**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 
| **ý** | ** ** | **Quarterly Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934** |
|------------|------------|---------------------------------------------------------------------------------------------------|

 

**For the quarterly period endedJune 30, 2004**

 

**OR**

** **
| **o** | ** ** | **Transition Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom         to         **

 

**Commission File Number: 0-24081**

 

**EVOLVINGSYSTEMS, INC.**

(Exactname of registrant as specified in its charter)

** **

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

 

**(303) 802-1000**

(Registrant’stelephone number)

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days.  Yes ý No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o No ý

 

As of August 3, 2004 there were 15,962,461shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

 

 

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**EVOLVING SYSTEMS, INC.****Quarterly Report on Form 10-Q****June 30, 2004****Table of Contents**

 
| **PART I**                                                                                                   | **FINANCIAL INFORMATION** |   |
|--------------------------------------------------------------------------------------------------------------|---------------------------|--------|
|                                                                                                         |                      |
| Item 1. Financial Statements                                                                                 |                      |
|                                                                                                         |                      |
| Consolidated Balance Sheets (Unaudited) as of June 30, 2004 and  December 31, 2003                           |                      |
|                                                                                                         |                      |
| Consolidated Statements of Operations  (Unaudited) for the Three and Six Months Ended June 30, 2004 and 2003 |                      |
|                                                                                                         |                      |
| Consolidated Statements of Cash Flows  (Unaudited) for the Six Months Ended June 30, 2004 and 2003           |                      |
|                                                                                                         |                      |
| 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 on Senior Securities                                                                        |                      |
|                                                                                                         |                      |
| Item 4. Submission of Matters to a Vote of  Security Holders                                                 |                      |
|                                                                                                         |                      |
| Item 5. Other Information                                                                                    |                      |
|                                                                                                         |                      |
| Item 6.  Exhibits and Reports on Form 8-K                                                                    |                      |
|                                                                                                         |                      |
| Signature                                                                                                    |                      |

 

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PART I.  FINANCIAL INFORMATION

 

ITEM 1.  FINANCIALSTATEMENTS

 

**EVOLVING SYSTEMS, INC.CONSOLIDATED BALANCE SHEETS(in thousands except share and per share data)(unaudited)**

 
| ** **                                                                                                                                                                      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                                      |       |               |       |                   |       |
| Current assets:                                                                                                                                                                 |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                       |       | $                  | 22,462     |                   | $          | 17,999 |   |
| Current portion of restricted cash                                                                                                                                              |       | 100                |       | 100                    |       |
| Contract receivables, net of allowance of  $44 and $65 at June 30, 2004 and December 31, 2003, respectively                                                                     |       | 2,570              |       | 9,292                  |       |
| Unbilled work-in-progress                                                                                                                                                       |       | 16                 |       | 622                    |       |
| Prepaid and other current assets                                                                                                                                                |       | 1,216              |       | 868                    |       |
| Total current assets                                                                                                                                                            |       | 26,364             |       | 28,881                 |       |
| Property and equipment, net                                                                                                                                                     |       | 1,791              |       | 1,579                  |       |
| Intangible assets, net                                                                                                                                                          |       | 3,413              |       | 3,845                  |       |
| Goodwill                                                                                                                                                                        |       | 6,955              |       | 6,996                  |       |
| Long-term restricted cash                                                                                                                                                       |       | 400                |       | 400                    |       |
| Total assets                                                                                                                                                                    |       | $                  | 38,923     |                   | $          | 41,701 |   |
|                                                                                                                                                                            |       |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |               |       |                   |       |
| Current liabilities:                                                                                                                                                            |       |               |       |                   |       |
| Current portion of long-term obligations                                                                                                                                        |       | $                  | 30         |                   | $          | 29 |   |
| Accounts payable and accrued liabilities                                                                                                                                        |       | 2,379              |       | 3,044                  |       |
| Unearned revenue                                                                                                                                                                |       | 9,483              |       | 11,972                 |       |
| Total current liabilities                                                                                                                                                       |       | 11,892             |       | 15,045                 |       |
| Long-term obligations                                                                                                                                                           |       | 149                |       | 183                    |       |
| Total liabilities                                                                                                                                                               |       | 12,041             |       | 15,228                 |       |
| Commitments and contingencies                                                                                                                                                   |       |               |       |                   |       |
| Stockholders’ equity:                                                                                                                                                      |       |               |       |                   |       |
| Common stock, $0.001 par value; 25,000,000  shares authorized; 15,952,503 and 15,778,540 shares issued and outstanding as  of June 30, 2004 and December 31, 2003, respectively |       | 16                 |       | 16                     |       |
| Additional paid-in capital                                                                                                                                                      |       | 67,682             |       | 67,342                 |       |
| Other comprehensive loss                                                                                                                                                        |       | (7                 | )          | —                 |       |
| Accumulated deficit                                                                                                                                                             |       | (40,809            | )          | (40,885                | )          |
| Total stockholders’ equity                                                                                                                                                 |       | 26,882             |       | 26,473                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                 |       | $                  | 38,923     |                   | $          | 41,701 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

