**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **ý** | ** ** | **Quarterly Report Pursuant to Section 13  or 15(d) of the Securities Exchange Act of 1934**                                                                                                                    |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                      |
| ** ** | ** ** | **For the quarterly period ended March 31,  2005**                                                                                                                                                                   |
|       |       |                                                                                                                                                                                                                      |
| ** ** | ** ** | **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) | ** ** | (IRS 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)                            |

 

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes ýNo o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).  Yes oNo ý

 

As of May 9,2005 there were 16,024,102 shares outstanding of Registrant’s Common Stock (parvalue $0.001 per share).

 

 

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**EVOLVING SYSTEMS, INC.**

**Quarterly Report on Form 10-Q**

**March 31, 2005**

**Table of Contents**

 
| **PART I –  FINANCIAL INFORMATION** | ** **                                                                                                  |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------------------|
| Item  1                                       | Financial  Statements                                                                                       |   |
|                                          | Consolidated Balance Sheets  (Unaudited) as of March 31, 2005 and December 31, 2004               |   |
|                                          | Consolidated  Statements of Operations (Unaudited) for the Three Months Ended March 31,  2005 and 2004 |   |
|                                          | Consolidated  Statements of Cash Flows (Unaudited) for the Three Months Ended March 31,  2005 and 2004 |   |
|                                          | Notes  to Unaudited Consolidated Financial Statements                                                       |   |
| Item  2                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 |   |
| Item  3                                       | Quantitative  and Qualitative Market Risk Disclosures                                                       |   |
| Item 4                                        | Controls  and Procedures                                                                                    |   |
| **PART II – OTHER  INFORMATION**    | ** **                                                                                                  |
| Item 1                                        | Legal  Proceedings                                                                                          |   |
| Item 2                                        | Changes in  Securities                                                                                      |   |
| Item 3                                        | Defaults  of 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

 

ITEM 1. FINANCIAL STATEMENTS

 

**EVOLVING SYSTEMS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands except share data)**

 
| ** **                                                                                                                                                                                  | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                                                             |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                   |       | $                        | 6,479      |                        | $          | 11,386 |   |
| Current portion of restricted cash                                                                                                                                                          |       | 100                      |       | 100                         |       |
| Contract receivables, net of allowance of $44 at March 31,  2005 and December 31, 2004                                                                                            |       | 8,529                    |       | 11,296                      |       |
| Unbilled work-in-progress                                                                                                                                                                   |       | 967                      |       | 1,323                       |       |
| Prepaid and other current assets                                                                                                                                                            |       | 1,896                    |       | 1,832                       |       |
| Total current assets                                                                                                                                                                        |       | 17,971                   |       | 25,937                      |       |
| Property and equipment, net                                                                                                                                                                 |       | 2,323                    |       | 2,563                       |       |
| Intangible assets, net                                                                                                                                                                      |       | 18,202                   |       | 19,993                      |       |
| Goodwill                                                                                                                                                                                    |       | 36,868                   |       | 37,698                      |       |
| Long-term restricted cash                                                                                                                                                                   |       | 300                      |       | 300                         |       |
| Total assets                                                                                                                                                                                |       | $                        | 75,664     |                        | $          | 86,491 |   |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                               |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                                                        |       |                     |       |                        |       |
| Current portion of notes payable and long-term  obligations                                                                                                                                 |       | $                        | 1,372      |                        | $          | 31 |   |
| Short-term notes payable                                                                                                                                                                    |       | 1,995                    |       | 4,880                       |       |
| Accounts payable and accrued liabilities                                                                                                                                                    |       | 6,872                    |       | 8,357                       |       |
| Payable to Tertio sellers                                                                                                                                                                   |       | —                   |       | 2,664                       |       |
| Deferred foreign income taxes                                                                                                                                                               |       | 115                      |       | 265                         |       |
| Unearned revenue                                                                                                                                                                            |       | 12,426                   |       | 13,083                      |       |
| Total current liabilities                                                                                                                                                                   |       | 22,780                   |       | 29,280                      |       |
| Long-term liabilities:                                                                                                                                                                      |       |                     |       |                        |       |
| Long-term obligations                                                                                                                                                                       |       | 98                       |       | 125                         |       |
| Notes payable                                                                                                                                                                               |       | 11,063                   |       | 11,849                      |       |
| Deferred foreign income taxes                                                                                                                                                               |       | 4,208                    |       | 4,642                       |       |
| Total liabilities                                                                                                                                                                           |       | 38,149                   |       | 45,896                      |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| Commitments and contingencies                                                                                                                                                               |       |                     |       |                        |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| Series B convertible redeemable preferred  stock; $.001 par value; 966,666 shares issued and outstanding as of March 31,  2005 and December 31, 2004.                        |       | 11,281                   |       | 11,281                      |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                  |       |                     |       |                        |       |
| Common stock, $0.001 par value; 25,000,000 shares  authorized; 16,024,102 and 15,987,217 shares issued and outstanding as of March 31,  2005 and December 31, 2004, respectively. |       | 16                       |       | 16                          |       |
| Additional paid-in capital                                                                                                                                                                  |       | 67,821                   |       | 67,765                      |       |
| Other comprehensive income                                                                                                                                                                  |       | 1,006                    |       | 1,994                       |       |
| Accumulated deficit                                                                                                                                                                         |       | (42,609                  | )          | (40,461                     | )          |
| Total stockholders’ equity                                                                                                                                                             |       | 26,234                   |       | 29,314                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                             |       | $                        | 75,664     |                        | $          | 86,491 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| License fees and services                                                    |       | $                                     | 5,081      |   | $ | 3,219 |   |
| Customer support                                                             |       | 4,757                                 |       | 2,547 |   |
| Total revenue                                                                |       | 9,838                                 |       | 5,766 |   |
|                                                                         |       |                                  |       |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                  |       |   |   |
| Costs of license fees and services, excluding  depreciation and amortization |       | 2,976                                 |       | 1,070 |   |
| Costs of customer support, excluding depreciation  and amortization          |       | 2,031                                 |       | 1,663 |   |
| Sales and marketing                                                          |       | 2,392                                 |       | 936 |   |
| General and administrative                                                   |       | 2,501                                 |       | 935 |   |
| Product development                                                          |       | 110                                   |       | 491 |   |
| Depreciation                                                                 |       | 376                                   |       | 274 |   |
| Amortization                                                                 |       | 1,421                                 |       | 218 |   |
| Restructuring and other expenses (recovery)                                  |       | (48                                   | )          | — |   |
| Total costs of revenue and operating expenses                                |       | 11,759                                |       | 5,587 |   |
| Income (loss) from operations                                                |       | (1,921                                | )          | 179 |   |
|                                                                         |       |                                  |       |   |   |
| Other income (expense):                                                      |       |                                  |       |   |   |
| Interest income (expense), net                                               |       | (390                                  | )          | 57 |   |
| Other expense                                                                |       | (115                                  | )          | — |   |
| Total other income (expense), net                                            |       | (505                                  | )          | 57 |   |
|                                                                         |       |                                  |       |   |   |
| Income (loss) before income taxes                                            |       | (2,426                                | )          | 236 |   |
| Benefit from income  taxes                                                   |       | 278                                   |       | 8 |   |
| Net income (loss)                                                            |       | $                                     | (2,148     | ) | $ | 244 |   |
|                                                                         |       |                                  |       |   |   |
| **Basic income (loss) per common share**                                     |       | $                                     | (0.12      | ) | $ | 0.02 |   |
|                                                                         |       |                                  |       |   |   |
| **Diluted income (loss) per common share**                                   |       | $                                     | (0.12      | ) | $ | 0.01 |   |
|                                                                         |       |                                  |       |   |   |
| Weighted average basic shares outstanding                                    |       | 18,598                                |       | 15,837 |   |
| Weighted average diluted shares outstanding                                  |       | 18,598                                |       | 17,939 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                 |       |                                  |       |   |   |
| Net income (loss)                                                                         |       | $                                     | (2,148     | ) | $ | 244 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation                                                                              |       | 376                                   |       | 274 |   |
| Amortization of intangible assets                                                         |       | 1,421                                 |       | 219 |   |
| Amortization of debt issuance costs                                                       |       | 13                                    |       | — |   |
| Interest expense added to debt principal                                                  |       | 317                                   |       | — |   |
| Gain on impairment and disposal of property and  equipment                                |       | (11                                   | )          | — |   |
| Benefit from deferred foreign income taxes                                                |       | (465                                  | )          | — |   |
| Change in operating assets and liabilities:                                               |       |                                  |       |   |   |
| Contract receivables                                                                      |       | 2,684                                 |       | 4,250 |   |
| Unbilled work-in-progress                                                                 |       | 394                                   |       | 546 |   |
| Prepaid and other assets                                                                  |       | (86                                   | )          | (230 | ) |
| Accounts payable and accrued liabilities                                                  |       | (553                                  | )          | (293 | ) |
| Unearned revenue                                                                          |       | (441                                  | )          | (1,395 | ) |
| Long-term obligations                                                                     |       | (19                                   | )          | (10 | ) |
| Net cash provided by operating activities                                                 |       | 1,482                                 |       | 3,605 |   |
|                                                                                      |       |                                  |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                 |       |                                  |       |   |   |
| Purchase of property and equipment                                                        |       | (158                                  | )          | (568 | ) |
| Proceeds from sale of property and equipment                                              |       | 11                                    |       | — |   |
| Business combinations, net of cash acquired                                               |       | (676                                  | )          | 41 |   |
| Net cash used in investing activities                                                     |       | (823                                  | )          | (527 | ) |
|                                                                                      |       |                                  |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                 |       |                                  |       |   |   |
| Capital lease payments                                                                    |       | (8                                    | )          | (7 | ) |
| Principal payments on notes payable                                                       |       | (2,889                                | )          | — |   |
| Payment of amount due to Tertio sellers                                                   |       | (2,616                                | )          | — |   |
| Proceeds from the issuance of stock                                                       |       | 56                                    |       | 210 |   |
| Net cash (used in) provided by financing activities                                       |       | (5,457                                | )          | 203 |   |
|                                                                                      |       |                                  |       |   |   |
| Effect of exchange rate changes on cash                                                   |       | (109                                  | )          | 1 |   |
|                                                                                      |       |                                  |       |   |   |
| Net (decrease) increase in cash and cash equivalents                                      |       | (4,907                                | )          | 3,282 |   |
| Cash and cash equivalents at beginning of period                                          |       | 11,386                                |       | 17,999 |   |
| Cash and cash equivalents at end of period                                                |       | $                                     | 6,479      |   | $ | 21,281 |   |
|                                                                                      |       |                                  |       |   |   |
| Supplemental disclosure of other cash and non-cash  financing transactions:               |       |                                  |       |   |   |
| Interest paid                                                                             |       | $                                     | 114        |   | $ | 7 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

 

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1)****   Basisof Presentation**

 

*Interim Consolidated Financial Statements*. Theaccompanying consolidated financial statements of Evolving Systems, Inc. (“EvolvingSystems” or the “Company”) have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) havebeen condensed or omitted pursuant to such rules and regulations. However,management believes that the disclosures included in these financial statementsare adequate to make the information presented not misleading. The unaudited consolidatedfinancial statements included in this document have been prepared on the samebasis as the annual consolidated financial statements, and in management’sopinion, reflect all adjustments, which include normal recurring adjustments,necessary for a fair presentation in accordance with GAAP. The results for the threemonths ended March 31, 2005 are not necessarily indicative of the resultsthat the Company will have for any subsequent quarter or full fiscal year.  These consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and the notes to those statements for the year ended December 31,2004 included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004.

 

*Use of Estimates*.The preparation of financial statements in conformity with accountingprinciples generally accepted in the U.S. requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements as well as the reported amounts of revenue and expenses during thereporting period. Estimates have been made by management with respect to thecollectibility of accounts receivable, estimates to complete long-termcontracts and in establishing the estimated fair values of acquired assets andliabilities. Actual results could differ from these estimates.

 

*Foreign Currency Translation*. The Company’s foreign subsidiaries useas their functional currency the local currency of the countries in which theyoperate. Their assets and liabilities are translated into U.S. dollars at theexchange rates in effect at the balance sheet date. Revenues, expenses, andcash flows are translated at the average rates of exchange prevailing duringthe period. Translation gains and losses are included in comprehensive income(loss) within stockholders’ equity. Realized and unrealized transaction gainsand losses resulting from the remeasurement of non-functional currencyfinancial instruments are included in the determination of net income (loss).Transaction gains for the three months ended March 31, 2005 and 2004 wereapproximately $125,000 and $3,000, respectively.

 

*ComprehensiveIncome*. The Company’s comprehensive income (loss) iscomprised of its net income (loss) and foreign currency translation adjustment. For the three months ended March 31, 2005 and 2004, totalcomprehensive income (loss) was ($3.1) million and $246,000, respectively.

 

*Principlesof Consolidation*. The consolidated financial statementsinclude the accounts of the Company and its subsidiaries, all of which are whollyowned.  All significant intercompanytransactions and balances have been eliminated.

 

*Reclassification.*As a result of the significance of the intangible assets andthe related amortization expense from the acquisitions of Tertio TelecomsLimited (“Tertio”) and Telecom Software Enterprises LLC. (“TSE”), the Companyis now reporting amortization expense as a separate line item on the statementsof operations. In prior periods amortization of intangibles was shown withincosts of license fees and services and costs of customer support. Prior periodbalances have been reclassified to conform with the current period’spresentation.

 

*RevenueRecognition.*The Company derives revenue from two primarysources: license fees/services and customer support.  We recognize revenue in accordance withStatements of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amendedand interpreted by SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions.” In addition we have adoptedStaff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” whichprovides further interpretive guidance for public companies on the recognition,presentation and disclosure of revenue in financial statements.

