       | 80                                          |       | $                                       | 2.06       |                                                          |       |                                                 |       |   |
| Less options  forfeited                        |       | (67                                         | )          | $                                       | 2.28       |                                                          |       |                                                 |       |   |
| Less options  expired                          |       | (46                                         | )          | $                                       | 5.20       |                                                          |       |                                                 |       |   |
| Less options  exercised                        |       | —                                      |       | $                                       | —     |                                                          |       |                                                 |       |   |
| Options  outstanding at June 30, 2008     |       | 4,501                                       |       | $                                       | 2.99       |                                                          | 5.56       |                                                 | $          | 1,104 |   |
|                                           |       |                                        |       |                                    |       |                                                          |       |                                                 |       |
| Options  exercisable at June 30, 2008     |       | 3,647                                       |       | $                                       | 3.18       |                                                          | 4.85       |                                                 | $          | 998 |   |

 

Theweighted-average grant-date fair value of stock options granted during the sixmonths ended June 30, 2008 was $1.67. No options were granted during the three months ended June 30,2008.

 

As of June 30,2008, there were approximately $1.6 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 1.4 years.

 

The totalintrinsic value of stock option exercises for the three months ended June 30,2008 and 2007 was $0 and $23,000, respectively. The total fair value of stock options vested during the three monthsended June 30, 2008 and 2007 was $0.3 million and $0.2 million,respectively.

 

The totalintrinsic value of stock option exercises for the six months ended June 30,2008 and 2007 was $0 and $23,000, respectively. The total fair value of stock options vested during the six months endedJune 30, 2008 and 2007 was $0.5 million and $0.3 million, respectively.

 

The deferredincome tax benefits from stock option expense related to Evolving Systems U.K.totaled approximately $14,000 and $8,000 for the three months ended June 30,2008 and 2007, respectively.  Thedeferred income tax benefits from stock option expense related to EvolvingSystems U.K. totaled approximately $29,000 and $19,000 for the six months endedJune 30, 2008 and 2007, respectively.

 

Cash received fromstock option exercises for the three months ended June 30, 2008 and 2007was $0 and $19,000, respectively.  Cashreceived from stock option exercises for the six months ended June 30,2008 and 2007 was $0 and $19,000, respectively.

 

**EmployeeStock Purchase Plan**

 

Under the EmployeeStock Purchase Plan (“ESPP”), we are authorized to issue up to 1,100,000 sharesof our common stock to full-time employees, nearly all of whom are eligible toparticipate. Under the terms of the ESPP, employees may elect to have up to 15%of their gross compensation withheld through payroll deduction to purchase ourcommon stock, capped at $25,000 annually. The purchase price of the stock is85% of the lower of the closing price on the first day or the last day of eachthree-month participation period. As of June 30, 2008, there were 270,000shares available for purchase.  For eachof the three and six month periods ended June 30, 2008 and 2007, werecorded compensation expense of $5,000 and $11,000, respectively, associatedwith grants under the ESPP which includes the fair value of the look-backfeature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period based uponemployee participation.

 

The fair value ofeach grant made under our ESPP is estimated on the date of grant using theBlack-Scholes model.  The Black-Scholesmodel uses four assumptions to calculate the fair value of each option grant.  The expected term of each grant is based uponthe three-month participation period of each grant.  The risk-free interest rate is based upon therate currently available on zero-coupon U.S. Treasury instruments with aremaining term equal to the expected term of each grant.  The expected volatility is based uponhistorical volatility of our common stock. The expected dividend yield is based upon historical and anticipatedpayment of dividends.  The weightedaverage assumptions used in the fair value calculations are as follows:

 

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| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected term  (years)   |       | 0.25                                            |       | 0.25                                          |       | 0.25 |   | 0.25 |   |
| Risk-free  interest rate |       | 1.9                                             | %          | 5.0                                           | %          | 1.6 | % | 5.1 | % |
| Expected  volatility     |       | 68.9                                            | %          | 70.1                                          | %          | 69.8 | % | 70.1 | % |
| Expected  dividend yield |       | 0                                               | %          | 0                                             | %          | 0 | % | 0 | % |

 

Cash received fromemployee stock plan purchases for the three months ended June 30, 2008 and2007 was 20,000 and $19,000, respectively. Cash received from employee stock plan purchases for each of the sixmonth periods ended June 30, 2008 and 2007 was $36,000.

 

**NOTE 5 – CONCENTRATION OF CREDIT RISK**

 

For the three and six months ended June 30, 2008, two significantcustomers (defined as contributing at least 10%) accounted for 29% (18% and11%) and 27% (15% and 12%), respectively, of total revenue.  These customers are large telecommunicationsoperators located in the U.S. and U.K., respectively.  For the three and six months ended June 30,2007, two significant customers accounted for 37% (22% and 15%) and 36% (22%and 14%), respectively, of total revenue. These customers are large telecommunications operators located in theU.S. and U.K., respectively.

 

As of June 30, 2008, four significant customers accounted forapproximately 58% (18%, 16%, 13% and 11%) of contract receivables.  These customers are large telecommunications operatorslocated in Germany, Chile, Pakistan and the U.K., respectively.  At December 31, 2007, one significantcustomer accounted for approximately 42% of contract receivables.  This customer is a large telecommunications operator located in the U.S.

 

**NOTE 6 – LONG-TERM DEBT**

 

Long-termdebt consists of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **2008**          | ** ** | **2007**              | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |              |       |                  |       |   |   |
| Senior term loan  with financial institution, interest at a fixed rate of 8.25%, principal  installments and interest payments are due monthly with final maturity on  February 22, 2010. The loan is secured by substantially all of our  assets.                                                                                                                                 |       | $                 | 3,333      |                  | $          | — |   |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |              |       |                  |       |
| Senior note  payable to financial institution, interest at the one-month London InterBank  Offered Rate (“LIBOR”) plus a margin of 5.25% at December 31, 2007;  however, the LIBOR rate cannot be less than 3.75%, interest rate was 10.25%  at December 31, 2007. In February 2008, this note payable was  replaced by our new $4.0 million senior term loan. |       | —            |       | 4,419                 |       |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |              |       |                  |       |
| $4.5 million  senior revolving credit facility payable to financial institution, interest  at one-month LIBOR plus 4.0%; however, the LIBOR rate cannot be less than  3.75%; interest rate was 9.00% at December 31, 2007. In  February 2008, this revolver was replaced with our $6.0 million senior  revolving credit facilities.                                           |       | —            |       | 2,000                 |       |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |              |       |                  |       |
| Long-term unsecured  subordinated notes payable, interest ranges from 11-14% with a weighted  average rate of 12.60% and 12.82% at June 30, 2008 and December 31,  2007, respectively, accrued interest and principal are due in full  May 16, 2011.                                                                                                                     |       | 4,550             |       | 4,767                 |       |
| Total debt                                                                                                                                                                                                                                                                                                                                                                              |       | 7,883             |       | 11,186                |       |
| Less current  portion                                                                                                                                                                                                                                                                                                                                                                   |       | (2,000            | )          | (2,500                | )          |
| Long-term debt,  excluding current portion                                                                                                                                                                                                                                                                                                                                              |       | $                 | 5,883      |                  | $          | 8,686 |   |

 

OnFebruary 22, 2008, we replaced our existing senior term note and seniorrevolving facility with a new $4.0 million senior term loan, a $1.0 millionU.S. revolving credit facility (“U.S. Revolving Facility”) and a $5.0 millionU.K. revolving credit facility (“U.K. Revolving Facility”).