1

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**EVOLVING SYSTEMS, INC.CONSOLIDATED STATEMENTS OFOPERATIONS(in thousands except per share data)(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUE**                                                 |       |                            |       |                          |       |   |   |   |   |
| License fees and services                                   |       | $                               | 2,383      |                          | $          | 3,181 |   | $ | 5,602 |   | $ | 8,185 |   |
| Customer support                                            |       | 2,878                           |       | 3,258                         |       | 5,425 |   | 6,845 |   |
| Total revenue                                               |       | 5,261                           |       | 6,439                         |       | 11,027 |   | 15,030 |   |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                 |       |                            |       |                          |       |   |   |   |   |
| Costs of license fees and services,  excluding depreciation |       | 1,134                           |       | 1,288                         |       | 2,211 |   | 3,181 |   |
| Costs of customer support, excluding  depreciation          |       | 2,021                           |       | 1,667                         |       | 3,895 |   | 2,974 |   |
| Sales and marketing                                         |       | 901                             |       | 720                           |       | 1,837 |   | 1,425 |   |
| General and administrative                                  |       | 934                             |       | 935                           |       | 1,869 |   | 1,851 |   |
| Product development                                         |       | 241                             |       | 380                           |       | 732 |   | 656 |   |
| Depreciation                                                |       | 265                             |       | 319                           |       | 539 |   | 649 |   |
| Restructuring and other expenses (benefit)                  |       | —                          |       | (80                           | )          | — |   | 38 |   |
| Total costs of revenue and operating  expenses              |       | 5,496                           |       | 5,229                         |       | 11,083 |   | 10,774 |   |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| Income (loss) from operations                               |       | (235                            | )          | 1,210                         |       | (56 | ) | 4,256 |   |
| Other income, net                                           |       | 67                              |       | 49                            |       | 124 |   | 96 |   |
| Income (loss) before income taxes                           |       | (168                            | )          | 1,259                         |       | 68 |   | 4,352 |   |
| Benefit from income taxes                                   |       | —                          |       | —                        |       | 8 |   | — |   |
| Net income (loss)                                           |       | $                               | (168       | )                             | $          | 1,259 |   | $ | 76 |   | $ | 4,352 |   |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| **Basic income (loss) per common share**                    |       | $                               | (0.01      | )                             | $          | 0.09 |   | $ | 0.00 |   | $ | 0.32 |   |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| **Diluted income (loss) per common share**                  |       | $                               | (0.01      | )                             | $          | 0.08 |   | $ | 0.00 |   | $ | 0.29 |   |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| Weighted average basic shares outstanding                   |       | 15,853                          |       | 13,884                        |       | 15,845 |   | 13,661 |   |
| Weighted average diluted shares outstanding                 |       | 15,853                          |       | 15,319                        |       | 17,590 |   | 14,888 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

2

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**EVOLVING SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)(unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          |       |                          |       |   |   |
| Net income                                                                         |       | $                             | 76         |   | $ | 4,352 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                          |       |   |   |
| Depreciation                                                                       |       | 539                           |       | 649 |   |
| Amortization of intangible assets                                                  |       | 432                           |       | — |   |
| Gain on disposal of property and equipment                                         |       | —                        |       | (4 | ) |
| Bad debt recovery                                                                  |       | (21                           | )          | (41 | ) |
| Change in operating assets and liabilities:                                        |       |                          |       |   |   |
| Contract receivables                                                               |       | 6,743                         |       | 8,126 |   |
| Unbilled work-in-progress                                                          |       | 606                           |       | 58 |   |
| Prepaid and other assets                                                           |       | (350                          | )          | (165 | ) |
| Accounts payable and accrued liabilities                                           |       | (665                          | )          | (1,098 | ) |
| Unearned revenue                                                                   |       | (2,490                        | )          | (4,451 | ) |
| Long-term obligations                                                              |       | (19                           | )          | 72 |   |
| Net cash provided by operating activities                                          |       | 4,851                         |       | 7,498 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |       |                          |       |   |   |
| Purchase of property and equipment                                                 |       | (756                          | )          | (192 | ) |
| Proceeds from sale of property and  equipment                                      |       | 3                             |       | 7 |   |
| Cash acquired in acquisition, net of cash  paid                                    |       | 41                            |       | — |   |
| Net cash used in investing activities                                              |       | (712                          | )          | (185 | ) |
|                                                                               |       |                          |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |       |                          |       |   |   |
| Capital lease payments                                                             |       | (14                           | )          | (17 | ) |
| Proceeds from the issuance of common stock                                         |       | 340                           |       | 851 |   |
| Net cash provided by financing activities                                          |       | 326                           |       | 834 |   |
|                                                                               |       |                          |       |   |   |
| **EFFECT OF EXCHANGE RATES ON CASH**                                               |       | (2                            | )          | — |   |
|                                                                               |       |                          |       |   |   |
| Net increase in cash and cash equivalents                                          |       | 4,463                         |       | 8,147 |   |
| Cash and cash equivalents at beginning of  period                                  |       | 17,999                        |       | 8,601 |   |
| Cash and cash equivalents at end of period                                         |       | $                             | 22,462     |   | $ | 16,748 |   |
|                                                                               |       |                          |       |   |   |
| Supplemental disclosure of other cash and  non-cash activities:                    |       |                          |       |   |   |
| Interest paid                                                                      |       | $                             | 7          |   | $ | 8 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