 

Themajority of the Company’s license fees and services revenue is generated fromfixed-price contracts which provide for both licenses to its software productsand services. Revenue under these arrangements, where the services aredetermined to be essential to the functionality of the delivered software, isrecognized using the percentage-of-completion method of accounting, inaccordance with SOP

 

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97-2 and SOP 81-1, “Accountingfor Long-Term Construction Type Contracts,” once a license agreement has beensigned, the fee is fixed or determinable and collectibility is reasonablyassured.  The percentage of completionfor each contract is estimated based on the ratio of direct labor hoursincurred to total estimated direct labor hours. The estimated percentage of completion on contracts entered into by theCompany’s United Kingdom (“U.K.”) subsidiary, Tertio, are based upon the ratioof project costs incurred to total estimated project costs.  The use of project costs approximates what wouldhave resulted had direct labor hours been used since the majority of projectcosts consist of direct labor.  Due tothe fact that the estimated direct labor hours and project costs, and changesthereto, can have a significant impact on revenue recognition, these estimatesare critical and are reviewed by management regularly. Amounts billed inadvance of services being performed are recorded as unearned revenue. Unbilledwork-in-progress represents revenue earned but not yet billable under the termsof the fixed-price contracts. All such amounts are expected to be billed andcollected during the succeeding 12 months.

 

Inarrangements where the services are not essential to the functionality of thedelivered software, the Company recognizes license revenue when a licenseagreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is reasonably assured. Where applicable, feesfrom multiple element arrangements are unbundled and recorded as revenue as theelements are delivered to the extent that Vendor Specific Objective Evidence (“VSOE”)of the fair value of the undelivered elements exists. If VSOE for theundelivered elements does not exist, fees from such arrangements are deferreduntil the earlier of the date that VSOE does exist on the undelivered elementsor all of the elements have been delivered.

 

Servicesrevenue provided under fixed-price contracts is generally recognized using the proportionalperformance method of accounting, which is similar to the percentage ofcompletion method described above. Revenue from professional services providedpursuant to time-and-materials based contracts and training services arerecognized as the services are performed, as that is when the Company’sobligation to its customers under such arrangements is fulfilled.

 

Customersupport and maintenance revenue is generally recognized ratably over theservice contract period. When maintenance or training services are bundled withthe original license fee arrangement, their fair value, based upon VSOE, isdeferred and recognized during the periods such services are provided.

 

TheCompany may encounter budget and schedule overruns on fixed pricecontracts caused by increased labor, overhead or material costs. Adjustments tocost estimates are made in the periods in which the facts requiring suchrevisions become known. Estimated losses, if any, are recorded in the period inwhich current estimates of total contract revenue and contract costs indicate aloss.

 

**(2) ****Business Combinations**

 

**Tertio**

 

On November 2, 2004, the Company acquired all ofthe outstanding shares of privately-held, U.K.-based Tertio. Totalconsideration for Tertio’s net assets determined in accordance with GAAPapproximated $40.2 million, consisting of $11.0 million incash, approximately $15.9 million in seller-financed notes, 966,666 shares of Series BPreferred Stock with an estimated fair value of approximately $11.3 million andapproximately $2.0 million in estimated transaction-related costs. Of the total purchase price, 10% wasdeposited in escrow with Wells Fargo Bank, N.A. as escrow agent to secure thesellers’ representations and warranties under the purchase agreement.  Ofthe funds deposited in escrow, 80% will remain in escrow until November 2,2005 and the remaining 20% will remain in escrow until November 2, 2007,unless sooner released to the Company in payment of indemnification claims.Both Evolving Systems and Tertio operate on a calendar year.The acquisition was recorded as apurchase business combination and Tertio’s results of operations have beencombined with Evolving Systems’ from the acquisition date forward.

 

Tertio’sactivation and mediation solutions fit well with elements of the Company’sproduct portfolio, enabling it to provide activation solutions andstrengthening its current network mediation and service assurance offerings.  In addition, the acquisition provides theCompany with global reach and a customer base that includes many of the world’sleading communications carriers. The purchase price for Tertio includedgoodwill because the Company concluded that increased scale may be achievedfrom a financial, customer and product perspective. In addition, Tertio broughta quality, experienced work force.

 

In January 2005,Tertio changed its name to Evolving Systems Limited and is sometimes referredto in the Form 10-Q as “Evolving Systems U.K.”.

 

**TSE**

 

On October 15,2004, the Company acquired all of the outstanding ownership interests inprivately-held TSE. Total GAAP consideration for TSE approximated $2.4million, consisting of $1.5 million in cash, a note payable of $889,000 andapproximately $55,000 in transaction-related costs.  The note payable was due and paid on March 31,2005. Of the total purchase price, $250,000

 

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was deposited in escrowfor one year with Wells Fargo Bank, N.A. as escrow agent to secure the sellers’representations and warranties under the purchase agreement.  The Companyagreed to pay additional consideration of up to $3.5 million contingent uponthe achievement of certain specified revenue and gross margin results. Up to$2.5 million of the contingent consideration may be payable over a 24 monthperiod from the closing date and additional contingent consideration of up to$1.0 million may be paid through the year 2011 if certain specified sales ofTSE products occur. In accordance with Statement of Financial AccountingStandard (“SFAS”) No. 141, the contingent consideration will not berecorded until the contingency is resolved and the additional consideration isdistributable. The Company paid $447,000 of contingent consideration recordedat December 31, 2004 during the first quarter of 2005.  During the three months ended March 31,2005, the Company recorded additional contingent consideration and resulting goodwillof approximately $56,000, which will be paid in the second quarter of 2005,related to certain specified gross margin results achieved by the sale of TSE productsduring the period. The acquisition was treated as a purchase businesscombination and the results of TSE’s operations have been combined withEvolving Systems’ from the acquisition date forward. Both Evolving Systems andTSE operate on a calendar year.

 

TSE’sproducts are sold to U.S. wireline and wireless carriers, and provide forsimulation of the nation’s centralized Number Portability Administration Center(“NPAC”) and a testing environment for critical back office systems thatcarriers use for enabling number portability. Other products in the TSEportfolio are used for enhanced integration between back office OperationalSupport Systems (“OSS”).  TSE hasinstalled its products at many of the leading wireless and wireline carriers inNorth America. By acquiring TSE, the Company has expanded its customer base andextended the set of solutions it offers its Local Number Portability (“LNP”)customers. The primary reason for a valuation which gives rise to goodwill isrelated to the value the Company placed on the TSE’s solid reputation as a providerof LNP products, our expectation of new customers and the experienced employeesacquired in the TSE acquisition.

 

**Pro Forma Financial Information**

 

The financial information in the table belowsummarizes the combined results of operations of Evolving Systems, Inc.,TSE and Tertio on a pro forma basis, as though the companies had been combinedas of the period presented below.  Theimpact of the In-Process Research and Development (“IPR&D”) charges associated with the acquisitions hasbeen excluded.  This pro forma financialinformation is presented for informational purposes only and is not necessarilyindicative of the results of operations that would have been achieved had theacquisitions actually taken place as of the beginning of the period presentedbelow.  The following amounts are inthousands, except per share amounts.

 

| ** **             | ** ** | **Three Months  Ended March 31,  2004** | ** ** |
|------------------------|------------|----------------------------------------------|------------|
| Revenues               |       | $                                            | 12,291     |   |
| Net loss               |       | $                                            | (63        | ) |
| Basic loss per share   |       | $                                            | (0.00      | ) |
| Diluted loss per share |       | $                                            | (0.00      | ) |

 

**(3) Goodwilland Intangible Assets**

 

The Company has recorded goodwill and intangibleassets from its acquisitions of CMS in 2003 and TSE and Tertio in 2004.  In accordance with SFAS No. 142,goodwill is not amortized but is subject to an impairment test at leastannually.  Goodwill is assessed on anannual basis for impairment at the reporting unit level by applying afair-value-based test. Changes in the carrying amounts of goodwill by reportingunit for the three months ended March 31, 2005 are as follows (inthousands): 

 

| ** **                                 | ** ** | **License and  Services** | ** ** | **Customer  Support** | ** ** | **Total  Goodwill** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|-----------------------|------------|---------------------|------------|
| Balance as of December 31,  2004      | ** ** | $                         | 20,689     | ** **            | $          | 17,009              | ** ** | $ | 37,698 | ** ** |
| Adjustments to goodwill                    |       | (52                       | )          | (67                   | )          | (119                | )          |
| Effects of foreign currency exchange rates |       | (390                      | )          | (321                  | )          | (711                | )          |
| Balance as of March 31, 2005          |       | $                         | 20,247     |                  | $          | 16,621              |       | $ | 36,868 |   |

 

The Company recorded goodwill adjustments during theperiod related to the finalization of the Tertio purchase price, which isexpected to be completed in the second quarter of 2005 and contingentconsideration and resulting goodwill of approximately $56,000 related tocertain specified gross margin results achieved by the sale of TSE products duringthe period.

 

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The Company’s annual goodwill impairment test wasconducted as of July 31, 2004, and it was determined that goodwill, atthat time related solely to the CMS acquisition, was not impaired as of thetest date. Additionally, goodwill is assessed for impairment at each reportingperiod end if certain events have occurred indicating that an impairment mayhave occurred. From July 31, 2004 through March 31, 2005, no eventshave occurred that management believes may have impaired goodwill.

 

Identifiable intangible balances include the cumulativeeffects of changes in foreign currency exchange rates since the acquisitiondate and were as follows as of March 31, 2005 (in thousands):

 
| ** **                          | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Useful  Life** | ** ** |
|-------------------------------------|------------|-------------------|------------|-------------------------------|------------|------------------|------------|
| **Identifiable intangible assets:** |       |              |       |                          |       |             |       |
| Purchased software                  |       | $                 | 8,990      |                          | $          | 829              |       | 5 yrs |   |
| Customer contracts                  |       | 2,151             |       | 940                           |       | 1 yr             |       |
| Purchased licenses                  |       | 1,335             |       | 376                           |       | 5 yrs            |       |
| Trademarks and tradenames           |       | 1,167             |       | 80                            |       | 6 yrs            |       |
| Business partnerships               |       | 1,455             |       | 86                            |       | 7 yrs            |       |
| Customer relationships              |       | 6,308             |       | 893                           |       | 2-7 yrs          |       |
|                                |       | $                 | 21,406     |                          | $          | 3,204            |       |   |   |
|                                     |            |                   |            |                               |            |                  |            |  |  |  |  |

 

As of December 31, 2004, identifiableintangibles were as follows (in thousands):

 
| ** **                          | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Estimated  Useful Life** | ** ** |
|-------------------------------------|------------|-------------------|------------|-------------------------------|------------|----------------------------|------------|
| **Identifiable intangible assets:** |       |              |       |                          |       |                       |       |
| Purchased software                  |       | $                 | 9,180      |                          | $          | 326                        |       | 5 yrs |   |
| Customer contracts                  |       | 1,859             |       | 305                           |       | 1 yr                       |       |
| Purchased licenses                  |       | 1,335             |       | 309                           |       | 5 yrs                      |       |
| Trademarks and tradenames           |       | 1,196             |       | 33                            |       | 6 yrs                      |       |
| Business partnerships               |       | 1,491             |       | 35                            |       | 7 yrs                      |       |
| Customer relationships              |       | 6,740             |       | 800                           |       | 2-7 yrs                    |       |
|                                |       | $                 | 21,801     |                          | $          | 1,808                      |       |   |   |

 

Amortizationexpense of identifiable intangible assets was $1.4 million and $219,000 for thethree months ended March 31, 2005 and 2004, respectively.

 

**(4) Earnings Per Common Share**

 

Basic earnings per share (“EPS”) is computed bydividing net income or loss available to common stockholders by the weightedaverage number of shares outstanding during the period, including common stockissuable under participating securities, such as the Series B Convertible,Redeemable Preferred Stock (“Series B Preferred Stock”). Diluted EPS iscomputed using the weighted average number of shares outstanding, includingparticipating securities, plus all potentially dilutive common stockequivalents. Common stock equivalents consist of stock options, warrants andshares held in escrow. The following is the reconciliation of the numeratorsand denominators of the basic and diluted EPS computations for the three monthsended March 31 (in thousands except per share data):

 

| ** **                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                 |       |                                  |       |   |   |
| Weighted average common shares outstanding                           |       | 15,988                                |       | 15,837 |   |
| Participating securities                                             |       | 2,610                                 |       | — |   |
| Basic weighted average common shares outstanding                     |       | 18,598                                |       | 15,837 |   |
| Effect of dilutive securities - options, warrants  and escrow shares |       | —                                |       | 2,102 |   |
| Diluted weighted average common shares outstanding                   |       | 18,598                                |       | 17,939 |   |

 

7

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Weighted average options to purchase 1.7 millionand 313,000 shares of common stock were excluded from the dilutive stockcalculation for the three months ended March 31, 2005 and 2004,respectively, because their exercise prices were greater than the average fairvalue of the Company’s stock for the period.

 

Weighted average options to purchase 1.9 millionshares of common stock were excluded from the dilutive stock calculation forthe three months ended March 31, 2005, as their effect would have beenanti-dilutive as a result of the net loss for the period.

 

Theparticipating securities reflect 2.9 million shares of Series B PreferredStock less the 290,000 shares that are held in escrow.  In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128 “Earnings Per Share”, shares thatare contingently issuable are not included in the computation of basic EPSuntil all necessary conditions have been satisfied (in essence, when issuanceof the shares are no longer contingent).

 

**(5) Stock-BasedCompensation**

 

TheCompany applies the intrinsic-value-based method prescribed by AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations in accounting for employee stock-basedcompensation arrangements. Non-employee stock compensation arrangements areaccounted for under SFAS No. 123 and Emerging Issues Task Force (“EITF”)Issue No. 96-18, “Accounting for Equity Instruments that are Issued toOther than Employees, or in Conjunction with Selling Goods or Services.”

 

SFAS No. 123,“Accounting for Stock-BasedCompensation” and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, anamendment of FASB Statement No. 123,” established accounting anddisclosure requirements using a fair-value-based method of accounting for stock-basedemployee compensation plans. As permitted by existing accounting standards, theCompany has elected to continue to apply the intrinsic-value-based method ofaccounting described above, and has adopted only the disclosure requirements ofSFAS No. 123, as amended. The following table illustrates the effecton net income (loss) if the fair-value-based method had been applied to alloutstanding and unvested awards in each period (in thousands, except per sharedata):

 
| ** **                                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                          |       |                                  |       |   |   |
| Net income (loss), as reported                                |       | $                                     | (2,148     | ) | $ | 244 |   |
| Stock based compensation expense under the fair  value method |       | (608                                  | )          | (579 | ) |
| Pro forma net loss                                            |       | $                                     | (2,756     | ) | $ | (335 | ) |
|                                                          |       |                                  |       |   |   |
| Earnings (loss) per common share as reported:                 |       |                                  |       |   |   |
| Basic                                                         |       | $                                     | (0.12      | ) | $ | 0.02 |   |
| Diluted                                                       |       | $                                     | (0.12      | ) | $ | 0.01 |   |
| Pro forma loss per common share:                              |       |                                  |       |   |   |
| Basic                                                         |       | $                                     | (0.15      | ) | $ | (0.02 | ) |
| Diluted                                                       |       | $                                     | (0.15      | ) | $ | (0.02 | ) |

 

**(6) Concentration of Credit Risk**

 

For the three months ended March 31, 2005, theCompany recognized 26% (14% and 12%) of total revenue from two significantcustomers (defined as contributing at least 10%), in the telecommunicationsindustry.  For the three months ended March 31,2004, the Company recognized 76% (34%, 18%, 13% and 11%), of total revenue fromfour significant customers, all in the telecommunications industry.