 

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We used proceeds from the $4.0 million senior term loan to pay down ourexisting senior term note balance of approximately $3.8 million.  The $4.0 million senior term loan bearsinterest at a fixed rate of 8.25% and is payable in 24 equal monthlyinstallments of principal, plus all accrued interest, beginning March 10,2008, with final maturity on February 22, 2010.  The senior term loan is secured bysubstantially all assets of Evolving Systems, Inc. and subjects us tocertain affirmative and negative covenants, including financial covenantsrelated to maintaining a specified ratio of debt to EBITDA, as defined, minimumEBITDA, minimum liquidity, and a specified fixed charge ratio.

 

The remainingscheduled principal payments as of June 30, 2008 on our senior term loanare as follows (in thousands):

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2008                                        |       | $          | 1,000      |   |
| 2009                                        |       | 2,000      |       |
| 2010                                        |       | 333        |       |
|                                        |       | $          | 3,333      |   |

 

Additionally, we obtained a new $1.0 million U.S. Revolving Facility thatbears interest at Prime Rate plus 0.5%. Prime Rate was 5.00% as of June 30, 2008.  Borrowings under the senior revolvingfacilities are limited to a percentage of our eligible accounts receivable andcash.  The U.S. Revolving Facility issecured by all assets of Evolving Systems, Inc. and is subject to the samecovenants as the senior term loan.  Allaccrued interest on outstanding borrowings under the U.S. Revolving Facility ispaid monthly, with any outstanding balance due with a final maturity of February 22,2011.  As of June 30, 2008, we had$1.0 million in availability, but no borrowing outstanding under this U.S.Revolving Facility.

 

We also entered into a $5.0 million U.K. Revolving Facility that bearsinterest at Prime Rate plus 0.5%.  PrimeRate was 5.00% as of June 30, 2008. Borrowings under the U.K. Revolving Facility are limited to a percentageof our eligible accounts receivable and cash. The U.K. Revolving Facility is secured by all assets of Evolving SystemsHoldings Ltd and Evolving Systems Limited and is subject to the same covenantsas the Senior Term Loan.  All accruedinterest on outstanding borrowings under the Senior Revolving Facility is paidmonthly, with any outstanding balance due with a final maturity of February 22,2011.  As of June 30, 2008, we had$4.3 million in availability, but no borrowing outstanding under this U.K.Revolving Facility,

 

In connection with the replacement of our existing senior term note andsenior revolving facility with the new senior term loan and U.S. RevolvingFacility and the U.K. Revolving Facility, we recorded a write-off of debtissuance costs associated with the retired senior debt of approximately $0.3million.  Additionally, we capitalizeddebt issuance costs related to our new senior debt of approximately $0.3million.  These newly capitalized debtissuance costs will be amortized over the term of the new senior debt.

 

On February 22,2008, we paid $272,000 to retire $279,000 of subordinated debt and relatedaccrued interest held by two of our subordinated note holders.  The retirements included principal of$217,000 and accrued interest of $62,000. The $7,000 gain on extinguishment of this debt is reflected within ourother income (expense) on the consolidated statement of operations.  On February 22, 2008, we also paid$728,000 in accrued interest to the remaining subordinated note holders.

 

Wewere in compliance with all of our debt covenants as of June 30, 2008.

 

**NOTE 7 – INCOME TAXES**

 

Werecorded net income tax expense of $113,000 and $83,000 for the three monthsended June 30, 2008 and 2007, respectively.  The net expense during the three months endedJune 30, 2008 consisted of current income tax expense of $175,000,partially offset by a deferred tax benefit of $62,000, both of which wereprimarily related to our U.K.-based operations. The net expense during the three months ended June 30, 2007consisted of current income tax expense of $72,000 and deferred tax expense of$11,000, both of which were primarily related to our U.K.-based operations.

 

Werecorded net income tax expense of $39,000 and $223,000 for the six monthsended June 30, 2008 and 2007, respectively.  The net expense during the six months ended June 30,2008 consisted of current income tax expense of $180,000, partially offset by adeferred tax benefit of $141,000, both of which were primarily related to ourU.K.-based operations.  The net expenseduring the six months ended June 30, 2007 consisted of current income taxexpense of $262,000, partially offset by a deferred tax benefit of $39,000,both of which were primarily related to our U.K.-based operations.

 

EffectiveApril 2007, our Indian subsidiary was subject to a 10% minimum alternativetax.  This tax did not have a materialimpact on our results for the three and six months ended June 30, 2008,and we do not expect this tax to have a material impact on future results.

 

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Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe amortization of these identifiable intangibles is not deductible for incometax purposes, we established a long-term deferred tax liability of $4.6 millionat the acquisition date for the expected difference between what would beexpensed for financial reporting purposes and what would be deductible forincome tax purposes. As of June 30, 2008 and December 31, 2007, thiscomponent of the deferred tax liability was $1.0 million and $1.2 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

As of June 30, 2008and December 31, 2007 we continued to maintain a full valuation allowanceon the domestic net deferred tax asset as we have determined it is more likelythan not that we will not realize our domestic deferred tax assets.  Such assets primarily consist of certain netoperating loss carryforwards.  Weassessed the realizability of our domestic deferred tax assets using allavailable evidence.  In particular, weconsidered both historical results and projections of profitability for thereasonably foreseeable future periods. We are required to reassess our conclusions regarding the realization ofour deferred tax assets at each financial reporting date. A future evaluationcould result in a conclusion that all or a portion of the valuation allowanceis no longer necessary which could have a material impact on our results ofoperations and financial position.

 

Effective January 1,2007, the company adopted the provisions of FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”(“FIN 48”).  FIN 48 prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return.  For those benefits to berecognized, a tax position must be more-likely-than-not to be sustained uponexamination by taxing authorities.  Therewas not a material impact on the company’s consolidated financial position andresults of operations as a result of the adoption of the provisions of FIN 48.

 

On January 1,2007, we recorded a FIN 48 transition adjustment consisting of a $0.4 milliondecrease in our deferred tax assets related to Research and Development TaxCredits that was offset by a corresponding decrease in our valuation allowancebecause we determined that it was not more likely than not that our deferredtax assets will be realized.  As of June 30,2008 and December 31, 2007, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes our unrecognized tax positions over the next twelvemonths.