3

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**EVOLVINGSYSTEMS, INC.**

 

**NOTES TO UNAUDITED****CONSOLIDATED FINANCIALSTATEMENTS**

 

**(1)  Basis of Presentation**

 

*Interim Consolidated Financial Statements*. Theaccompanying consolidated financial statements of Evolving Systems, Inc.(“Evolving Systems” or the “Company”) have been prepared pursuant to the rulesand regulations 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 unauditedconsolidated financial statements included in this document have been preparedon the same basis as the annual consolidated financial statements, and inmanagement’s opinion, reflect all adjustments, which include normal recurringadjustments, necessary for a fair presentation in accordance with GAAP. Theresults for the three and six months ended June 30, 2004 arenot necessarily indicative of the results that the Company will have for anysubsequent quarter or full fiscal year. These consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements and the notes to thosestatements for the year ended December 31, 2003 including the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003.

 

*Use ofEstimates*. The preparation of financialstatements in conformity with GAAP requires the Company’s management to makeestimates and assumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. Actual results could differ from those estimates.

 

*ForeignCurrency Translation*. The rupee is thefunctional currency for the Company’s Indian subsidiary. The Company translatesasset and liability accounts to the U.S. dollar based on the exchange rateas of the balance sheet date, while statement of operations and cash flow statementamounts are translated to the U.S. dollar at the average exchange rate forthe period. Exchange gains or losses resulting from such translation areincluded as a separate component of stockholders’ equity. Transaction gains andlosses are recognized in income during the period in which they occur. Duringthe three and six months ended June 30, 2004, the Company recognized a nettransaction gain (loss) of approximately $1,000 and ($2,000), respectively.

 

*ComprehensiveIncome*. The Company’s comprehensive income(loss) is comprised of its net income (loss) and foreign currency translationadjustment.  For the three and six months ended June 30, 2004, totalcomprehensive income (loss) was ($177,000) and $69,000, respectively. For thethree and six months ended June 30, 2003, comprehensive income equaled netincome of $1.3 million and $4.4 million, respectively, as there were no foreigncurrency translation adjustments during the periods.

 

*Principlesof Consolidation*.  The consolidated financial statements include the accounts of theCompany and its subsidiaries.  Allsignificant intercompany transactions and balances have been eliminated.

 

*Revenue Recognition.***The Company derives revenue from two primarysources: license fees/services and customer support.  We recognize revenue in accordance withStatements of Position, or 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, or SAB, No. 104, “Revenue Recognition,” whichprovides further interpretive guidance for public companies on the recognition,presentation and disclosure of revenue in financial statements.

 

The majority of our license fees and servicesrevenue is generated from fixed-price contracts that provide for both licensesto our software products and services. Revenue under these arrangements, wherethe services are essential to the functionality of the delivered software, is recognizedusing the percentage-of-completion method of accounting, in accordance with SOP97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.” Thepercentage of completion for each contract is determined based on the ratio ofdirect labor hours incurred to total estimated direct labor hours. Due to thefact that the estimated direct labor hours can have a significant impact onrevenue recognition, these estimates are critical and are reviewed bymanagement regularly. Amounts billed in advance of services being performed arerecorded as unearned revenue. Unbilled work-in-progress represents revenueearned but not yet billable under the terms of the fixed-price contracts andall such amounts are expected to be billed and collected during the succeeding12 months.

 

In arrangements where the services are notessential to the functionality of the delivered software, we recognize licenserevenue when a license agreement has been signed, delivery has occurred, thefee is fixed or determinable and collectibility is reasonably assured. Whereapplicable, fees from multiple element arrangements are unbundled and recordedas revenue as the elements are delivered to the 

 

4

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extent that vendor specific objectiveevidence (“VSOE”) of fair value of the undelivered elements exists. If VSOE forthe undelivered elements does not exist, fees from such arrangements aredeferred until the earlier of the date that VSOE does exist on the undeliveredelements or all of the elements have been delivered.