 

As of March 31,2005, five significant customers accounted for approximately 64% (18%, 12%,12%, 11% and 11%) of contract receivables. At December 31, 2004, three significant customers accounted forapproximately 58% (30%, 17% and 11%) of contract receivables.

 

In the past, andcurrently, the Company earns a significant portion of its revenue from a smallnumber of customers in the communications industry. This has been mitigatedsomewhat by the expansion of the Company’s customer base through recentacquisitions. However, the loss of any significant customer, delays in deliveryor acceptance of any of our products by a customer, delays in the performanceof services for a customer, or delays in collection of customer receivablescould be materially harmful to the Company’s business, financial condition,results of operations and cash flows.

 

8

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**(7) NotesPayable**

 

TheCompany’s notes payable consist of the following (in thousands):

 

| ** **                                                                                                                                                                                                            | ** ** | **As of March 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| Long-term seller financed notes payable, interest at  weighted average rate of 11.62%, due in varying quarterly principal  installments beginning March 31, 2006, with final maturity on December 31,  2007 |       | $                              | 12,496     |   |
| Short-term seller financed note payable, interest at  5.50%, due June 30, 2005                                                                                                                                   |       | 2,000                          |       |
| Debt issuance costs                                                                                                                                                                                                   |       | (97                            | )          |
| Total notes payable                                                                                                                                                                                                   |       | 14,399                         |       |
| Less current portion, net                                                                                                                                                                                             |       | (3,336                         | )          |
| Long-term debt, excluding current installments, net                                                                                                                                                                   |       | $                              | 11,063     |   |

 

TheCompany entered into the long-term seller-financed notes payable (“Long-TermNotes”) on November 2, 2004, in conjunction with the acquisition ofTertio.  From the acquisition datethrough November 2, 2006, the Long-Term Notes bear interest at 11.0% perannum. From November 2, 2006 through the maturity date of December 31,2007, the notes will bear interest at 14.0% per annum. For accounting purposes,interest is recognized using an effective rate of 11.62% for the term of thenotes. Interest is accrued and added to the principal balance through December 31,2005, and beginning March 31, 2006, interest is payable in cash on aquarterly basis in addition to the scheduled principal payments. Accruedinterest of approximately $546,000 has been added to the principal balance ofthe Long-Term Notes from their inception through March 31, 2005. The Long-TermNotes payable may be prepaid at any time without penalty. Beginning in March 2005,if the Company’s quarterly cash balances exceed $7.0 million, the holder of theLong-Term Notes may require a prepayment on the note equal to the amount bywhich the quarterly cash balance exceeds $7.0 million. Based on its projectionsof cash balances, the Company believes that these additional payments will notbe required through March 31, 2006. The scheduled principal payments onthe Long-Term Notes are as follows (in thousands):

 

| **Payment date**       | ** ** | **Amount** | ** ** |
|------------------------|------------|------------|------------|
| March 31, 2006    |       | $          | 1,340      |   |
| June 30, 2006     |       | 3,110      |       |
| December 31, 2006 |       | 1,430      |       |
| March 31, 2007    |       | 1,870      |       |
| June 30, 2007     |       | 3,110      |       |
| December 31, 2007 |       | 1,636      |       |
|                   |       | $          | 12,496     |   |

 

The Long-Term Notes have an effective interest rate ofapproximately 11.62% and a maturity date of December 31, 2007. In the 2005proxy, the Company is asking stockholders to approve the exchange of thelong-term notes into convertible notes. The outstanding principal balance onthe notes plus accrued interest through May 16, 2005 will total approximately$12.7 million, and upon stockholder approval, would be exchanged for notes thatwould be convertible into approximately 3.8 million shares of the Company’scommon stock at $3.296 per share. The convertible notes would bear interest atthe Federal Applicable Rate, which is approximately 3.5% as of May 2005.In addition, all principal and unpaid interest would be due and payable on December 31,2007 under the convertible notes. If the Company’s quarterly cash balancesexceed $7.0 million the holder of the convertible note may require a prepaymenton the note equal to the amount by which the quarterly cash balance exceeds$7.0 million. The notes are secured by substantially all of the assets ofEvolving Systems and a pledge, subject to certain limitations, of the shares ofits subsidiaries.

 

The Long-Term Notes subject the Company to certainaffirmative and negative covenants, including a financial covenant indexed tothe Company’s computation of EBITDA, as defined. The Company will be requiredto comply with such covenants beginning June 30, 2005.

 

Evolving Systems has agreed to convene a meeting ofits stockholders to seek the approval from its stockholders of the exchange ofthe Long-Term Notes into convertible notes. The Company’s inability to convenethe Initial Shareholders’ Meeting, as

 

9

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defined,by May 16, 2005, constitutes an event of default under this note. TheCompany believes it will be able to convene this meeting by the appointed time.

 

The Company also entered into the short-term sellerfinanced note payable on November 2, 2004, in conjunction with theacquisition of Tertio.  The firstinstallment of $2.0 million was paid on March 31, 2005. The finalinstallment of $2.0 million is due on June 30, 2005. The short-term sellerfinanced note bears interest at a rate per annum equal to five and one-halfpercent, due on each of the previously mentioned payment dates. Upon an eventof default, the short-term seller financed note would bear interest at thegreater of (a) eight and one-half percent or (b) the London InterbankOffering Rate (LIBOR). The short-term seller financed note may be prepaid atany time without penalty.

 

The notes issued in connection with the Tertioacquisition prohibit the Company from declaring dividends to our commonstockholders during the term of the notes.

 

Thepromissory note payable, which was issued in conjunction with the acquisitionof TSE, was paid in full on March 31, 2005 in accordance with theacquisition agreement. Interest expense of $427,000 was recognized during thethree months ended March 31, 2005 related to notes payable issued in theTSE and Tertio acquisitions.

 

**(8) IncomeTaxes**

 

TheCompany recorded a net income tax benefit of $278,000 and $8,000 for the threemonths ended March 31, 2005 and 2004, respectively. The net benefit duringthe three months ended March 31, 2005 consists of current income taxexpense of approximately $190,000 and a deferred tax benefit of $468,000 bothof which are related to the Company’s UK-based operations.

 

Inconjunction with the acquisition of Tertio, certain identifiable intangibleassets were recorded.  Since theamortization of these identifiable intangibles is not deductible for income taxpurposes, a long-term deferred tax liability of $4.6 million was established atthe acquisition date for the expected difference between what would be expensedfor financial reporting purposes and what would be deductible for income taxpurposes. As of March 31, 2005, this deferred tax liability was $4.2million. This deferred tax liability is carried on the books of the Company’sUnited Kingdom subsidiary, and has no impact on the Company’s ability torecover its U.S.-based deferred tax assets.

 

Inconjunction with the acquisition of Tertio, future revenue under contracts inexistence at the acquisition dates was reduced to an amount equal to theCompany’s estimated costs to fulfill its obligations under the contracts plus areasonable profit margin on the Company’s estimated fulfillment effort.  The resulting reduction of future revenuerecorded for financial reporting purposes is not deductible for income taxpurposes and thus, a current deferred tax liability of approximately $600,000was established at the acquisition date. As of March 31, 2005, thisdeferred tax liability was $115,000. Both of the aforementioned deferred tax liabilities will be recognizedas a reduction of current income tax expense as the identifiable intangiblesare amortized and the contract revenue is recognized.

 

As of March 31,2005 and December 31, 2004, the Company continued to maintain a fullvaluation allowance on the domestic net deferred tax asset due to uncertaintiesrelated to the Company’s ability to utilize its domestic deferred tax assets,primarily consisting of certain net operating loss carryforwards, before theyexpire.  The Company’s assessment of thisvaluation allowance was made using all available evidence, both positive andnegative.  In particular, the Companyconsidered both its historical results and its projections of profitability forthe reasonably foreseeable future periods. The Company’s realization of its recorded net deferred tax assets isdependent on future taxable income and, therefore, the Company is not reasonablyassured that such benefits will be realized. The Company is required to reassess its conclusions regarding therealization of its deferred tax assets at each financial reporting date. It isreasonably possible that future evaluation could result in a conclusion thatall or a portion of the valuation allowance is no longer necessary which couldhave a material impact on the Company’s results of operations and financialposition.

 

**(9) Restructuring and Other Expenses**

 

Inearly 2002, management implemented a restructuring plan (the “Plan”) due to thedownturn in the U.S. telecommunications industry, the Company’s sharp declinein revenue, the FCC’s delay in ruling on wireless number portability and otherfactors.  The Plan included workforcereductions, restructuring of the Company’s headquarters building lease, theclosure of its satellite field offices and the write down of certain fixedassets, all of which were executed in 2002. At March 31, 2005 and December 31,2004, the remaining accrual related to the closure of the satellite offices.

 

*Closure of satellite offices.*  The Company closed all of its satellite fieldoffices during 2002.  Because the coststo sublease or terminate these lease commitments are based on estimates, theCompany may incur additional costs related to the satellite officeclosures.  During the three months ended March 31,2005 the Company recorded a recovery of $48,000 related to the closure of thesatellite offices as the actual costs to close these facilities were less thanits original estimate.  As of March 31,2005 approximately $15,000 was included

 

10

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in accounts payable andaccrued liabilities, and approximately $1,000 was included in long-termobligations, related to the closure of the satellite offices.

 

Thefollowing table summarizes the change in the accrual balance since December 31,2004 (in thousands):

 

| ** **                             | ** ** | **Closure of  Satellite Offices** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| Accrual balance December 31, 2004 |       | $                                 | 79         |   |
| 1st quarter adjustments                |       | (48                               | )          |
| 1st quarter cash payments, net         |       | (15                               | )          |
| Accrual balance March 31, 2005    |       | $                                 | 16         |   |

 

**(10) SegmentInformation**

 

In accordance with SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information,” the Company definesoperating segments as components of an enterprise for which separate financialinformation is available.  Thisinformation is reviewed regularly by the chief operating decision-maker, ordecision-making group, to evaluate performance and to make operating decisions.The Company has identified its Chief Executive Officer and Chief FinancialOfficer as its chief operating decision-makers. These chief operating decisionmakers review revenues by segment and review overall results of operations.

 

The Companycurrently operates its business as two operating segments based on revenuetype: license fees/services revenue and customer support revenue (as shown onthe consolidated statements of operations). License fees and services revenue represents the fees received from thelicense of software products and those services directly related to thedelivery of the licensed products as well as custom development, integrationservices and time and materials work. Customer support revenue includes annual support fees, recurringmaintenance fees, fees for maintenance upgrades and warranty fees.  Warranty services are typically bundled witha license sale and the related revenue, based on VSOE, is deferred andrecognized ratably over the warranty period. With the acquisition of Tertio,the Company now provides products and services on a global basis. In addition,the Company has a product development facility in Bangalore, India.  Total assets by segment have not been specifiedbecause the information is not available to the chief operating decision-makinggroup.

 

Segmentinformation is as follows (in thousands):

 
| ** **                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **Revenue**                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| License fees and services                                    |       | $                                     | 5,081      |   | $ | 3,219 |   |
| Customer support                                             |       | 4,757                                 |       | 2,547 |   |
|                                                         |       | 9,838                                 |       | 5,766 |   |
|                                                         |       |                                  |       |   |   |
| **Segment profit, excluding depreciation and  amortization** |       |                                  |       |   |   |
| License fees and services                                    |       | 2,105                                 |       | 2,149 |   |
| Customer support                                             |       | 2,726                                 |       | 884 |   |
|                                                         |       | 4,831                                 |       | 3,033 |   |
|                                                         |       |                                  |       |   |   |
| Other operating expenses                                     |       | 5,003                                 |       | 2,362 |   |
| Depreciation and amortization                                |       | 1,797                                 |       | 492 |   |
| Restructuring and other                                      |       | (48                                   | )          | — |   |
| Income (loss) from operations                                |       | $                                     | (1,921     | ) | $ | 179 |   |

 

***Geographic Regions***

 

The Company uses the customer locations as the basisof attributing revenues to individual countries. Financial information relatingto the Company’s operations by geographic region is as follows (in thousands):

 

11

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| ** **                           | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **Revenue**                          |       |                                  |       |   |   |
| United States                        |       | $                                     | 5,016      |   | $ | 5,766 |   |
| Europe, Middle East, Africa and Asia |       | 4,822                                 |       | — |   |
| Total revenues                       |       | $                                     | 9,838      |   | $ | 5,766 |   |

 

| ** **                           | ** ** | **As of March 31,  2005** | ** ** | **As of December 31,  2004** | ** ** |
|--------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| **Long-lived assets, net**           | ** ** | ** **                     | ** ** | ** **                        | ** ** |
| United States                        |       | $                              | 14,208     |                              | $          | 14,681 |   |
| Europe, Middle East, Africa and Asia |       | 43,185                         |       | 45,573                            |       |
| Total long-lived assets              |       | $                              | 57,393     |                              | $          | 60,254 |   |

 

**(11)Commitments and Contingencies**

 

Aspermitted under Delaware law, the Company has agreements with its officers anddirectors under which it agrees to indemnify them for certain events oroccurrences while the officer or director is, or was serving, at the Company’srequest in this capacity. The term of the indemnification period is indefinite.There is no limit on the amount of future payments the Company could berequired to make under these indemnification agreements; however, the Companymaintains Director and Officer insurance policies, as well as an EmploymentPractices Liability Insurance Policy, that may enable it to recover a portionof any future amounts paid. As a result of the Company’s insurance policycoverage, it believes the estimated fair value of these indemnificationagreements is minimal. Accordingly, the Company has no liabilities recorded forthese agreements as of March 31, 2005 and December 31, 2004.