 

We conductbusiness globally and, as a result, Evolving Systems, Inc. or one or moreof our subsidiaries file income tax returns in the U.S. federal jurisdictionand various state and foreign jurisdictions. In the normal course of business, we are subject to examination bytaxing authorities throughout the world, including the U.S., the U.K., Germanyand India.

 

**NOTE 8 – STOCKHOLDERS’ EQUITY**

 

OnFebruary 25, 2008, holders of 461,758 shares of Series B PreferredStock with a carrying value of $5.4 million, or approximately 96% of theoutstanding preferred stock, converted their shares of preferred stock into1,385,274 shares of our common stock in accordance with the conversionprovisions of the Series B Preferred Stock.  On March 19, 2008, a holder of 16,992shares of Series B Preferred Stock with a carrying value of $0.2 million,which represented the remainder of the outstanding preferred stock, convertedhis shares of preferred stock into 50,976 shares of our common stock inaccordance with the conversion provisions of the Series B PreferredStock.  As we previously includedthe Series B Convertible Preferred Stock as a participating security forbasic EPS purposes, these conversions did not change our basic or diluted EPScalculations.

 

**NOTE 9 – SEGMENT INFORMATION**

 

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” we define operating segments as components of anenterprise for which separate financial information is reviewed regularly bythe chief operating decision-making group to evaluate performance and to makeoperating decisions. We have identified our Chief Executive Officer and ChiefFinancial Officer as our chief operating decision-makers (CODM). These chiefoperating decision makers review revenues by segment and review overall resultsof operations.

 

Wecurrently operate business as two operating segments based on revenuetype:  license fees and services revenueand customer support revenue (as shown on the consolidated statements ofoperations).  License fees and services(L&S) revenue represents the fees received from the license of softwareproducts and those services directly related to the delivery of the licensedproducts, as well as fees for custom development, integration services and timeand materials work.  Customer support(CS) revenue includes annual support fees, recurring maintenance fees, fees formaintenance upgrades and warranty services. Warranty services that are similar to software maintenance services aretypically bundled with a license sale. Total assets by segment have not beendisclosed as the information is not available to the chief operatingdecision-making group.

 

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Segment information is as follows (in thousands):

 
| ** **                                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Revenue**                                                                |       |                                            |       |                                          |       |   |   |   |   |
| License fees and  services                                                 |       | $                                               | 5,342      |                                          | $          | 4,742 |   | $ | 10,174 |   | $ | 8,733 |   |
| Customer support                                                           |       | 4,303                                           |       | 4,380                                         |       | 8,598 |   | 8,850 |   |
|                                                                       |       | 9,645                                           |       | 9,122                                         |       | 18,772 |   | 17,583 |   |
|                                                                       |       |                                            |       |                                          |       |   |   |   |   |
| **Revenue  less cost of revenue, excluding depreciation and amortization** |       |                                            |       |                                          |       |   |   |   |   |
| License fees and  services                                                 |       | 3,440                                           |       | 2,801                                         |       | 6,048 |   | 4,868 |   |
| Customer support                                                           |       | 2,671                                           |       | 2,664                                         |       | 5,473 |   | 5,641 |   |
|                                                                       |       | 6,111                                           |       | 5,465                                         |       | 11,521 |   | 10,509 |   |
|                                                                       |       |                                            |       |                                          |       |   |   |   |   |
| **Unallocated  costs**                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Other operating  expenses                                                  |       | 4,380                                           |       | 4,192                                         |       | 9,060 |   | 8,331 |   |
| Depreciation and  amortization                                             |       | 631                                             |       | 644                                           |       | 1,241 |   | 1,320 |   |
| Restructuring  and other                                                   |       | —                                          |       | —                                        |       | — |   | (1 | ) |
| Interest income                                                            |       | (39                                             | )          | (81                                           | )          | (117 | ) | (145 | ) |
| Interest expense                                                           |       | 283                                             |       | 451                                           |       | 619 |   | 915 |   |
| (Gain) loss on  debt extinguishment                                        |       | —                                          |       | —                                        |       | 290 |   | (42 | ) |
| Foreign currency  exchange (gain) loss                                     |       | (32                                             | )          | 104                                           |       | (142 | ) | 162 |   |
| **Income  (loss) before income taxes**                                     |       | $                                               | 888        |                                          | $          | 155 |   | $ | 570 |   | $ | (31 | ) |

 

***Geographic Regions***

 

We are headquartered in Englewood, a suburb ofDenver, Colorado.  We use customerlocations as the basis for attributing revenues to individual countries.  We provide products and services on a globalbasis through our headquarters and our London-based Evolving Systems U.K.subsidiary.  Additionally, personnel inBangalore, India provide software development services to our globaloperations.  Financial information relatingto operations by geographic region is as follows (in thousands):

 
| ** **     | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------|------------|-----------------------------------------------------|------------|
| ** **     | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **     | ** ** | **L&S**                                         | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| United States  |       | $                                                   | 822        |   | $ | 2,439 |   | $ | 3,261 |   | $ | 1,053 |   | $ | 2,542 |   | $ | 3,595 |   |
| United Kingdom |       | 1,194                                               |       | 635 |   | 1,829 |   | 1,567 |   | 757 |   | 2,324 |   |
| Other          |       | 3,326                                               |       | 1,229 |   | 4,555 |   | 2,122 |   | 1,081 |   | 3,203 |   |
| Total Revenue  |       | $                                                   | 5,342      |   | $ | 4,303 |   | $ | 9,645 |   | $ | 4,742 |   | $ | 4,380 |   | $ | 9,122 |   |

 
| ** **     | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------|------------|---------------------------------------------------|------------|
| ** **     | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| ** **     | ** ** | **L&S**                                       | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| United States  |       | $                                                 | 1,221      |   | $ | 4,909 |   | $ | 6,130 |   | $ | 1,664 |   | $ | 5,177 |   | $ | 6,841 |   |
| United Kingdom |       | 2,387                                             |       | 1,317 |   | 3,704 |   | 2,740 |   | 1,501 |   | 4,241 |   |
| Other          |       | 6,566                                             |       | 2,372 |   | 8,938 |   | 4,329 |   | 2,172 |   | 6,501 |   |
| Total Revenue  |       | $                                                 | 10,174     |   | $ | 8,598 |   | $ | 18,772 |   | $ | 8,733 |   | $ | 8,850 |   | $ | 17,583 |   |

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| **Long-lived  assets, net**   |       |              |       |                  |       |
| United States                 |       | $                 | 7,386      |                  | $          | 7,814 |   |
| United Kingdom                |       | 24,361            |       | 24,883                |       |
| Other                         |       | 72                |       | 84                    |       |
| Total long-lived  assets, net |       | $                 | 31,819     |                  | $          | 32,781 |   |

 

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Revenuerelated to our product lines is as follows (in thousands):

 
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **           | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Revenue**          |       |                                            |       |                                          |       |   |   |   |   |
| Activation           |       | $                                               | 5,325      |                                          | $          | 4,905 |   | $ | 10,017 |   | $ | 9,478 |   |
| Numbering  solutions |       | 3,492                                           |       | 3,279                                         |       | 6,424 |   | 6,081 |   |
| Mediation            |       | 828                                             |       | 938                                           |       | 2,331 |   | 2,024 |   |
|                 |       | $                                               | 9,645      |                                          | $          | 9,122 |   | $ | 18,772 |   | $ | 17,583 |   |

 

**NOTE 10 – COMMITMENTS ANDCONTINGENCIES**

 

**(a)          Other Commitments**

 

Aspermitted under Delaware law, we have agreements with officers and directorsunder which we agree to indemnify them for certain events or occurrences whilethe officer or director is, or was serving, at our request in this capacity.The term of the indemnification period is indefinite. There is no limit on theamount of future payments we could be required to make under theseindemnification agreements; however, we maintain Director and Officer insurancepolicies, as well as an Employment Practices Liability Insurance Policy, thatmay enable us to recover a portion of any amounts paid. As a result of ourinsurance policy coverage, we believe the estimated fair value of theseindemnification agreements is minimal. Accordingly, there were no liabilitiesrecorded for these agreements as of June 30, 2008 or December 31,2007.

 

Weenter into standard indemnification terms with customers and suppliers, asdiscussed below, in the ordinary course of business.  As we may subcontract the development of deliverablesunder customer contracts, we could be required to indemnify customers for workperformed by subcontractors. Depending upon the nature of the customerindemnification, the potential amount of future payments we could be requiredto make under these indemnification agreements may be unlimited. We may be ableto recover damages from a subcontractor if the indemnification to customersresults from the subcontractor’s failure to perform. To the extent we areunable to recover damages from a subcontractor, we could be required toreimburse the indemnified party for the full amount. We have never incurredcosts to defend lawsuits or settle claims relating to indemnification arisingout of subcontractors’ failure to perform. As a result, we believe the estimatedfair value of these agreements is minimal. Accordingly, there were noliabilities recorded for these agreements as of June 30, 2008 or December 31,2007.

 

Ourstandard license agreements contain product warranties that the software willbe free of material defects and will operate in accordance with the statedrequirements for a limited period of time. The product warranty provisions require us to cure any defects throughany reasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, there were no liabilitiesrecorded for these product warranty provisions as of June 30, 2008 or December 31,2007.

 

Oursoftware arrangements generally include a product indemnification provisionwhereby we will indemnify and defend a customer in actions brought against thecustomer for claims that our products infringe upon a copyright, trade secret,or valid patent. We have not historically incurred any significant costsrelated to product indemnification claims. Accordingly, there were noliabilities recorded for these indemnification provisions as of June 30,2008 or December 31, 2007.

 

Inrelation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreedto indemnify certain parties from any losses, actions, claims, damages orliabilities (or actions in respect thereof) resulting from any claim raised bya third party.  We do not believe thatthere will be any claims related to these indemnifications. Accordingly, therewere no liabilities recorded for these agreements as of June 30, 2008 or December 31,2007.

 

**(b)         Litigation**

 

During the fourthquarter of 2006, a previous vendor filed a complaint in the Superior Court ofNew Jersey against us asserting we breached certain provisions of a licenseagreement.  While the outcome of thismatter is uncertain, we believe we have paid all fees due under our licenseagreement and we are vigorously defending this claim.

 

We are involved invarious other legal matters arising in the normal course of business.  Losses, including estimated costs to defend,were recorded for these matters to the extent they were probable of loss andthe amount of loss could be reasonably estimated.

 

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**NOTE11 – RELATED PARTY TRANSACTIONS**

 

Effective January 1,2008, we entered into a consulting agreement with Stephen K. Gartside, Jr.,our previous President and CEO and current Chairman of the Board.  Under the agreement, we will pay Mr. Gartsidea fee of $20,000 for consulting services provided to us during 2008.  We had current obligations in theconsolidated balance sheets, under the agreement, of $5,000 and $0 as of June 30,2008 and December 31, 2007, respectively. We recorded $5,000 and $0 of general and administrative expense in theconsolidated statements of operations, related to this agreement, for the threemonths ended June 30, 2008 and 2007, respectively.  We recorded $10,000 and $0 of general andadministrative expense in the consolidated statements of operations, related tothis agreement, for the six months ended June 30, 2008 and 2007,respectively.

 

**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**SPECIAL NOTE ABOUT FORWARD-LOOKINGSTATEMENTS**

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements thathave been made pursuant to the provisions of the Private Securities LitigationReform Act of 1995.  Theseforward-looking statements are based on current expectations, estimates, andprojections about Evolving Systems’ industry, management’s beliefs, and certainassumptions made by management. Forward-looking statements include our expectations regarding product,services, and maintenance revenue, annual savings associated with theorganizational changes effected in prior years, and short- and long-term cashneeds.  In some cases, words such as “anticipates,”“expects,” “intends,” “plans,” “believes,” “estimates,” variations of thesewords, and similar expressions are intended to identify forward-lookingstatements.  The statements are notguarantees of future performance and are subject to certain risks, uncertainties,and assumptions that are difficult to predict; therefore, actual results maydiffer materially from those expressed or forecasted in any forward-lookingstatements.  Risks and uncertainties ofour business include those set forth in our Annual Report on Form 10-K forthe year ended December 31, 2007 under “Item 1A. Risk Factors” as well asadditional risks described in this Form 10-Q.  Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as a resultof new information, future events, or otherwise.  However, readers should carefully review therisk factors set forth in other reports or documents we file from time to timewith the Securities and Exchange Commission, particularly the Quarterly Reportson Form 10-Q and any Current Reports on Form 8-K.*

 

**OVERVIEW**

 

We area worldwide provider of software solutions and services to telecommunicationscarriers, with more than 65 operators in over 40 countries.  Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, highly reliable software solutions fora range of Operations Support Systems (“OSS”). Our *TertioTM*solution is a leading packagedsolution for service activation in the wireless industry.

 

Werecognize revenue in accordance with the prescribed accounting standards forsoftware revenue recognition under generally accepted accountingprinciples.  Our license fees andservices revenues fluctuate from period to period as a result of the timing ofrevenue recognition on existing projects.