 

TheCompany enters into standard indemnification terms with its customers, asdiscussed below, in the ordinary course of business. Because the Companysubcontracts some of the development of its deliverables under its customercontracts, the Company could be required to indemnify its customers for workperformed by its subcontractors. Depending upon the nature of the customerindemnification, the potential amount of future payments the Company could berequired to make under these indemnification agreements may be unlimited. TheCompany may be able to recover damages from a subcontractor if theindemnification to its customers results from the subcontractor’s failure toperform. To the extent the Company is unable to recover damages from its subcontractors;the Company could be required to reimburse the indemnified party for the fullamount. The Company has never incurred costs to defend lawsuits or settleclaims relating to indemnification arising out of its subcontractors’ failureto perform. As a result, the Company believes the estimated fair value of theseagreements is minimal. Accordingly, the Company has no liabilities recorded forthese agreements as of March 31, 2005 and December 31, 2004.

 

TheCompany’s standard license agreements contain a warranty provision that thesoftware will be free of material defects and will operate in accordance withthe stated requirements.  The warrantyprovisions require the Company to cure any defects through any reasonablemeans.  To date, no claims under thewarranty provisions have been brought to the Company’s attention.  The Company’s customers typically purchaseannual maintenance services as well and as a matter of course, the Companyprovides fixes for known defects through the provision of such maintenanceservices.  As a result, the Companybelieves the estimated fair value of the warranty provisions in the licenseagreements in place with its customers is minimal.  Accordingly, the Company has not recordedliabilities for these warranty provisions as of March 31, 2005 and December 31,2004.

 

TheCompany’s software arrangements generally include a product indemnificationprovision that will indemnify and defend a client in actions brought againstthe client that claim the Company’s products infringe upon a copyright, tradesecret, or valid patent. Historically, the Company has not incurred anysignificant costs related to product indemnification claims. Accordingly, theCompany has no liabilities recorded as of March 31, 2005 and December 31,2004.

 

Inrelation to the acquisitions of Tertio, TSE and CMS, the Company agreed toindemnify certain parties of and from any losses, actions, claims, damages orliabilities (or actions in respect thereof) resulting from any claim raised bya third party. The Company does not believe that there will be any claims relatedto these indemnifications. Accordingly, the Company has no liabilities recordedfor these agreements as of March 31, 2005 and December 31, 2004.

 

Fromtime to time the Company is involved in various legal proceedings arising inthe normal course of business operations. We are not currently involved in anysuch proceedings.

 

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**(12)Recent Accounting Pronouncements**

 

In December 2004,the FASB issued SFAS No. 123(Revised), “Share-Based Payment.” This statementreplaces SFAS No. 123, “Accounting for Stock-Based Compensation” andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”Under the modified prospective method of adoption, SFAS No. 123(R)requires companies to apply a fair-value-based measurement method in accountingfor share-based payment transactions with employees and to record compensationcost for all stock awards granted after the required effective date and toawards modified, repurchased, or cancelled after that date. In addition, theCompany is required to record compensation expense (as awards previouslygranted continue to vest) for the unvested portion of those awards that remainoutstanding at the date of adoption. In accordance with adoption provisionsreleased by the SEC, SFAS 123(R) will be effective for the Company on January 1,2006. Management has not yet determined the impact that SFAS 123(R) will haveon its financial position and results of operations, but expects that the stockincentive plans’ pro forma disclosure provides a reasonable measure of theexpected annual impact.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

*ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements that have been made pursuant tothe provisions of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are based oncurrent expectations, estimates, and projections about Evolving Systems’industry, management’s beliefs, and certain assumptions made bymanagement.  Forward-looking statementsinclude our expectations regarding product, services, and maintenance revenue,annual savings associated with the organizational changes effected in prioryears, and short- and long-term cash needs. In some cases, words such as “anticipates”, expects”, “intends”, “plans”,“believes”, “estimates”, variations of these words, and similar expressions areintended to identify forward-looking statements.  The statements are not guarantees of futureperformance and are subject to certain risks, uncertainties, and assumptionsthat are difficult to predict; therefore, actual results may differ materiallyfrom those expressed or forecasted in any forward-looking statements.  Risks and uncertainties of our businessinclude those set forth in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2004 under “Risk Factors” on pages 9through 22 as well as additional risks described in this Form 10-Q.  Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events, or otherwise.  However, readers should carefully review therisk factors set forth in other reports or documents the Company files fromtime to time with the Securities and Exchange Commission, particularly theQuarterly Reports on Form 10-Q and any Current Reports on Form 8-K.*

 

Evolving Systems, Inc.(“we”, “our”, “us”) is a provider of mission critical software products andservices to communications carriers. We maintain long-standing relationshipswith many of the largest wireline, wireless and cable communications carriersworldwide. Our customers rely on us to develop, deploy, enhance, maintain andintegrate complex, highly reliable software solutions for a range of OperationsSupport Systems (“OSS”) and Network Support Systems (“NSS”). Included among ourmore than 50 customers are four of the largest wireline carriers in North America,one of the largest cable companies in North America and three of the world’s 10largest wireless carriers. We offer software products and solutions in threecore areas — numbering solutions that enable carriers to comply withgovernment-mandated requirements regarding number portability and phone numberconservation; a service activation solution that is used to activate complexbundles of voice, video and data services; and mediation solutions supportingdata collection for both service assurance and billing applications.  Historically, our products have been used tosupport traditional telephony capabilities; however, today many communicationscarriers are using our products to support its Voice over Internet Protocol (“VoIP”)offerings.

 

Thecore Evolving Systems portfolio that included ordering and provisioningsolutions for Local Number Portability (“LNP”), as well as a number inventoryand assignment platform, has recently been expanded, as a result of threeacquisitions we made over a period of 12 months from November of 2003 to November of2004. Through the acquisition of CMS Communications, Inc. (“CMS”) in November 2003we acquired a network mediation and service assurance solution to add to ourproduct portfolio. Additionally, with the acquisition of Telecom SoftwareEnterprises, LLC (“TSE”) on October 15, 2004 we added LNP and WirelessNumber Portability (“WNP”) number ordering and provisioning testing productswhich provide new OSS system integration capabilities.  Most recently, on November 2, 2004, weacquired Tertio Telecoms Ltd. (“Tertio”), a privately held supplier of OSSsoftware solutions to communication carriers throughout Europe, the MiddleEast, Africa and Asia, expanding our markets beyond North America.  Tertio’s activation solution, ***ProvidentTM,***and mediation solution ***EvidentTM***, strengthen our overallproduct portfolio. Our significantly expanded product and service capabilitiesnow enable us to address a larger portion of our customer’s application needs.As a result, we have become a company with global reach and a customer basethat includes many of the world’s leading communications carriers.  We are positioned as a provider of OSS, NSSand comprehensive systems integration capabilities. These complementarycompetencies enable us to address and implement solutions across much of acustomer’s back office.

 

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**CompanyBackground**

 

Foundedin 1985, we initially focused on providing custom software development andprofessional services to a limited number of telecommunications companies inthe United States. In 1996, concurrent with the passage of theTelecommunications Act of 1996 (“the Telecom Act”), we made a strategicdecision to add software products to our established professional services offerings.Since that time we have built a strong product portfolio, of which we are bestknown for our LNP and service activation solutions.

 

Historically,we have helped our customers integrate our products into their existingbusiness process and OSS environments. In 2002, we initiated a restructuringplan, which, in addition to significant operational cost reductions and greaterleverage of offshore development, included the reengineering of our businessmodel to a solutions strategy.  Thesolutions business model reflects a more balanced mix of services and products,as well as integration and product enhancements for our customers’ back officeto meet the specific requirements of each customer. This customer specificeffort is complementary to product development investments driven by moretraditional marketing efforts. Solutions which include our products, as well asproduct extensions and integration, are typically licensed to our customers andsupported by us. In 2004, our sales reach was expanded to include both directand indirect sales.  New partnershipswith network equipment providers and system integrators to extend our reach tonew geographical regions as well as helping us further penetrate our existingterritories were achieved during the year. We have also created packaged products with our channel partners, wherewe provide the underlying product and our partner provides some or most of theintegration services.

 

**CriticalAccounting Policies**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations is basedon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America, or GAAP. We review the accounting policies we use in reporting ourfinancial results on a regular basis. The preparation of our consolidatedfinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenue and expenses, and relateddisclosure of contingent assets and liabilities. In many cases, the accountingtreatment of a particular transaction is specifically dictated by GAAP and doesnot require our judgment in its application. Our senior management has reviewed these critical accounting policiesand related disclosures with our Audit Committee.  We have identified the policies below ascritical to our business operations and the understanding of our results ofoperations.

 

•                  Revenuerecognition

 

•                  Allowancefor doubtful accounts

 

•                  Incometaxes

 

•                  Intangibleassets

 

•                  Businesscombinations

 

•                  Capitalizationof internal software development costs

 

For adetailed discussion on the application of these accounting policies, see “Item7: Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in our Annual Report on Form 10-K for the year ended December 31,2004.

 

**RecentDevelopments**

 

**Acquisitionof TSE**

 

In October 2004,we acquired TSE.  TSE’s ***VeriPortTM*** and ***VerifyTM***products are sold to United States of America (“U.S.”) wirelineand wireless carriers, and provide for simulation of the nation’s centralizedNumber Portability Administration Center (“NPAC”) and a testing environment forcritical back office systems that carriers use for enabling number portability.Other products in the TSE portfolio are used for enhanced integration betweenback office OSS systems.  TSE hasinstalled its products at several of the leading wireless and wireline carriersin North America. By acquiring TSE, we have expanded our customer base andextended the set of solutions we offer our numbering solutions customers.

 

**Acquisitionof Tertio**

 

In November 2004,we acquired Tertio, our third acquisition in a twelve month period. Byacquiring Tertio we became a global company with a customer base that includesmany of the world’s largest communication carriers. Tertio’s activation and mediation

 

14

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solutions, Provident andEvident, fit well with elements of our product portfolio, enabling us to provideactivation solutions and strengthening our current mediation and serviceassurance offerings.

 

In January 2005,we changed Tertio’s name to Evolving Systems Limited (“Evolving Systems U.K.”).We also renamed the Provident activation product “Tertio”, to build on thestrong recognition of the Tertio brand in the service activation market. Thename changes are reflected in this filing where appropriate.

 

**Expansionof Offshore Development Subsidiary**

 

In February 2004,we formed Evolving Systems Networks India Private Limited, a wholly ownedsubsidiary of Evolving Systems (“Evolving Systems India”).  For several years, offshore development,through a subcontractor, had been a key aspect of our low-cost,accelerated-deployment strategy. With the formation of Evolving Systems Indiawe now have more control and flexibility and lower costs than with our previousoutsourced development, which used an offshore third party contractor. As of March 31,2005, we had approximately 65 employees in our Indian office with plans forfurther expansion as demand dictates.

 

**CustomerSupport Revenue Deferral**

 

Duringthe first quarter of 2004, we deferred the recognition of customer supportrevenue for one of our largest customers. Under this maintenance arrangement,the customer purchased professional services, specified licensed softwareupgrades and support services.  Sincefair value of the undelivered specified licensed software upgrades did notexist, all of the revenue related to this contract was deferred until the specifiedlicensed software upgrades were delivered and accepted by the customer.  During the third quarter of 2004, wedelivered and obtained acceptance of the specified licensed software upgrades.Since vendor specific objective evidence of fair value existed for all of theremaining undelivered elements in the arrangement, we recognized the residualamount of revenue for all delivered elements at that time.  Our 2005 customer support contract with thesame customer did not contain these additional accounting elements, and was notdeferred. Accordingly, we recognized approximately $1.0 million of customersupport revenue related to this contract in the first quarter of 2005.

 

**Resultsof Operations**

 

Thefollowing table presents the Company’s consolidated statements of operationsreflected as a percentage of total revenue.

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **REVENUE**                                                                  |       |                                  |       |   |   |
| License fees and services                                                    |       | 52                                    | %          | 56 | % |
| Customer support                                                             |       | 48                                    | %          | 44 | % |
| Total revenue                                                                |       | 100                                   | %          | 100 | % |
|                                                                         |       |                                  |       |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                  |       |   |   |
| Costs of license fees and services, excluding  depreciation and amortization |       | 30                                    | %          | 18 | % |
| Costs of customer support, excluding depreciation  and amortization          |       | 21                                    | %          | 29 | % |
| Sales and marketing                                                          |       | 24                                    | %          | 16 | % |
| General and administrative                                                   |       | 25                                    | %          | 16 | % |
| Product development                                                          |       | 1                                     | %          | 9 | % |
| Depreciation                                                                 |       | 4                                     | %          | 5 | % |
| Amortization                                                                 |       | 15                                    | %          | 4 | % |
| Restructuring and other expenses                                             |       | —                                |       | — |   |
| Total costs of revenue and operating expenses                                |       | 120                                   | %          | 97 | % |
|                                                                         |       |                                  |       |   |   |
| Income (loss) from operations                                                |       | (20                                   | )%         | 3 | % |
| Other (expense) income, net                                                  |       | (5                                    | )%         | 1 | % |
| Income (loss) before income taxes                                            |       | (25                                   | )%         | 4 | % |
| Benefit from income taxes                                                    |       | 3                                     | %          | — |   |
| Net income (loss)                                                            |       | (22                                   | )%         | 4 | % |

 

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**The threemonths ended March 31, 2005 compared to the three months ended March 31,2004**

 

**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 asintegration services and time and materials work.  Customer support revenue includes annual support fees,recurring maintenance fees, maintenance upgrades and warranty fees.  Warranty services are typically bundled witha license sale and the related revenue, based on VSOE, is deferred andrecognized ratably over the warranty period.  Total revenue was $9.8 million and $5.8 millionfor the three months ended March 31, 2005 and 2004, respectively. Thefollowing table presents the Company’s revenue by product group (in thousands).