 

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**RESULTSOF OPERATIONS**

 

Thefollowing table presents the unaudited consolidated statements of operationsreflected as a percentage of total revenue.

 
| ** **                                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **REVENUE**                                                                  |       |                                            |       |                                          |       |   |   |   |   |
| License fees and  services                                                   |       | 55                                              | %          | 52                                            | %          | 54 | % | 50 | % |
| Customer support                                                             |       | 45                                              | %          | 48                                            | %          | 46 | % | 50 | % |
| Total revenue                                                                |       | 100                                             | %          | 100                                           | %          | 100 | % | 100 | % |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| **COSTS  OF REVENUE AND OPERATING EXPENSES**                                 |       |                                            |       |                                          |       |   |   |   |   |
| Costs of license  fees and services, excluding depreciation and amortization |       | 20                                              | %          | 21                                            | %          | 22 | % | 22 | % |
| Costs of  customer support, excluding depreciation and amortization          |       | 17                                              | %          | 19                                            | %          | 17 | % | 18 | % |
| Sales and  marketing                                                         |       | 23                                              | %          | 24                                            | %          | 23 | % | 24 | % |
| General and  administrative                                                  |       | 13                                              | %          | 18                                            | %          | 14 | % | 18 | % |
| Product  development                                                         |       | 10                                              | %          | 4                                             | %          | 11 | % | 5 | % |
| Depreciation                                                                 |       | 2                                               | %          | 3                                             | %          | 3 | % | 3 | % |
| Amortization                                                                 |       | 4                                               | %          | 4                                             | %          | 4 | % | 5 | % |
| Restructuring  and other                                                     |       | —                                          | %          | —                                        | %          | — | % | — | % |
| Total costs of  revenue and operating expenses                               |       | 89                                              | %          | 93                                            | %          | 94 | % | 95 | % |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations                                                      |       | 11                                              | %          | 7                                             | %          | 6 | % | 5 | % |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Interest income                                                              |       | 1                                               | %          | 1                                             | %          | 1 | % | 1 | % |
| Interest expense                                                             |       | (3                                              | )%         | (5                                            | )%         | (3 | )% | (5 | )% |
| Gain (loss) on  debt extinguishment                                          |       | —                                          | %          | —                                        | %          | (2 | )% | — | % |
| Foreign currency  exchange gain (loss)                                       |       | —                                          | %          | (1                                            | )%         | 1 | % | (1 | )% |
| Other expense,  net                                                          |       | (2                                              | )%         | (5                                            | )%         | (3 | )% | (5 | )% |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss)  before income taxes                                           |       | 9                                               | %          | 2                                             | %          | 3 | % | — | % |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income tax  expense                                                          |       | 1                                               | %          | 1                                             | %          | — | % | 1 | % |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss)                                                           |       | 8                                               | %          | 1                                             | %          | 3 | % | (1 | )% |

 

***Revenue***

 

Revenueis comprised of license fees/services and customer support.  License fees and services revenue representthe fees we receive from the licensing of our software products and thoseservices directly related to the delivery of the licensed product as well as integrationservices and time and materials work. Customer supportrevenue includes annual support, recurring maintenance, maintenance upgradesand warranty services.  Warranty servicesconsist of maintenance services and are typically bundled with a license saleand the related revenue, based on Vendor-Specific Objective Evidence (VSOE), isdeferred and recognized ratably over the warranty period.  The following table presents our revenue byproduct group (in thousands):

** **
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **           | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Activation           |       | $                                               | 5,325      |                                          | $          | 4,905 |   | $ | 10,017 |   | $ | 9,478 |   |
| Numbering  solutions |       | 3,492                                           |       | 3,279                                         |       | 6,424 |   | 6,081 |   |
| Mediation            |       | 828                                             |       | 938                                           |       | 2,331 |   | 2,024 |   |
|                 |       | $                                               | 9,645      |                                          | $          | 9,122 |   | $ | 18,772 |   | $ | 17,583 |   |

 

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**LicenseFees and Services**

 

License fees and services revenue increased 13%, or $0.6 million, to$5.3 million for the three months ended June 30, 2008 from $4.7 millionfor the three months ended June 30, 2007. This increase in license fees and services revenue was composed of anincrease of $0.4 million in revenue from our activation products and anincrease of $0.2 million in revenue from our numbering solutions products.  The increase in our activation productrevenue is the result of growth in the activation customer account base as wellas to revenue from our *Dynamic SIM Allocation*TMsolution.  The increase in our numberingsolutions product revenue is the result of our expansion into internationalmarkets with our*NumeriTrack®* and our*Dynamic SIM Allocation*TM solutions.  Our*Dynamic SIM Allocation*TMsolution uses core technology from both our service activation products and ournumbering solutions *NumeriTrack®*product.  When reporting revenue resultswe apportion the revenue associated with*Dynamic SIM Allocation*TMsolution evenly across our activation and numbering solutions product revenue.

 

License fees and services revenue increased 17%, or $1.5 million, to$10.2 million for the six months ended June 30, 2008 from $8.7 million forthe six months ended June 30, 2007. This increase in license fees and services revenue was composed of anincrease of $0.6 million in revenue from our activation products, an increaseof $0.3 million in revenue from our numbering solutions products and anincrease of $0.6 million in revenue from our mediation products.  The increase in our activation productrevenue is the result of growth in the activation customer account base as wellas to revenue from our *Dynamic SIM Allocation*TMsolution.  The increase in our numberingsolutions product revenue is the result of our expansion into internationalmarkets with our*NumeriTrack®* and our*Dynamic SIM Allocation*TM solutions.  Our*Dynamic SIM Allocation*TMsolution uses core technology from both our service activation products and ournumbering solutions *NumeriTrack®*product.  When reporting revenue resultswe apportion the revenue associated with*Dynamic SIM Allocation*TMsolution evenly across our activation and numbering solutions productrevenue.  The increase in our mediationproduct revenue is the result of follow on sales from our existing mediationaccount base.

 

**Customer Support**

 

Customer support revenue decreased $0.1 million, or 2%, to $4.3 millionfor the three months ended June 30, 2008 from $4.4 million for the threemonths ended June 30, 2007.  Thedecrease in customer support revenue resulted from a decrease of $0.1 millionin mediation customer support revenue. The decrease in mediation customer support revenue is the result of adecline in our network mediation account base.

 

Customer support revenue decreased $0.3 million, or 3%, to $8.6 millionfor the six months ended June 30, 2008 from $8.9 million for the sixmonths ended June 30, 2007.  Thedecrease in customer support revenue resulted from a decrease of $0.3 millionin mediation customer support revenue. The decrease in mediation customer support revenue is the result of adecline in our network mediation account base.

 

***Costsof Revenue, Excluding Depreciation and Amortization***

 

Costs of revenue, excluding depreciation and amortization, consistprimarily of personnel costs and other direct costs associated with thesepersonnel, facilities costs, cost of third-party software and partnercommissions.  Costs of revenue, excludingdepreciation and amortization, were $3.5 million and $3.7 million for the threemonths ended June 30, 2008 and 2007, respectively. Costs of revenue,excluding depreciation and amortization, were $7.3 million and $7.1 million forthe six months ended June 30, 2008 and 2007, respectively.   These costs are discussed further below.

 

**Costs of License Fees and Services, ExcludingDepreciation and Amortization**

 

Costs of license fees and services, excluding depreciation andamortization, were $1.9 million for each of the three month periods ended June 30,2008 and 2007, respectively.  As apercentage of license fees and services revenue, costs of license fees andservices, excluding depreciation and amortization, decreased to 36% for thethree months ended June 30, 2008 from 41% for the three months ended June 30,2007.  The decrease in costs as apercentage of revenue is due to the increased utilization of our lower cost offshoredevelopment resources in India.

 

Costs of license fees and services, excluding depreciation andamortization, increased $0.2 million, or 7%, to $4.1 million for the six monthsended June 30, 2008 from $3.9 million for the six months ended June 30,2007.  The increase in costs is theresult of higher costs necessary to support the increase in license fees andservices revenue.  As a percentage oflicense fees and services revenue, costs of license fees and services,excluding depreciation and amortization, decreased to 41% for the six monthsended June 30, 2008 from 44% for the six months ended June 30,2007.  The decrease in costs as apercentage of revenue is due to the increased utilization of our lower costoffshore development resources in India.

 

**Costs of Customer Support, Excluding Depreciationand Amortization**

 

Costs of customer support, excluding depreciation and amortization,decreased $0.1 million, or 5%, to $1.6 million for the three months ended June 30,2008 from $1.7 million for the three months ended June 30, 2007.  As a percentage of customer support revenue,costs of customer support revenue, excluding depreciation and amortization,decreased to 38% for the three months ended June 30, 2008 from 39% for thethree months ended June 30, 2007. These decreases are the result of decreased costs necessary to supportlower customer support revenue.

 

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Costs of customer support, excluding depreciation and amortization,decreased $0.1 million, or 3%, to $3.1 million for the six months ended June 30,2008 from $3.2 million for the six months ended June 30, 2007.  The decrease in costs is the result of decreasedcosts necessary to support lower customer support revenue.  As a percentage of customer support revenue,costs of customer support revenue, excluding depreciation and amortization,remained constant at 36% for each of the six month periods ended June 30,2008 and June 30, 2007.

 

***Salesand Marketing***

 

Sales and marketing expenses primarily consist of compensation costs,including bonuses and commissions, travel expenses, advertising, marketing andfacilities expenses.  Sales and marketingexpenses remained constant at $2.2 million for each of the three month periodsended June 30, 2008 and June 30, 2007.  As a percentage of total revenue, sales andmarketing expenses decreased to 23% for the three months ended June 30,2008 from 24% for the three months ended June 30, 2007. The flat cost baseon increased revenues is the result of decreases in costs associated withtransitioning headcount from mature markets to international markets, offset byincreases in travel costs associated with our expansion into new internationalmarkets, as well as higher sales incentive compensation relating to improvedfinancial results.

 

Sales and marketing expenses increased $0.2 million, or 4%, to $4.4million for the six months ended June 30, 2008 from $4.2 million for the sixmonths ended June 30, 2007.  As apercentage of total revenue, sales and marketing expenses decreased to 23% forthe six months ended June 30, 2008 from 24% for the six months ended June 30,2007. The increase in the expense base is the result of increased travel costsassociated with our expansion into new international markets, as well as higherincentive compensation related to our improved financial results.

 

***Generaland Administrative***

 

General and administrative expenses consist principally of employeerelated costs and professional fees for the following departments: facilities,finance, legal, human resources, and certain executive management.  General and administrative expenses decreased$0.4 million, or 25%, to $1.2 million from $1.6 million for the threemonths ended June 30, 2008 and 2007, respectively.  As a percentage of total revenue, general andadministrative expenses for the three months ended June 30, 2008 and 2007,decreased to 13% from 18%, respectively. These decreases were a result of decreased professional fees, as well aslower headcount and lower landlord costs related to our headquarters facilitylease.

 

General and administrative expenses decreased $0.5 million, or 17%, to$2.7 million from $3.2 million for the six months ended June 30, 2008and 2007, respectively.  As a percentageof total revenue, general and administrative expenses for the six months ended June 30,2008 and 2007, decreased to 14% from 18%, respectively.  These decreases were a result of decreasedprofessional fees, as well as lower headcount and lower landlord costs relatedto our headquarters facility lease.

 

***ProductDevelopment***

 

Productdevelopment expenses consist primarily of employee related costs andsubcontractor expenses.  Productdevelopment expenses increased $0.6 million, or 165%, to $1.0 million from $0.4million for the three months ended June 30, 2008 and 2007,respectively.  As a percentage ofrevenue, product development expenses for the three months ended June 30,2008 and 2007, increased to 10% from 4%, respectively.  These increases are the result of increasedinvestments made in our activation products, including, but not limited to, thedevelopment of *TertioTM Service Verification*, *TertioTM Service Activation* and *TertioTMProcess Management*.  We havealso increased investment in internationalizing our *NumeriTrack®*product, as well as investing in the development of our *Dynamic SIM Allocation*TM product.

 

Product development expenses increased $1.1 million, or 122%, to $2.0million from $0.9 million for the six months ended June 30, 2008 and 2007,respectively.  As a percentage ofrevenue, product development expenses for the six months ended June 30,2008 and 2007, increased to 11% from 5%, respectively.  These increases are the result of increased investmentsmade in our activation products, including, but not limited to, the developmentof *TertioTM Service Verification*, *TertioTM Service Activation* and *TertioTMProcess Management*.  We havealso increased investment in internationalizing our *NumeriTrack®*product, as well as investing in the development of our *Dynamic SIM Allocation*TM product.

 

***Depreciation***

 

Depreciation expense consists of depreciation of long-lived propertyand equipment.  Depreciation expense was$0.3 million for each of the three month periods ended June 30, 2008 and2007, respectively, and $0.5 million for each of the six month periods ended June 30,2008 and 2007, respectively.

 

***Amortization***

 

Amortization expense consists of amortization of identifiableintangible assets acquired through our acquisitions of CMS, TSE and EvolvingSystems U.K.  Amortization expense was$0.4 million for each of the three month periods ended June 30, 2008 and2007, respectively, and $0.8 million for each of the six month periods ended June 30,2008 and 2007, respectively.

 

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***Interest Expense***

 

Interestexpense includes interest expense on our long-term debt and capital leaseobligations as well as amortization of debt issuance costs.  Interest expense was $283,000 and $451,000for the three months ended June 30, 2008 and 2007, respectively, andinterest expense was $619,000 and $915,000 for the six months ended June 30,2008 and 2007, respectively.  Thesedecreases of $168,000 and $296,000, for the three and six months ended June 30,2008, respectively, were the result of reduced levels of debt and to lowerinterest rates on our senior debt.

 

***Gain (Loss) on Debt Extinguishment***

 

                In February 2008, we wrote-off the remainingdebt issuance costs of $297,000 related to our senior term not payable that wasreplaced during the three months ended March 31, 2008.  This loss related to the debt issuance costwrite-off was partially offset by a $7,000 gain resulting from us paying$272,000 to retire $279,000 of subordinated debt and related accrued interestheld by two of our subordinated note holders. The retirements included principal of $217,000 and accrued interest of$62,000.