 

| ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Numbering solutions |       | $                                     | 3,790      |   | $ | 5,101 |   |
| Mediation           |       | 1,855                                 |       | 665 |   |
| Activation          |       | 4,193                                 |       | — |   |
|                |       | $                                     | 9,838      |   | $ | 5,766 |   |

 

**License Fees and Services**

 

License fees and services revenue increased 58% to $5.1million for the three months ended March 31, 2005, from $3.2 million forthe three months ended March 31, 2004. The increase in license fees and services revenue is due to activationsales related to products acquired in the Tertio acquisition and increasedmediation revenue, offset by lower revenue from our number portability andinventory products.  The decline innumber portability and inventory products is due to industry consolidation andsmaller overall license sales which is reflective of the maturity of thenarrowband numbering solutions market in the U.S.

 

**Customer Support**

 

Customer support revenue increased 87% to $4.8 millionfor the three months ended March 31, 2005, from $2.5 million for the threemonths ended March 31, 2004.  The increasein customer support revenue during the first quarter of 2005 is due to increasedrevenue related to the support of activation products acquired in the Tertioacquisition as well as increased customer support revenue related to numberingsolutions products, partially offset by price reductions in certain customersupport contracts. Numbering solutions customer support revenue was lower inthe first quarter of 2004 due to a large customer support contract that wasdeferred until the acceptance of specified upgrades, which occurred during thethird quarter of 2004.

 

**Costs of Revenue, Excluding Depreciation andAmortization**

 

Costsof revenue, excluding depreciation and amortization, consist primarily ofpersonnel costs, facilities costs, the costs of third-party software and allother direct costs associated with these personnel. Total costs of revenue,excluding depreciation and amortization, were $5.0 million and $2.7 millionfor the three months ended March 31, 2005 and 2004, respectively.

 

**Costs of LicenseFees and Services, Excluding Depreciation and Amortization**

 

Costsof license fees and services, excluding depreciation and amortization, were $3.0million and $1.1 million for the three months ended March 31, 2005and 2004, respectively.  The increase of$1.9 million, or 178%, is due to more projects in delivery as a result of theTertio acquisition, as well as additional costs related to the U.K. developmenttransition to our off-shore development model which utilizes Evolving SystemsIndia. As a percentage of license fees and services revenue, costs of license feesand services, excluding depreciation and amortization, increased to 59% for thethree months ended March 31, 2005 from 33% for the three months ended March 31,2004.  The increase as a percentage of licensefees and services revenues was due to the aforementioned increased costs relatedto the U.K. development transition to our off-shore development model and theincreased costs from Evolving Systems U.K. and TSE which exceeded the increasein revenue during the period.

 

**Costs ofCustomer Support, Excluding Depreciation and Amortization**

 

Costsof customer support, excluding depreciation and amortization, were $2.0 millionand $1.7 million for the three months ended March 31, 2005 and 2004,respectively.  The increase of $368,000,or 22%, is due to increased hours worked on customer support projects tosupport products acquired in the Tertio and TSE acquisitions.  As a percentage of customer support revenue,costs of customer support, excluding depreciation, decreased to 43% for the threemonths ended March 31, 2005 from 65% for the three months ended March 31,2004.  The decrease as a percentage of customersupport revenue is due to increased revenue in the first quarter of 2005 relatedto the aforementioned large support contract that was deferred during the firstquarter of 2004, but the related costs were expensed during the period and increasedrevenue from Evolving Systems U.K. and TSE customer support contracts.

 

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**Sales andMarketing**

 

Salesand marketing expenses primarily consist of compensation costs, including bonusesand commissions, travel expenses, advertising and occupancy expenses.  Sales and marketing expenses were $2.4million and $936,000 for the three months ended March 31, 2005 and 2004,respectively. The increase of $1.5 million, or 156%, is due to additional costsfrom Evolving Systems U.K. and TSE as well as increased expenses in the U.S.related to increased headcount for sales initiatives designed to penetrate newmarkets.  As a percentage of total revenue,sales and marketing expenses increased to 24% for the three months ended March 31,2005 from 16% for the three months ended March 31, 2004.  The increase as a percentage of revenue isdue to the combination of increased expenses from Evolving Systems U.K. and theincreased expenses in the U.S., which exceeded the increase in revenue duringthe period.

**Generaland Administrative**

 

Generaland administrative expenses consist principally of employee related costs andprofessional fees for the following departments; facilities, finance, legal,human resources, and executive management. General and administrative expenses were $2.5 million and $935,000 forthe three months ended March 31, 2005 and 2004, respectively.  The increase of $1.6 million or 167%, isprimarily due to costs from Evolving Systems U.K. as well as increased expensesin the U.S. related to significantly higher levels of professional fees.  As a percentage of total revenue, general andadministrative expenses increased to 25% for the three months ended March 31,2005 from 16% for the three months ended March 31, 2004.  The increase as a percentage of revenue isdue to the combination of increased expenses from Evolving Systems U.K. and increased professional fees inthe U.S., which was greater than the increase in revenue during the period.

 

**ProductDevelopment**

 

Productdevelopment expenses consist primarily of employee related costs, offshoredevelopment subcontractor expenses and costs to start up our offshore Indianfacility.  Product development expenseswere $110,000 and $491,000 for the three months ended March 31, 2005 and2004, respectively. The decrease of $381,000, or 78%, is due to decreased hoursspent on development of our ***ServiceXpressTM***toolkit, which ended in 2004. In addition, development in 2005 was principallyfocused on customer specific projects rather than general research anddevelopment efforts. Costs for customer-specific projects are reflected ascosts of the related revenue.  As apercentage of revenue, product development expenses decreased to 1% for the threemonths ended March 31, 2005 from 9% for the three months ended March 31,2004.  The decrease as a percentage ofrevenue is due to the decreased hours worked on product development versuscustomer specific projects and the increased revenue in the first quarter of2005 compared to 2004.

 

**Amortization**

 

Amortizationexpense consists of amortization of identifiable intangibles from ouracquisitions of CMS, TSE and Tertio. Amortization expense was $1.4 million and$218,000 for the three months ended March 31, 2005 and 2004,respectively.  The increase inamortization expense of $1.2 million or 552% is due to amortization related toidentifiable intangibles from the acquisitions of Tertio and TSE.  As a percentage of revenue amortizationexpense increased to 15% for the three months ended March 31, 2005 from 4%for the three months ended March 31, 2004. The increase as a percentage ofrevenue is due to the aforementioned increase in expenses which was greaterthan the increase in revenue during the period.

 

**Restructuringand Other Expense**

 

Duringthe three months ended March 31, 2005, we recorded a restructuring recoveryof $48,000 in accordance with the Company’s restructuring plan, as follows:

 

•                  *Closure of satelliteoffices.*  We closed all of oursatellite field offices during 2002. Because the costs to sublease or terminate these lease commitments arebased on estimates, we may incur additional costs related to the satelliteoffice closures.  During the three monthsended March 31, 2005 we recorded a recovery of $48,000 related to theclosure of the satellite offices as the actual costs to close this facilitieswere less than our original estimate. As of March 31, 2005 approximately$15,000 was included in accounts payable and accrued liabilities, andapproximately $1,000 was included in long-term obligations, related to theclosure of the satellite offices.

 

**Other Income (Expense), Net**

 

Other income (expense), net, was ($505,000) and$57,000 for the three months ended March 31, 2005 and 2004, respectively.  The expense during 2005 is primarily due to interestexpense from the notes payable issued in the acquisitions of TSE and Tertio.

 

**IncomeTaxes**

 

Werecorded net income tax benefits of $278,000 and $8,000 for the three monthsended March 31, 2005 and 2004, respectively.  The net benefit during the three months ended March 31,2005 consists of current income tax expense of approximately $190,000 and adeferred tax benefit of $468,000 both of which are related to the Company’sUK-based operations. This represents an

 

17

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11% effective tax rate,reflecting the blend of the estimated effective tax rate of our domestic pretaxincome of approximately 2% and the estimated effective tax rate related to ourU.K. pretax income of approximately 30%.

 

Inconjunction with the acquisition of Tertio, certain identifiable intangibleassets were recorded.  Since theamortization of these identifiable intangibles is not deductible for income taxpurposes, a long-term deferred tax liability of $4.6 million was established atthe acquisition date for the expected difference between what would be expensedfor financial reporting purposes and what would be deductible for income taxpurposes. As of March 31, 2005, this deferred tax liability was $4.2million. This deferred tax liability is carried on the books of the Company’sUnited Kingdom subsidiary, and has no impact on the Company’s ability to recoverits U.S.-based deferred tax assets.

 

Inconjunction with the acquisition of Tertio, future revenue under contracts inexistence at the acquisition dates was reduced to an amount equal to theCompany’s estimated costs to fulfill its obligations under the contracts plus areasonable profit margin on the Company’s estimated fulfillment effort.  The resulting reduction of future revenuerecorded for financial reporting purposes is not deductible for income taxpurposes and thus, a current deferred tax liability of approximately $600,000was established at the acquisition date. As of March 31, 2005, thisdeferred tax liability was $115,000. Both of the aforementioned deferred tax liabilities will be recognizedas a reduction of current income tax expense as the identifiable intangiblesare amortized and the contract revenue is recognized.

 

**Liquidityand Capital Resources**

 

Wehave historically financed operations through cash flows from operations andequity transactions.  At March 31,2005, our principal source of liquidity was $6.5 million in cash and cashequivalents.

 

Netcash provided by operating activities was $1.5 million in the three monthsended March 31, 2005. The main factors in the cash provided by operatingactivities for the three months ended March 31, 2005 were decreases inaccounts receivables of $2.7 million and unbilled work-in-progress of $394,000,interest expense added to debt principal of $317,000 and depreciation andamortization of $1.8 million. Offsetting increases to cash flows from operatingactivities for the three months ended March 31, 2005 was the net loss of$2.1 million, the deferred foreign income tax benefit of $465,000 and the decreasesin accounts payable and accrued liabilities of $553,000 and unearned income of$441,000.

 

Netcash provided by operating activities was $3.6 million for the three monthsended March 31, 2004.  The cashgenerated from operating activities is mainly due to collections of ourcontract receivables.  The cash flowgenerated from the collection of contract receivables was partially offset by adecrease in our unearned revenue balance due to recognition of revenue on ourannual customer support agreements and delivery of licensed software andservices.

 

Netcash used by investing activities during the three months ended March 31,2005 was $823,000. Cash used by investing activities for the three months endedMarch 31, 2005 consisted of additional consideration paid to the sellersof TSE and Tertio of $676,000 and capital expenditures primarily related to theTertio integration of $158,000.

 

Netcash used by investing activities during the three months ended March 31,2004 of $527,000 was primarily due to capital expenditures for internalhardware that improved performance and reliability of our product developmentenvironment.

 

Financingactivities used $5.5 million in cash for the three months ended March 31,2005. During the first quarter of 2005, we made payments of $5.5 million onnotes payable and an acquired dividend payable assumed in the Tertio acquisition.We received proceeds of $56,000 during the three months ended March 31,2005, from the issuance of stock related to our stock option and employee stockpurchase plans.

 

Financingactivities provided $203,000 for the three months ended March 31, 2004,related to the exercise of approximately 100,000 stock options.

 

Workingcapital (deficit) at March 31, 2005 was ($4.8) million compared to ($3.3)million at December 31, 2004. As previously mentioned, we acquired twocompanies, TSE and Tertio, during the fourth quarter of 2004. We made paymentsof approximately $6.2 million during the three months ended March 31, 2005related to notes payable, an acquired dividend obligation assumed andcontingent consideration related to the TSE and Tertio acquisitions. Theacquisition of Tertio also includes the issuance of long-term seller-financednotes (“Long-Term Notes”) of approximately $11.9 million of which $1.3 millionis due within the next twelve months.

 

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Webelieve that our current cash and cash equivalents, together with anticipatedcash flow from operations will be sufficient to meet our working capital andcapital expenditure requirements for at least the next twelve months. In makingthis assessment we considered the following:

 

•                  Ourcash and cash equivalents balance at March 31, 2005 of $6.5 million.

 

•                  Ourability to generate positive cash flows from operations. During 2003, 2004 andthe three months ended March 31, 2005 we generated cash flows from operationsof $6.9 million, $4.3 million and $1.5 million, respectively.

 

•                  Ourbacklog of approximately $16.9 million, including $4.7 million in license feesand services and $12.2 million in customer support at March 31, 2005.

 

•                  Ourcash forecast indicates that we will have sufficient liquidity to coveranticipated operating costs as well as debt service payments.

 

To theextent we are unable to invoice and collect in a timely manner under ourcustomer revenue arrangements, it could have an adverse impact on our abilityto meet our intended business objectives. Management believes that we have theability to further reduce operating expenses, if necessary, such that currentworking capital (exclusive of deferred revenue) and cash flows from operationswill be adequate to meet our cash needs through the next twelve months.

 

Notwithstandingthese assessments, if the timing of cash generated from operations isinsufficient to satisfy our liquidity requirements, or an unexpected adverseevent, or combination of events, occurs that is beyond management's control, wemay require access to additional funds to support our business objectivesthrough a credit facility or possibly the issuance of additional equity. Therecan be no assurance that additional financing will be available at all or thatif available, such financing will be obtainable on terms favorable to us andwould not be dilutive.

 

We issuedthe Long-Term Notes payable on November 2, 2004, in conjunction with theacquisition of Tertio.  From the acquisitiondate through November 2, 2006, the Long-Term Notes bear interest at 11.0%per annum. From November 2, 2006 through the maturity date of December 31,2007, the notes will bear interest at 14.0% per annum. Interest is accrued tothe principal balance through December 31, 2005, and beginning March 31,2006, interest is payable on a quarterly basis in addition to the scheduledprincipal payments. The Long-Term Notes may be prepaid at any time withoutpenalty. Beginning on March 31, 2005, if our quarterly cash balancesexceed $7.0 million the holder of the Long-Term Notes may require a prepaymenton the note equal to the amount by which the quarterly cash balance exceeds$7.0 million. Based on our current cash projections, no such additionalpayments will be required during the twelve months ended March 31, 2006.The scheduled principal payments on the long-term seller financed notes are asfollows (in thousands):

 

 

| **Payment date**       | ** ** | **Amount** | ** ** |
|------------------------|------------|------------|------------|
| March 31, 2006    |       | $          | 1,340      |   |
| June 30, 2006     |       | 3,110      |       |
| December 31, 2006 |       | 1,430      |       |
| March 31, 2007    |       | 1,870      |       |
| June 30, 2007     |       | 3,110      |       |
| December 31, 2007 |       | 1,636      |       |
|                   |       | $          | 12,496     |   |

 

In the upcoming annual stockholders’ meeting we areasking stockholders to approve the exchange of the Long-Term Notes into convertiblenotes (“Convertible Notes”). The currently outstanding notes plus accruedinterest through May 16, 2005 totaling approximately $12.7 million, uponstockholder approval, would be exchanged for notes that could be convertibleinto approximately 3.8 million shares of our common stock at $3.296 per share.The Convertible Notes would bear interest at the Federal Applicable Rate, whichis currently approximately 3.5%. In addition, all principal and unpaid interestwould be due and payable on December 31, 2007 under such Convertible Notes.If we do not obtain stockholder approval to permit holders to exchange some orall of the Long-Term Notes into Convertible Notes, and such notes are notconverted, we will be required to service the full amount of the Long-TermNotes and related interest payments. Our inability to convene the InitialShareholders’ Meeting, as defined, by May 16, 2005, constitutes an eventof default under this note. We believe we will be able to convene this meetingby the appointed time.

 

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TheLong-Term Notes subject us to certain affirmative and negative covenants,including a financial covenant indexed to our computation of EBITDA, asdefined.  We will be required to complywith such covenants beginning June 30, 2005.

 

**FactorsThat Might Affect Operating Results**

 

Theseresults should be read in conjunction with the risk factors defined in theCompany’s Annual Report on Form 10-K for the year ended December 31,2004. Statements contained in this Quarterly Report with respect to futurerevenue and expenses are “forward-looking statements” within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended. Actual results may differ.Among the factors that could cause actual results to differ are those describedbelow and in more detail in our Annual Report on Form 10-K.

 

**Risksrelated to Tertio Acquisition**

 

***We are subject to financial and operating risks associated withinternational sales and services.***

 

Historicallysales of our products have been limited to customers in the United States. Ouronly international operational experience has been with our Indian offshoredevelopment subsidiary. The acquisition of Tertio resulted in the addition ofsignificant sales and operations outside the United States, including Europe,Asia and Africa. If we are unable to manage our sales and operations on aglobal basis, our financial condition or results of operations could bematerially adversely affected.  Ourinternational business is subject to the financial and operating risksincluding:

 
| • |   | unexpected  changes in, or impositions of, legislative or regulatory requirements;                                                                                                                     |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| • |   | difficulties in  maintaining effective controls over financial reporting across geographically  dispersed entities, including those related to different business practices  in foreign countries;     |
|   |   |                                                                                                                                                                                                   |
| • |   | internal control  related risks of operating a foreign subsidiary;                                                                                                                                     |
|   |   |                                                                                                                                                                                                   |
| • |   | changes in  demand of our products and services due to the perception that we are an “American”  company in countries where the United States’ foreign policy is not viewed  favorably; |
| • |   | fluctuating  exchange rates, tariffs, currency repatriation restrictions and other  barriers;                                                                                                          |
| • |   | difficulties in  staffing and managing foreign subsidiary operations;                                                                                                                                  |
| • |   | import or export  restrictions;                                                                                                                                                                        |
| • |   | greater  difficulties in accounts receivable collection and longer payment cycles;                                                                                                                     |
| • |   | potentially  adverse tax consequences and additional tax considerations such as foreign  withholding taxes and payment of value added tax (“VAT”);                                           |
| • |   | potential  hostilities and changes in diplomatic and trade relationships;                                                                                                                              |
| • |   | changes in a  country’s economic or political conditions; and                                                                                                                                     |
| • |   | differing  customer and/or technology standards requirements.                                                                                                                                          |

 

***Our stockholders will be diluted by the conversion of outstandingSeries B Convertible Preferred Stock and, if approved by our stockholders,the exchange of the long-term notes into convertible notes.***

 

In consideration for ouracquisition of Tertio, we made a cash payment of $11.0 million, issued 966,666shares of Series B Convertible Preferred Stock (“Series B PreferredStock”), issued a short-term secured note with a principal amount of $4.0million bearing interest at 5.5% per annum and issued Long-term Notes with anaggregate principal amount of approximately $11.9 million bearing interestinitially at 11% per annum (increasing to 14% on the second anniversary). Subject to stockholder approval, the holders of the Long-Term Notes haveelected to exchange these notes for convertible notes, convertible into sharesof our common stock, and bearing interest at the applicable federal rate at thetime the Convertible Notes are issued, currently about 3.5%.

 

Each share of Series BPreferred Stock is convertible into three shares of our common stock whichcould result in the issuance of up to 2,899,998 shares of our commonstock.  In the event that the Series B Preferred Stock and/or theConvertible Notes are converted into shares of common stock, there will be asignificant dilutive effect on the ownership interests and voting rights of ourexisting stockholders.

 

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Prior to our acquisitionof Tertio, only one of our stockholders beneficially owned in excess of fivepercent of our common stock.  If the Series BPreferred Stock and the Convertible Notes are exchanged for shares of ourcommon stock, the holders and their affiliates would hold in excess of twentypercent (but no more than thirty-three percent) of the outstanding shares ofour common stock.  The sale by such holders of one or more large blocks ofour common stock could have a negative impact on the market price of our commonstock.  Additionally, such ownershipinterests could effectively deter a third party from making an offer to buy us,which might involve a premium over our current stock price or other benefitsfor our stockholders, or otherwise prevent changes in the control or managementof Evolving Systems.  In addition, there are no restrictions, in the formof a standstill agreement or otherwise, on the ability of such stockholders ortheir affiliates to purchase additional shares of our common stock and therebyfurther increase their ownership interests.

 

***The holders of our Series B Preferred Stock havepreferential rights that may be adverse to holders of our common stock.***

 

The holders of the Series BPreferred Stock have preferential rights with respect to distributions upon aliquidation of Evolving Systems, including certain business combinations deemedto be a liquidation.  Accordingly, no distributions upon liquidation maybe made to the holders of common stock until the holders of the Series BPreferred Stock have been paid their liquidation preference.  As a result,it is possible that, on liquidation, all amounts available for the holders ofequity of Evolving Systems would be paid to the holders of the Series BPreferred Stock, and that the holders of common stock would not receive anypayment.  Additionally, in connection with the Tertio acquisition we areobligated to file and keep effective a registration statement providing for theresale of the shares of our common stock issuable upon the conversion of the Series BPreferred Stock and the Convertible Notes.  If the Securities and ExchangeCommission refuses to declare the registration statement effective or we failto keep the registration statement effective, the holders of the Series BPreferred Stock will have the right to cause us to repurchase for cash theshares of the Series B Preferred Stock for $3.89 per share (on an asconverted basis), or approximately $11.3 million. If we are required to makethis payment, it would have a significant adverse impact on our liquidity andcould cause us to incur additional indebtedness.

 

Additionally, the Series BPreferred Stock, as well as the Convertible Notes (if approved), containcertain weighted average price based anti-dilution protections that, as long asthose securities remain outstanding, would be triggered if we issued shares of our common stock (subject tocertain adjustments and standard exclusions relating to Company options) below$3.89 per share.  In the event that weissued shares below this threshold, the holders of our common stock would bediluted to an unknown degree. Furthermore, the mere existence of such anti-dilution protections couldmake it difficult for us to issue any common stock below $3.89 per share, if atall.  In the event the anti-dilutionadjustments of the Series B Preferred Stock are triggered, suchadjustments would result in a deemed dividend to the Series B PreferredStock holders that would reduce income available to common stockholders.  The charge would be equal to the number ofadditional shares issuable as a result of the anti-dilution calculation,multiplied by the fair value of the common stock on the date of the issuance ofthe Series B Preferred Stock, or $4.64. The deemed dividend charge could negatively affect the price of ourcommon stock.

 

***The indebtedness incurred in connection with the Tertio acquisition maylimit our ability to grow and could adversely affect our financial condition.***

 

The indebtedness incurredwith respect to the short- and long-term secured notes and, possibly, theredemption of the Series B Preferred Stock, is material in relation to ourcurrent level of indebtedness, our ability to service the debt from ouroperating cash flow and our ability to repay the debt in full atmaturity.  If we do not obtain stockholder approval to permit holders toexchange the Long-Term Notes into Convertible Notes, and such notes are not convertedinto common stock, we will be required to service the full amount of thelong-term debt and related interest payments.  Additionally, if we do notreceive such stockholder approval, the Series B Preferred Stock will notautomatically be converted into common stock and will remain outstanding inaccordance with its terms.  No assurancecan be given that sufficient funds will be available to meet our operatingneeds, to pay the interest due on the short and the long-term secured notes or,if required, to redeem the Series B Preferred Stock.  The notes aresecured by a general lien on all of our assets.  If we are unable to paythe notes as they become due, the holders of the notes could foreclose on allof our assets. The increased level of our indebtedness, among other things,could:

 

•                  make it difficult for us to obtain any necessaryfuture financing for working capital, capital expenditures, debt servicerequirements or other purposes;

 

•                  limit our flexibility in planning for, orreacting to changes in, our business; and

 

•                  make us more vulnerable in the event of adownturn in our business.

 

If we incur new indebtedness inthe future, the related risks that we now face could intensify. Whether we areable to make required payments on our outstanding indebtedness and to satisfyany other future debt obligations will depend on our future operatingperformance and our ability to obtain additional debt or equity financing.

 

Nasdaq Rule 4350(i)(1)(C) requiresthat a company whose stock is traded on Nasdaq obtain stockholder approval inconnection with the acquisition of another company involving the issuance orpotential issuance of common stock equal to twenty percent or more of itscommon stock.  The issuance of the Series B Preferred Stock alone,does not exceed this twenty percent

 

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threshold.  However,because the issuance of the shares of common stock upon conversion of the Series BPreferred Stock and the Convertible Notes would, collectively, result in us issuingin excess of twenty percent of our outstanding shares of common stock, we arerequired under the Nasdaq rules to seek stockholder approval for theexchange of the Long-Term Notes into Convertible Notes.  No assurances canbe given that our stockholders will approve the matters required for suchconversion or that we will be able to obtain a sufficient quorum to vote on allsuch matters.  If our stockholders do not approve such exchange or do notapprove the amendment of our Articles of Incorporation to increase ourauthorized shares of common stock, needed to provide shares into which theConvertible Notes may be converted, the Long-Term Notes will remain outstandinguntil December 31, 2007 (unless earlier repaid), will require debtrepayments during 2006 and 2007, and our ability to continue to service suchdebt could adversely affect our financial condition.

 

***The terms and conditions of the Series B PreferredStock and the indebtedness incurred in connection with the Tertio acquisitionmay have an adverse impact on our results of operations and financialperformance.***

 

There is a potential thatthe Company will incur additional charges in the future related to variousprovisions of the financial instruments issued in connection with theacquisition of Tertio.  Subject tostockholder approval and election by the note holders, the Long-Term Notesinitially bearing interest at 11% per annum could be exchanged for acombination (based on the allocation election of the note holders) ofconvertible notes bearing interest at the applicable federal rate at the timethe convertible notes are issued (currently about 3.5%), and fixed rate,non-convertible notes bearing interest initially at 9% per annum. The holdersof the Long-Term Notes have elected to exchange the full principal of thosenotes, and accrued interest, for Convertible Notes. Such exchange is dependentupon the approval by the Company’s stockholders to increase the number ofauthorized shares and to approve such exchange. When and if such exchange occurs, the extinguishment of the Long-TermNotes and the issuance of the Convertible Notes will be recorded at their fairvalue, which could result in a charge reducing our income which in turn couldnegatively affect our stock price.  Fairvalue assessments are dependent upon market factors in existence at the time ofmeasurement.

 

In addition to theaforementioned charges related to remeasuring the Long-Term Notes exchange atfair value, if the conversion rate on the Convertible Notes is less than thefair value of the stock into which the notes are convertible, on the date ofissuance, the Company will be required to record as additional interest expensea beneficial conversion feature that will negatively affect interest expense inthe period in which the Convertible Notes are issued.

 

The inability to registershares of our common stock underlying the Series B Preferred Stock and/oran inability to keep such registration effective, as described above, couldresult in the Series B Preferred Stock becoming mandatorilyredeemable.  Currently, the Series BPreferred Stock is classified as non-permanent equity since the events thatwould require its redemption have not occurred. If we are unable to obtain and/or maintain the effectiveness of therelated registration statement, the Series B Preferred Stock will becomemandatorily redeemable at the option of the holders and the instrument will bereclassified as a liability.  Uponreclassification, the Series B Preferred Stock will be remeasured at itsthen current fair value and the difference between its fair value andredemption price will be charged to additional paid-in capital.  Such charge to equity may negatively impactthe price of our common stock. Subsequent changes to the fair value of this instrument would berecognized in earnings, as a charge or income, and such amounts could besignificant and unpredictable.

 

***Certain provisions of the notes payable issued inconjunction with the Tertio acquisition call for the acceleration of paymentsif certain covenants are breached or cash flow thresholds are achieved.***

 

The notes issued inconjunction with the Tertio acquisition contain certain affirmative andnegative covenants that, if breached, could result in the acceleration of suchnotes becoming immediately due and payable. The covenants include the Company’s agreement to do the following:

 

•                  Convene a stockholders’ meeting on orbefore May 16, 2005 to request approval of (a) the exchange of theLong-Term Notes for Convertible Notes and (b) an amendment to ourCertificate of Incorporation increasing the authorized common stock;

 

•                  comply with applicable laws andlicensing requirements;

 

•                  file and pay all applicable taxes asthey become due; and

 

•                  operate in the ordinary course ofbusiness.

 

The covenants alsoinclude the Company’s agreement not to do any of the following (except asspecifically authorized in such notes):

 

•                  liquidate, dissolve or wind-upoperations;

 

•                  pay any dividends or make prepaymentson any indebtedness;

 

•                  acquire any other businesses orentities or make investments in third parties;

 

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•                  sell or transfer a substantialportion of the Company’s assets;

 

•                  incur additional indebtedness orpermit any liens on the Company’s assets;

 

•                  make capital expenditures beyondestablished thresholds; or

 

•                  take certain other operationalactions.

 

The covenants may limitthe Company’s flexibility in planning for, or reacting to changes in, itsbusiness.  Failure to comply with suchcovenants, if not waived, could result in the acceleration of the notes. If theCompany is required to pay the notes on an accelerated basis, it would have asignificant adverse impact on the Company’s liquidity and financial conditionand could cause us to incur additional indebtedness.