 

In March 2007,we paid $77,000 to retire $119,000 of subordinated debt and related accrued interestheld by one of our subordinated note holders, resulting in a $42,000 gain ondebt extinguishment.  The retired debtincluded principal of $103,000 and accrued interest of $16,000.

 

***Foreign Currency Exchange Gain (Loss)***

 

Foreign currency transaction gains (losses) resulted from transactionsdenominated in a currency other than the functional currency of the respectivesubsidiary and were $32,000 and $(104,000) for the three months ended June 30,2008 and 2007, respectively, and $142,000 and $(162,000) for the six monthsended June 30, 2008 and 2007, respectively.  The gains (losses) were generated primarilythrough the remeasurement of certain non-functional currency denominatedfinancial assets and liabilities of our Evolving Systems U.K. subsidiary.

 

***Income Taxes***

 

Werecorded net income tax expense of $113,000 and $83,000 for the three monthsended June 30, 2008 and 2007, respectively.  The net expense during the three months endedJune 30, 2008 consisted of current income tax expense of $175,000, partiallyoffset by a deferred tax benefit of $62,000, both of which were primarilyrelated to our U.K.-based operations. The net expense during the three months ended June 30, 2007consisted of current income tax expense of $72,000 and deferred tax expense of$11,000, both of which were primarily related to our U.K.-basedoperations.  Our effective tax rate of13% for the three months ended June 30, 2008 was down from an effectiverate of 54% for the three months ended June 30, 2007.  This reduction in our effective tax raterelates principally to an increased benefit from research and development taxcredits for our U.K.-based operations. In addition, the U.K. corporate tax rate decreased from 30% to 28%effective April 1, 2008.

 

Werecorded net income tax expense of $39,000 and $223,000 for the six monthsended June 30, 2008 and 2007, respectively.  The net expense during the six months ended June 30,2008 consisted of current income tax expense of $180,000, partially offset by adeferred tax benefit of $141,000, both of which were primarily related to ourU.K.-based operations.  The net expenseduring the six months ended June 30, 2007 consisted of current income taxexpense of $262,000, partially offset by a deferred tax benefit of $39,000,both of which were primarily related to our U.K.-based operations.  Our effective tax rate of 7% for the sixmonths ended June 30, 2008 was down from the six months ended June 30,2007 when we recorded income tax expense of $223,000 on a loss before incometaxes of $31,000.  This reduction in oureffective tax rate relates to a change in earnings mix amongst our taxjurisdictions.  We also had an increasedbenefit from research and development tax credits for our U.K.-basedoperations.  Additionally, the U.K.corporate tax rate decreased from 30% to 28% effective April 1, 2008.

 

Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe amortization of these identifiable intangibles is not deductible for incometax purposes, we established a long-term deferred tax liability of $4.6 millionat the acquisition date for the expected difference between what would beexpensed for financial reporting purposes and what would be deductible forincome tax purposes. As of June 30, 2008 and December 31, 2007, thiscomponent of the deferred tax liability was $1.0 million and $1.2 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

**FINANCIAL CONDITION**

 

 Our working capital position decreased $1.4million to a $29,000 deficit as of June 30, 2008 from a $1.4 millionsurplus as of December 31, 2007. The decrease in our working capital position is attributable to $3.0million in existing cash used to retire our $2.0 million revolving creditfacility and to retire $1.0 million related to our subordinated notes,including accrued non-current interest. These debt payments were unscheduled payments and reduced balancesclassified as long-term as of December 31, 2007.  In addition, we made $0.4 million in capitalexpenditures, further reducing our working capital position.  This decrease in our working capital positiondue to early debt payments and capital expenditures was partially offset bycash received as part of our debt refinance of $4.0 million, of which $2.0million is classified as current.   Seealso, “Liquidity and Capital Resources,” for further discussion of our workingcapital.

 

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**CONTRACTUAL OBLIGATIONS**

 

Therehave been no material changes to the contractual obligations as disclosed inour 2007 Annual Report on Form 10-K.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We have historically financed operations through cashflows from operations as well as debt and equity transactions.  At June 30, 2008, our principal sourceof liquidity was $7.2 million in cash and cash equivalents as well as $5.3million available under our revolving lines of credit.  The following table summarizes our statementsof cash flows (in thousands):

 
| ** **                | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| Cash provided  (used) by: |       |                                          |       |   |   |
| Operating  activities     |       | $                                             | 3,937      |   | $ | 6,104 |   |
| Investing  activities     |       | (393                                          | )          | (145 | ) |
| Financing  activities     |       | (3,553                                        | )          | (1,098 | ) |
| Effect of  exchange rates |       | (13                                           | )          | (39 | ) |
| Net cash  provided (used) |       | $                                             | (22        | ) | $ | 4,822 |   |

 

Net cash provided by operating activities for the six months ended June 30,2008 and 2007 was $3.9 million and $6.1 million, respectively.  This $2.2 million decrease in cash providedby operating activities was primarily attributable to $0.8 million inunscheduled interest payments made on our subordinated notes as well as longercollection cycles for our increasing international customer base.

 

Net cash used by investing activities during the six months ended June 30,2008 and 2007 was $0.4 million and $0.1 million.  The cash used for the six months ended June 30,2008 related entirely to purchases of property and equipment.  The cash used for the six months ended June 30,2007 related primarily to purchases of property and equipment of $0.3 million,partially offset by a $0.2 million reduction in restricted cash.

 

Net cash used in financing activities for the six months ended June 30,2008 and 2007 was $3.6 million and $1.1 million, respectively.  Financing activities in the six months ended June 30,2008 consisted of principal payments on existing debt of approximately $7.3million, partially offset by borrowings related to our new senior term loan ofapproximately $3.7 million, net of issuance costs. Financing activities in thesix months ended June 30, 2007 consisted of principal payments on notespayable of $1.1 million.

 

Webelieve that our current cash and cash equivalents, together with anticipatedcash flow from operations and availability under our revolving line of creditwill be sufficient to meet our working capital, capital expenditure andfinancing requirements for at least the next twelve months. In making thisassessment we considered the following:

 

·                  Our cash andcash equivalents balance at June 30, 2008 of $7.2 million;

 

·                  The availabilityunder our revolving credit facilities of $5.3 million at June 30, 2008;

 

·                  Our demonstratedability to generate positive cash flows from operations;

 

·                  Our backlog asof June 30, 2008 of approximately $17.6 million, including $7.1 million inlicense fees and services and $10.5 million in customer support;

 

·                  Our plannedcapital expenditures; and

 

·                  Our cashforecast which indicates that we will have sufficient liquidity to coveranticipated operating costs and capital expenditures as well as debt servicepayments.