 

Additionally, the notesissued in conjunction with the Tertio acquisition require us to offer the noteholders a prepayment on such notes in the amount that our closing cash balanceexceeds $7.0 million at the end of any fiscal quarter beginning with thequarter ended March 31, 2005.  Sucha requirement will restrict our liquidity and cash management flexibility.  Until the notes are repaid, our ability toengage in transactions or to enter into agreements requiring significant cashinvestments may be adversely affected.

 

**RisksRelated to Our Business**

 

***Fluctuations in Quarterly Results of Operations***

 

Our operating resultshave fluctuated significantly in the past and may continue to fluctuatesignificantly in the future. Fluctuations in operating results may result involatility of the price of our common stock. These quarterly and annualfluctuations may result from a number of factors, including:

 

•                  thesize of new contracts and when the related revenue is recognized;

 

•                  ourrate of progress under our contracts;

 

•                  acquisition and integration costs;

 

•                  thetiming of customer and market acceptance of our products and service offerings;

 

•                  our ability to effectively manage offshoresoftware development in India;

 

•                  actualor anticipated changes in government laws and regulations related to thetelecommunications market;

 

•                  judicialor administrative actions about these laws or regulations;

 

•                  thenature and pace of enforcement of the Telecom Act as well as other similarforeign statutes, regulations and acts;

 

•                  productlifecycles;

 

•                  themix of products and services sold;

 

•                  changesin demand for our products and services;

 

•                  thetiming of third-party contractors’ delivery of software and hardware;

 

•                  budgetingcycles of our customers;

 

•                  changesin the terms and rates related to the renewal of support agreements;

 

•                  leveland timing of expenses for product development and sales, general andadministrative expenses;

 

•                  competitionby existing and emerging competitors in the communications software markets;

 

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•                  oursuccess in developing and selling new products, controlling cost, attractingand retaining qualified personnel and expanding our sales and customer focusedprograms;

 

•                  softwaredefects and other product quality problems;

 

•                  changesin our strategy;

 

•                  theextent of industry consolidation;

 

•                  foreignexchange fluctuations; and

 

•                  generaleconomic conditions.

 

Our expense levels arebased in significant part on our expectations regarding future revenue. Ourrevenue is difficult to forecast as the market for our products and services israpidly changing, and our sales cycle and the size and timing of significantcontracts vary substantially among customers. Accordingly, we may be unable to adjustspending in a timely manner to compensate for any unexpected shortfall inrevenue. Any significant shortfall from anticipated levels of demand for ourproducts and services could have a material adverse effect on our business,financial condition, results of operations and cash flows.

 

Based on these factors,we believe our future quarterly and annual operating results may varysignificantly from quarter to quarter and year to year. As a result,quarter-to-quarter and year-to-year comparisons of operating results are notnecessarily meaningful nor do they indicate what our future performance willbe. Furthermore, we believe that in future reporting periods if our operatingresults fall below the expectations of public market analysts or investors, it ispossible that the market price of our common stock could go down.

 

***Liquidity***

 

Our cash forecastindicates that we will have sufficient liquidity to cover anticipated operatingcosts as well as debt service payments, but to the extent we are unable to invoiceand collect in a timely manner under our customer revenue arrangements, or anunexpected adverse event, or combination of events, occurs that is beyondmanagement's control, it could have an adverse impact on our ability to meetour intended business objectives. Therefore, if the timing of cash generatedfrom operations is insufficient to satisfy our liquidity requirements, we mayrequire access to additional funds to support our business objectives through acredit facility or possibly the issuance of additional equity. There can be noassurance that additional financing will be available at all or that ifavailable, such financing will be obtainable on terms favorable to us and wouldnot be dilutive.

 

***Regulatory Uncertainties***

 

The market for our traditionalNorth American OSS products was created and has primarily been driven by theadoption of regulations under the Telecom Act requiring Regional Bell OperatingCompanies (“RBOCs”) to implement LNP as a condition to being permitted toprovide long distance services. Therefore, any changes to these regulations, orthe adoption of new regulations by federal or state regulatory authoritiesunder the Telecom Act, or any legal challenges to the Telecom Act, could hurtthe market for our products and services. For example, when the FCC delayedimplementation of the Telecom Act with respect to wireless carriers until November 2003,these delays had an impact on our revenue from our WNP products and services.Likewise, in mid-2001 when Verizon Wireless petitioned the FCC requestingforbearance from this requirement, we saw our wireless customers delay makingdecisions to purchase WNP products. WNP went into effect in November 2003.However, any invalidation, repeal or modification in the requirements imposedby the Telecom Act or the FCC, could materially harm our business, financialcondition and results of operations. In addition, customers may require, or wemay find it necessary or advisable, to modify our products or services toaddress actual or anticipated changes in regulations affecting our customers.This could also materially harm our business, financial condition, results ofoperations, and cash flows. Additionally, with our acquisition of Tertio, we are now subject tonumerous regulatory requirements of foreign jurisdictions.  Any compliance failures or changes in suchregulations could also materially harm our business, financial condition,results of operations and cash flows.

 

***Reliance on Significant Customers***

 

In the past, andcurrently, we earn a significant portion of our revenue from a small number ofcustomers in the communications industry. This has been mitigated somewhat bythe expansion of our customer base through our recent acquisitions. However,the loss of any significant customer, delays in delivery or acceptance of anyof our products by a customer, delays in the performance of services for acustomer, or delays in collection of customer receivables could be materiallyharmful to our business, financial condition, results of operations and cashflows.

 

***Integration of Tertio, TSE or Future Acquisitions***

 

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The integration of Tertioand TSE or future acquisitions may present risks and we may be unable toachieve the product, financial or strategic goals intended at the time of anyacquisition. The risks we may encounter in such transactions include:

 
| •   |   | we may have difficulty  assimilating the operations and personnel of the acquired company;                                                                                                                                                                                                                                                                                                                                                                           |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | we may have difficulty  effectively integrating the acquired technologies or products with our  current products and technologies;                                                                                                                                                                                                                                                                                                                                   |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | we may incur  unanticipated liabilities that are not covered by our indemnification rights  under the applicable acquisition agreements;                                                                                                                                                                                                                                                                                                                             |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | we may have difficulty  in maintaining controls, procedures and policies during the transition and  integration, as well as successfully completing in 2005 management’s  assessment of its internal controls over financial reporting as required by Section 404(a) of  the Sarbanes-Oxley Act and our independent registered public accounting firm’s  examination thereon as required by Section 404(b) of the  Sarbanes-Oxley Act; |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | customers of the  acquired company may decide not to renew their contracts with the combined  entity and other ongoing business may be disrupted by transition and  integration issues;                                                                                                                                                                                                                                                                              |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | we may not be  successful in cross-selling products between Evolving Systems’ and the  acquired companies’ customer bases;                                                                                                                                                                                                                                                                                                                                 |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | the financial and  strategic goals for the acquired and combined businesses may not be achieved;                                                                                                                                                                                                                                                                                                                                                                     |
| * * |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | due diligence processes  may have failed to identify significant issues with product quality,  intellectual property ownership, product architecture, legal and financial  contingencies, and product development;                                                                                                                                                                                                                                                   |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | significant impairment  charges may be recorded if intangible assets, including goodwill, acquired in  business combinations are determined to be unrecoverable or impaired;                                                                                                                                                                                                                                                                                         |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | acquisitions and their  subsequent integration require considerable time and commitment of  management, which can distract management from day-to-day operations and  result in additional costs which reduce profits;                                                                                                                                                                                                                                               |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | we do not know if we  have or will be able to identify and purchase assets and/or companies that  will complement our business;                                                                                                                                                                                                                                                                                                                                      |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | our stockholders may  experience additional dilution of their interests in Evolving Systems as a  result of the issuance of convertible preferred stock, other convertible  instruments and/or common stock in connection with our acquisitions;                                                                                                                                                                                                                     |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | certain management and  other employees of Tertio and TSE, or future acquisitions, may be critical to  the success of the acquired company, and we do not know if we will be  successful in retaining these individuals in the combined companies; and                                                                                                                                                                                                               |
|     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| •   |   | the price of our stock  may go down as stockholders who received stock in the CMS transaction, and  those receiving stock in connection with the Tertio transaction, or any  future transaction, elect to sell their shares, or the marketplace does not  favorably view the transaction.                                                                                                                                                                            |

 

Based on all of theforegoing, we believe it is possible for future revenue, expenses and operatingresults to vary significantly from quarter to quarter and year to year. As aresult, quarter-to-quarter and year-to-year comparisons of operating resultsare not necessarily meaningful or indicative of future performance.

 

***Lengthy Implementation Process; Customer Acceptance of Our Solutions,Risk of Software Defects***

 

Implementing oursolutions can be a relatively complex and lengthy process since we typicallycustomize these solutions for each customer’s unique environment. Often ourcustomers may also require rapid deployment of our software solutions,resulting in pressure on us to meet demanding delivery and implementationschedules. Delays in implementation may result in customer dissatisfactionand/or damage our reputation. This could materially harm our business,financial condition, results of operations and cash flows.

 

The majority of ourexisting contracts provide for acceptance testing by the customer, which can bea lengthy process. Unanticipated difficulties or delays in the customeracceptance process could result in higher costs, delayed payments, and deferralof

 

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revenue recognition. Inaddition, if our software contains defects or we otherwise fail to satisfyacceptance criteria within prescribed times, the customer may be entitled tocancel its contract and receive a refund of all or a portion of amounts paid orother amounts as damages, which could exceed related contract revenue and whichcould result in a future charge to earnings. Any failure or delay in achievingfinal acceptance of our software and services could have a material harmful effecton our business, financial condition, results of operations and cash flows.

 

***Lengthy Sales Cycle***

 

Large communicationssolutions used for enterprise-wide, mission-critical purposes, involvesignificant capital expenditures and lengthy implementation plans. Prospectivecustomers typically commit significant resources to the technical evaluation ofour products and services and require us to spend substantial time, effort andmoney providing education regarding our solutions. This evaluation process oftenresults in an extensive and lengthy sales cycle, typically ranging betweenthree and twelve months, making it difficult for us to forecast the timing andmagnitude of sales contracts. For example, customers’ budgetary constraints andinternal acceptance reviews may cause potential customers to delay or forego apurchase. The delay or failure to complete one or more large contracts couldmaterially harm our business, financial condition, results of operations andcash flows and cause our operating results to vary significantly from quarterto quarter and year to year.

 

***Consolidations and Budget Cutbacks in the Industry***

 

The U.S. communicationsindustry has recently experienced significant reorganization and consolidation.This may continue.  Mergers and acquisitionsof large communications companies, as well as the formation of new alliances,have resulted in a constantly changing marketplace for our products andservices. Delays associated with these changes are common. These consolidationshave caused us to lose customers and it is possible that we could loseadditional customers as a result of more consolidations. In addition, due to amajor downturn in the U.S. communications industry which began in the secondhalf of 2000 (and continues to the present), many of the companies in thecommunications industry reduced their capital expenditures in response tochanges in the communications marketplace; some companies have declaredbankruptcy, cancelled contracts, delayed payments to their suppliers or delayedadditional purchases.  The delay orfailure to complete one or more large contracts, or the loss of a significantcustomer, could materially harm our business, financial condition, results ofoperations, or cash flows, and cause our operating results to vary significantlyfrom quarter to quarter and year to year.

 

***Fixed-Price Contracts***

 

Currently, a largeportion of our revenue is from contracts that are on a fixed-price basis. Weanticipate that customers will continue to request we provide software andintegration services as a total solution on a fixed-price basis. Thesecontracts specify certain obligations and deliverables we must meet regardlessof the actual costs we incur. Projects done on a fixed-price basis are subjectto budget overruns. On occasion, we have experienced budget overruns, resultingin lower than anticipated margins. We can give no assurance we will not incursimilar budget overruns in the future, including overruns that result in losseson these contracts. If we incur budget overruns, our margins and results ofoperations may be materially harmed.

 

***Rapid Technological Change; Risks Associated with New Versions and NewProducts***

 

The market for ourproducts and services is subject to rapid technological changes, evolvingindustry standards, changes in carrier requirements and preferences andfrequent new product introductions and enhancements. The introduction ofproducts that incorporate new technologies and the emergence of new industrystandards can make existing products obsolete and unmarketable. To competesuccessfully, we must continue to design, develop and sell enhancements toexisting products and new products that provide higher levels of performanceand reliability in a timely manner, take advantage of technological advancementsand changes in industry standards and respond to new customer requirements. Asa result of the complexities inherent in software development, major newproduct enhancements and new products can require long development and testingperiods before they are commercially released and delays in planned deliverydates may occur. There can be no assurance we will successfully identify newproduct opportunities or will achieve market acceptance of new products broughtto market. In addition, products developed by others may cause our products tobecome obsolete or noncompetitive. If we fail to anticipate or respondadequately to changes in technology and customer preferences, or if ourproducts do not perform satisfactorily, or if we have delays in product development,our business, financial condition, results of operations may be materiallyharmed.

 

***Mature Market for Number Portability Products***

 

The market for our numberportability products is mature in the U.S and we may not be able tosuccessfully identify new product opportunities in the U.S. or abroad orachieve market acceptance of new products brought to the market.  Although wireless number portability was onlyrecently mandated in the U.S., many of the wireless carriers selected solutionsfrom our competitors and it is unclear how many new opportunities there will bewith these carriers.  If we are unable toidentify new product opportunities in the U.S. or abroad, our business,financial condition, results of operations or cash flows could be materiallyharmed.

 

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***Risks Associated with Managing Expense***

 

We have taken steps toreduce our expenses, such as reductions in staff, closing of our satellitefacilities, reductions in employee benefits and general cost control measures.If, as a result of such cost reductions, we have not adequately responded tobalance expenses against revenue, or if our fixed costs cannot be reducedenough, our financial condition could be materially harmed. Likewise, cutbacksin staff may have an impact on our ability to generate future revenue.

 

***Risks Associated with Offshore Development***

 

In February 2004, weformed Evolving Systems India, a wholly owned subsidiary of Evolving Systems,to transfer the services provided by our Indian subcontractor, Infosys, toEvolving Systems India.  If EvolvingSystems India fails to provide quality software in a timely fashion, this couldnegatively affect our ability to satisfy our customer contracts.  Furthermore, political changes anduncertainties in India could negatively impact the business climate there.  As a result, we may be unable tosatisfactorily perform our customer contracts and our business, financialcondition and results of operations could be materially harmed.

 

***Competition***

 

Our primary markets areintensely competitive and are subject to rapid technological changes, evolvingindustry standards and regulatory developments. We face continuous demand forimproved product performance, new product features and reduced prices, as well asintense pressure to accelerate the release of new products and productenhancements. Our existing and potential competitors include many largedomestic and international companies, including some competitors that havesubstantially greater financial, manufacturing, technological, marketing,distribution and other resources, larger installed customer bases andlonger-standing relationships with customers than we do. Our principalcompetitors in the LNP and WNP market include Telcordia Technologies, Inc.,Syniverse Technologies and Tekelec. Our principal competitors in activation areMetasolv and Comptel. In mediation, we compete with many different companieswith no single dominant competitor. There also can be no assurance thatcustomers will not offer competitive products or services in the future sincecustomers who have purchased solutions from us are not precluded from competingwith us. Many telecommunications companies have large internal developmentorganizations, which develop software solutions and provide services similar tothe products and services we provide. We also expect competition may increasein the future from Application Service Providers, existing competitors and fromother companies that may enter our existing or future markets with solutionswhich may be less costly, provide higher performance or additional features orbe introduced earlier than our solutions.

 

We believe that ourability to compete successfully depends on numerous factors. For example, thefollowing factors affect our ability to compete successfully:

 

•                  howwell we respond to our customers’ needs;

 

•                  thequality and reliability of our products and services and our competitors’products and services;

 

•                  theprice for our products and services, as well as the price for our competitors’products and services;

 

•                  howwell we manage our projects;

 

•                  ourtechnical subject matter expertise;

 

•                  thequality of our customer service and support;

 

•                  theemergence of new industry standards;

 

•                  thedevelopment of technical innovations;

 

•                  ourability to attract and retain qualified personnel;

 

•                  regulatorychanges; and

 

•                  generalmarket and economic conditions.

 

Some of these factors arewithin our control, and others are not. A variety of potential actions by ourcompetitors, including a reduction of product prices or increased promotion,announcement or accelerated introduction of new or enhanced products, orcooperative relationships among competitors and their strategic partners, couldharm our business, financial condition, results of operations and cash flows.There can be no assurance that we will be able to compete successfully withexisting or new competitors or that we will properly identify and address thedemands of new markets. This is particularly true in new markets where standardsare not yet established. Our failure to adapt to emerging market demands,respond to regulatory and technological changes or compete

 

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successfully withexisting and new competitors would materially harm our business, financialcondition, results of operations and cash flows.

 

***Risks Associated with Recruiting and Retaining Personnel***

 

Our ability to managefuture expansion, if any, effectively will require us to attract, train,motivate and manage new employees successfully, to integrate new management andemployees into our overall operations and to continue to improve ouroperations, financial and management systems. There can be no assurance that wewill be able to retain personnel or to hire additional personnel on a timelybasis, if at all. Because of the complexity of our software solutions, asignificant time lag exists between the hiring date of technical and salespersonnel and the time when they become fully productive. We have at times experienceddifficulty in recruiting and retaining such personnel. In addition, our stockoption plan terminates on January 19, 2006 and under Nasdaq rules wewill be required to obtain stockholder approval to establish a new equitycompensation plan. If we are unsuccessful in obtaining this approval, ourability to attract or retain employee may be harmed. Our failure to retainpersonnel or to hire qualified personnel on a timely basis could materiallyharm our business, financial condition, results of operations and cash flows.

 

***Product Liability***

 

Our agreements with ourcustomers typically contain provisions designed to limit our exposure topotential liability for damages arising out of the use of or defects in ourproducts. These limitations, however, tend to vary from customer to customerand it is possible that these limitations of liability provisions may not beeffective. We currently have errors and omissions insurance, which, subject tocustomary exclusions, covers claims resulting from failure of our softwareproducts or services to perform the function or to serve the purpose intended.To the extent that any successful product liability claim is not covered bythis insurance, we may be required to pay for a claim. This could be expensive,particularly since our software products may be used in critical businessapplications. Defending such a suit, regardless of its merits, could beexpensive and require the time and attention of key management personnel,either of which could materially harm our business, financial condition andresults of operations. In addition, our business reputation could be harmed byproduct liability claims, regardless of their merit or the eventual outcome ofthese claims.

 

***Protection of Intellectual Property***

 

Our success and abilityto compete are dependent to a significant degree on our proprietary technology.We rely on a combination of patent, copyright, trademark and trade secret laws,as well as confidentiality agreements and licensing arrangements, to establishand protect our proprietary rights. We have U.S. patents on elements of our LNPproducts, ***NumberManager®*** and ***OrderPath®***, and elements of ourOmniPresenceServer application and have applied for patent protection onvarious other elements of our ***OmniPresenceServer***TM application and our ServiceXpressTest Harness application. In addition, we have registered or filed forregistration of certain of our trademarks. Despite these precautions, it may bepossible for a third party to copy or otherwise obtain and use our products ortechnology without authorization or to develop similar technology independentlythrough reverse engineering or other means. In addition, the laws of someforeign countries may not adequately protect our proprietary rights. There canbe no assurance that our means of protecting our proprietary rights in the U.S.or abroad will be adequate or that others will not independently developtechnologies that are similar or superior to our technology, duplicate ourtechnology or design around any of our patents.

 

***Risks of Infringement***

 

It is also possible thatour business activities may infringe upon the proprietary rights of others, orthat other parties may assert infringement claims against us. If we becomeliable to any third party for infringing its intellectual property rights, wecould be required to pay substantial damage awards and to developnon-infringing technology, obtain licenses, or to cease selling theapplications that contain the infringing intellectual property. Litigation issubject to inherent uncertainties, and any outcome unfavorable to us couldmaterially harm our business. Furthermore, we could incur substantial costs indefending against any intellectual property litigation, and these costs couldincrease significantly if any dispute were to go to trial. Our defense of anylitigation, regardless of the merits of the complaint, likely would betime-consuming, costly, and a distraction to our management personnel. Adversepublicity related to any intellectual property litigation also could harm thesale of our products and damage our competitive position.

 

Certainsoftware developed or used by Evolving Systems, as well as certain softwareacquired in our acquisitions of TSE or Tertio, may include or be derived fromsoftware that is made available under an open source software license.

 

•                  Such open source software may be madeavailable under a license such as the GNU General Public License (“GPL”) or GNULesser General Public License (“LGPL”) which imposes certain obligations on usin the event we were to distribute derivative works based on the open sourcesoftware.  These obligations may requireus to make source code for these derivative works available to the public orlicense the derivative works under a particular type of open source softwarelicense, rather than the license terms we customarily use to protect oursoftware.

 

•                  There is little or no legal precedentfor interpreting the terms of certain of these open source licenses, includingthe terms addressing the extent to which a derivative work based on open sourcesoftware may be subject to these licenses. We

 

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believe we have complied with our obligations underthe various applicable open source licenses. However, if the owner of any open source software were to successfullyestablish that we had not complied with the terms of an open source license fora particular derivative work based on that open source software, we may beforced to release the source code for that derivative work to the public orcease distribution of that work.

 

•                  We generally prohibit the combinationof our proprietary software with open source software.  Despite these restrictions, parties maycombine our proprietary software with open source software without ourauthorization, in which case such parties could be forced to release to thepublic the source code of our proprietary software.

 

***InternationalTerrorism***

 

The continued threat ofterrorism within the U.S. and throughout the world and acts of war may causesignificant disruption to commerce throughout the world. Our business andresults of operations could be materially and adversely affected to the extentthat such disruptions result in delays or cancellations of customer orders,delays in collecting cash, a general decrease in corporate spending oninformation technology, or our inability to effectively market, manufacture orship our products. We are unable to predict whether war and the threat ofterrorism or the responses thereto will result in any long-term commercialdisruptions or if such activities or responses will have any long-term materialadverse effect on our business, results of operations, financial condition orcash flows.

 

***Possible Volatility of Stock Price***

 

Thetrading price of our common stock has been subject to wide fluctuations inresponse to quarterly variations in operating results, announcements oftechnological innovations or new products by us or our competitors, merger andacquisition activity, changes in financial estimates by securities analysts,the operating and stock price performance of other companies that investors maydeem comparable to us, general stock market and economic considerations andother events or factors. This may continue in the future.

 

Inaddition, the stock market has experienced volatility that has particularlyaffected the market prices of stock of many technology companies and often hasbeen unrelated to the operating performance of these companies. These broadmarket fluctuations may negatively impact the trading price of our commonstock. As a result of the foregoing factors, we cannot assure our investorsthat our common stock will trade at or higher than its current price.

 

***Effects of Future Sales of Our Common Stockin the Public Market***

 

If ourstockholders sell substantial amounts of our common stock in the public market,the market price of our common stock could fall. The perception among investorsthat such sales will occur could also produce this effect. These factors alsocould make it more difficult to raise funds through future offerings of commonstock.

 

***Reporting Requirements***

 

Becauseour common stock is publicly traded, we are subject to certain rules andregulations of federal, state and financial market exchange entities chargedwith the protection of investors and the oversight companies whose securitiesare publicly traded.  These entities,including the Public Company Accounting Oversight Board, the SEC and theNasdaq, have recently issued new requirements and regulations and are currentlydeveloping additional regulations and requirements in response to recent lawsenacted by Congress, most notably the Sarbanes-Oxley Act of 2002.  Our compliance with certain of these rules,such as Section 404 of the Sarbanes-Oxley Act, is likely to require thecommitment of significant and managerial resources. We are currently reviewingour material internal control systems, processes and procedures in compliancewith the requirements of Section 404. There can be no assurance that such a review will not result in theidentification of significant deficiencies or material weaknesses in ourinternal controls.

 

***We Have Never PaidCash Dividends***

 

Wehave never paid cash dividends on our common stock. We currently intend toretain all future earnings, if any, for use in the operation of our business.In addition, the notes issued in connection with the Tertio acquisitionprohibit us from declaring dividends to our common stockholders during the termof the notes. Accordingly, we do not anticipate paying cash dividends on ourcommon stock in the foreseeable future.

 

***Certain Anti-Takeover Provisions***

 

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Ourrestated certificate of incorporation allows our board of directors to issue upto 2,000,000 shares of preferred stock and to determine the price, rights,preferences and privileges of those shares without any further vote or actionby our stockholders. The rights of the holders of our common stock will besubject to, and may be adversely affected by, the rights of the holders of anypreferred stock that may be issued in the future. Issuance of preferred stock,while providing desired flexibility in connection with possible acquisitionsand other corporate purposes, could make it more difficult for a third party toacquire a majority of our outstanding voting stock. In 1999, our Board ofdirectors designated 250,000 shares of Series A Junior ParticipatingPreferred Stock that contain “poison pill” provisions. In connection with theTertio acquisition, we issued 966,666 shares of Series B Preferred Stock.We have no current plans to issue additional shares of preferred stock.

 

Inaddition, we are subject to the anti-takeover provisions of Section 203 ofDelaware General Corporation Law, which prohibit us from engaging in a “businesscombination” with an “interested stockholder” for a period of three yearsafter the date of the transaction in which the person became an interestedstockholder, unless the business combination is approved in the prescribedmanner. The application of Section 203 and certain provisions of ourrestated certificate of incorporation, including a classified board ofdirectors, may have the effect of delaying or preventing changes in control ofour management, which could adversely affect the market price of our commonstock by discouraging or preventing takeover attempts that might result in thepayment of a premium price to our stockholders.

 

Basedon all of the foregoing, we believe it is possible for future revenue, expensesand operating results to vary significantly from quarter to quarter. As aresult, quarter-to-quarter comparisons of operating results are not necessarilymeaningful or indicative of future performance. Furthermore, we believe that itis possible that in any given quarter, including the current quarter, ouroperating results could differ from the expectations of public market analystsor investors. In such event, or in the event that adverse conditions prevail,or are perceived to prevail, with respect to our business or generally, themarket price of our common stock would likely go down.

 

ITEM  3.  QUANTITATIVE ANDQUALITATIVE MARKET RISK DISCLOSURES

 

**ForeignExchange Risk**

 

In theordinary course of business, we are exposed to certain market risks, includingchanges in foreign currency exchange rates and interest rates. Uncertaintiesthat are either non-financial or non-quantifiable such as political, economic,tax, other regulatory, or credit risks are not included in the followingassessment of market risks.

 

Wetransact business in various foreign currencies. As we continue to expand ourinternational business, we are subject to increasing exposure from adversemovements in foreign exchange rates. At the present time, we do not hedge ourforeign currency exposure, nor do we use derivative financial instruments forspeculative trading purposes.

 

**InterestRate Risk**

 

In theordinary course of business we are exposed to the risk of changes in interestrates.  Our cash balances are subject tointerest rate fluctuations and as such, interest income amounts may fluctuatefrom current levels.

 

Foradditional information about Evolving Systems’ risk factors see EvolvingSystems’ Annual Report on Form 10-K for the year ended December 31,2004.

 

ITEM 4.  CONTROLSAND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures. As of March 31, 2005, the end of the period covered by this report, we evaluated, under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.

 

(b) Changes in internal controls. During the period covered by this report, there were no significant changes in our internal

controls or in other factors that could significantly affect our internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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**PART II.  OTHER INFORMATION**

 

ITEM 1. LEGAL PROCEEDINGS

 

Fromtime to time we are involved in various legal proceedings arising in the normalcourse of business operations.               We are currently not aware of any legalproceedings that would have a material effect on our business, financialcondition or results of operations.

 

ITEM 2. CHANGES IN SECURITIES

 

None

 

ITEM 3. DEFAULTS ON SENIORSECURITIES

 

None

 

ITEM 4. SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS

 

None

 

ITEM 5. OTHER INFORMATION

 

As wereported on our Form 8-K filed on May 3, 2005, Evolving SystemsLimited, a wholly-owned subsidiary of Evolving Systems Holdings Limited, whichis our wholly-owned subsidiary, entered into a lease agreement (the “Lease”)with Balfour Beatty PLC on March 30, 2005 for office space in London,England.  A copy of the Lease is attached hereto as Exhibit 10.1.

 

ITEM 6. EXHIBITS

 

(a)          Exhibits

 

Exhibit 10.1 – Lease agreement dated as of March 30,2005, by and between Evolving Systems Limited and Balfour Beatty PLC

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: May 16,  2005 | /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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