 

We are exposed to foreign currency rate risks which impact the carryingamount of our foreign subsidiaries and our consolidated equity, as well as ourconsolidated cash position due to translation adjustments.  For the six months ended June 30, 2008,the effect of exchange rate changes resulted in a $13,000 decrease toconsolidated cash.  During the six monthsended June 30, 2007, the effect of exchange rate changes resulted in a$39,000 decrease in consolidated cash. We do not currently hedge our foreign currency exposure, but we monitorrate changes and may hedge our exposures in the future.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

Wehave no off-balance sheet arrangements that have a material current effect orthat are reasonably likely to have a material future effect on our financialcondition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources.

 

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**ITEM3.  QUANTITATIVE AND QUALITATIVE MARKETRISK DISCLOSURES**

 

In the ordinarycourse of business, we are exposed to certain market risks, including changesin interest rates and foreign currency exchange rates. Uncertainties that areeither non-financial or non-quantifiable such as political, economic, tax,other regulatory, or credit risks are not included in the following assessmentof market risks.

 

***InterestRate Risks***

 

Our cash balancesare subject to interest rate fluctuations and as a result, interest incomeamounts may fluctuate from current levels. We are exposed to interest rate risk related to our senior revolvingcredit facilities entered into in February 2008.  These obligations are variable interest ratenotes based on Prime Rate.  Fluctuationsin Prime Rate affect our interest rates.

 

***ForeignCurrency Risk***

 

We are exposed tofavorable and unfavorable fluctuations of the U.S. dollar (our functionalcurrency) against the currencies of our operating subsidiaries. Any increase(decrease) in the value of the U.S. dollar against any foreign currencythat is the functional currency of one of our operating subsidiaries will causethe parent company to experience unrealized foreign currency translation losses(gains) with respect to amounts already invested in such foreigncurrencies.  In addition, we and ouroperating subsidiaries are exposed to foreign currency risk to the extent thatwe enter into transactions denominated in currencies other than our respectivefunctional currencies, such as accounts receivable (including intercompanyamounts) that are denominated in a currency other than their own functionalcurrency. Changes in exchange rates with respect to these items will result inunrealized (based upon period-end exchange rates) or realized foreign currencytransaction gains and losses upon settlement of the transactions. In addition,we are exposed to foreign exchange rate fluctuations related to our operatingsubsidiaries’ monetary assets and liabilities and the financial results offoreign subsidiaries and affiliates when their respective financial statementsare translated into U.S. dollars for inclusion in our consolidated financialstatements. Cumulative translation adjustments are recorded in accumulatedother comprehensive income (loss) as a separate component of equity. As aresult of foreign currency risk, we may experience economic loss and a negativeimpact on earnings and equity with respect to our holdings solely as a resultof foreign currency exchange rate fluctuations.

 

The relationship between the Great British pound,Indian rupee and the U.S. dollar, which is our functional currency, is shownbelow, per one U.S. dollar:

 
| **Spot rates:** | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Great British  Pound |       | 0.50140                     |       | 0.50092                         |       |
| Indian Rupee         |       | 42.84490                    |       | 39.43218                        |       |

 
| ** **              | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **Average rates:** | ** ** | **June 30, 2008**      | ** ** | **June 30, 2007**    | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
| Great British  Pound    |       | 0.50717                          |       | 0.50386                        |       | 0.50653 |   | 0.50782 |   |
| Indian Rupee            |       | 41.56813                         |       | 41.28346                       |       | 40.65428 |   | 42.64969 |   |

 

At the present time, we do not hedge our foreign currency exposure or usederivative financial instruments that are designed to reduce our long-termexposure to foreign currency exchange risk.  To the extentthat translation and transaction gain and losses become significant, we willconsider various options to reduce this risk.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”), that are designed toprovide reasonable assurance that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in Securities andExchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure.

 

Our management,including our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of our disclosure controls and procedures as of theend of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective as of the end of such period.

 

In designing andevaluating our disclosure controls and procedures, management recognized thatdisclosure controls and procedures, no matter how well conceived and operated,can provide only reasonable, not absolute, assurance that the objectives of thedisclosure controls and procedures are met.  Additionally, in designingdisclosure controls and procedures, our management necessarily was required toapply its judgment in evaluating the cost-benefit relationship of possibledisclosure controls and procedures. The design of any disclosure controls andprocedures also is based in part upon certain assumptions about the likelihood 

 

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of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

 

During the three and sixmonths ended June 30, 2008, there were no changes in our internal controlsover financial reporting (as defined in Rule 13a-15(f) under theExchange Act) or in other factors that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

**PART II — OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

During the fourthquarter of 2006, a previous vendor filed a complaint in the Superior Court ofNew Jersey against us asserting we breached certain provisions of a licenseagreement.  While the outcome of thismatter is uncertain, we believe we have paid all fees due under our licenseagreement and we are vigorously defending this claim.

 

We are involved invarious other legal matters arising in the normal course of business.  Losses, including estimated costs to defend,were recorded for these matters to the extent they were probable of loss andthe amount of loss could be reasonably estimated.

 

**ITEM1A.  RISK FACTORS**

 

This Quarterly Report on Form 10-Q should be read in conjunctionwith the risk factors defined in our Annual Report on Form 10-K for theyear ended December 31, 2007 under “Item 1A. Risk Factors.”

 

**ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Weheld our Annual Meeting of Stockholders on June 10, 2008. According to thefinal proxy tally received from the Company’s transfer agent, the results ofthe voting on Proposals 1and 2, as described in the Company’s ProxyStatement, were as follows:

 

**Proposal #1:  Election of Directors**

 

ThaddeusDupper was elected to serve a three-year term until 2011.

For15,026,856

Withheld476,279

 

DavidS. Oros was elected to serve a three-year term until 2011.

For15,028,456

Withheld474,679

 

SteveB. Warnecke was re-elected to serve a three-year term until 2011.

For15,026,756

Withheld476,379

 

**Proposal #2:  Ratification of Independent Registered PublicAccounting Firm**

 

GrantThornton LLP was ratified as the independent registered public accounting firmfor the year ending December 31, 2008.

 

For15,006,123

Against129,948

Abstain367,063

 

**ITEM 5. OTHER INFORMATION**

 

None

 

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**ITEM6.  EXHIBITS**

 

(a)          Exhibits

 

Exhibit 31.1 – Certification pursuant to Section 302of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 – Certification pursuant to Section 302of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 – Certification pursuant to Section 906of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 – Certification pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| Date:  August 6, 2008 | /s/ BRIAN R.  ERVINE                          |
|----------------------------|-----------------------------------------------|
|                       | Brian R. Ervine                               |
|                       | Executive Vice  President, Chief              |
|                       | Financial and  Administrative Officer,        |
|                       | Treasurer and  Assistant Secretary            |
|                       | (Principal  Financial and Accounting Officer) |

 

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