 

Services revenue provided under fixed-pricecontracts is generally recognized using the percentage-of-completion method ofaccounting described above. Revenue from professional services providedpursuant to time-and-materials contracts and training services are recognizedas the services are performed.

 

Customer support and maintenance revenue isgenerally recognized ratably over the service contract period. When maintenanceor training services are bundled with the original license fee arrangement,their fair value, based upon VSOE, is deferred and recognized during theperiods such services are provided.

 

We may encounter budget and schedule overrunson fixed price contracts caused by increased material, labor or overhead costs.Adjustments to cost estimates are made in the periods in which the factsrequiring such revisions become known. Estimated losses, if any, are recordedin the period in which current estimates of total contract revenue and contractcosts indicate a loss.

 

**(2)  Earnings (Loss) Per CommonShare**

 

Basic earnings (loss) per common share (“EPS”)is computed by dividing net income (loss) by the weightedaverage number of common shares outstanding during the period. Diluted EPS iscomputed using the weighted average number of common shares plus all dilutivepotential common shares outstanding during the period using the treasury stockmethod unless the effect of the potential common shares is anti-dilutive.

 

Thereconciliation of basic and diluted weighted average common shares outstandingis as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **2004**                                              | ** ** | **2003**                        | **2004**   | ** **                    | **2003**   |
|                                                  |       |                            |       |                          |       |   |   |   |   |
| Basic weighted average common shares  outstanding     |       | 15,853                          |       | 13,884                        |       | 15,845 |   | 13,661 |   |
| Effect of dilutive securities - options and  warrants |       | —                          |       | 1,435                         |       | 1,745 |   | 1,227 |   |
| Diluted weighted average common shares  outstanding   |       | 15,853                          |       | 15,319                        |       | 17,590 |   | 14,888 |   |

 

Optionsto purchase 2.9 million shares of common stock were excluded from the dilutivestock calculation for the three months ended June 30, 2004 because, due to thenet loss for the period, they would have been anti-dilutive.  Options to purchase 393,000 shares of commonstock were excluded from the dilutive stock calculation for the six monthsended June 30, 2004 because their exercise prices were greater than the averagefair value of the Company’s stock for the period.

 

Optionsto purchase 23,000 and 247,000 shares of common stock were excluded from thedilutive common stock calculation for the three and six months ended June 30,2003, respectively, because their exercise prices were greater than the averagefair value of the Company’s stock for the period.

 

**(3)  Stock-Based Compensation**

 

The Company has elected to follow Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” or APB No. 25, and relatedinterpretations in accounting for its employee stock options.  Under APB No. 25, because the exercise priceof the Company’s employee stock options is generally equal to the market priceof the underlying stock on the date of the grant, no compensation expense isrecognized.  Statements of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation” or SFASNo. 123, establishes an alternative method of expense recognition forstock-based compensation awards to employees based on estimated fairvalues.  The Company elected not to adoptSFAS No. 123 for expense recognition purposes.

 

In accordance with the interim disclosure provisions of Statement ofFinancial Accounting Standards, or SFAS No. 148, “Accounting for Stock BasedCompensation Transition and Disclosure-an Amendment of SFAS No. 123,” the proforma effect on the Company’s net income (loss) had compensation expense beenrecorded for the three and six months ended June 30, 2004 and 2003,respectively, as determined under the fair value method, as prescribed in SFASNo. 123, is shown below (in thousands, except per share data);

 

5

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| ** **                                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **2004**                                                      | ** ** | **2003**                        | **2004**   | ** **                    | **2003**   |
|                                                          |       |                            |       |                          |       |   |   |   |   |
| Net income (loss) as reported                                 |       | $                               | (168       | )                             | $          | 1,259 |   | $ | 76 |   | $ | 4,352 |   |
| Stock based compensation expense under the  fair value method |       | (395                            | )          | (1,109                        | )          | (974 | ) | (1,176 | ) |
| Pro forma net income (loss)                                   |       | $                               | (563       | )                             | $          | 150 |   | $ | (898 | ) | $ | 3,176 |   |
| Net income (loss) per common share as  reported:              |       |                            |       |                          |       |   |   |   |   |
| Basic                                                         |       | $                               | (0.01      | )                             | $          | 0.09 |   | $ | — |   | $ | 0.32 |   |
| Diluted                                                       |       | $                               | (0.01      | )                             | $          | 0.08 |   | $ | — |   | $ | 0.29 |   |
| Pro forma net income (loss)                                   |       |                            |       |                          |       |   |   |   |   |
| Basic                                                         |       | $                               | (0.04      | )                             | $          | 0.01 |   | $ | (0.06 | ) | $ | 0.23 |   |
| Diluted                                                       |       | $                               | (0.04      | )                             | $          | 0.01 |   | $ | (0.06 | ) | $ | 0.21 |   |

 

**(4)  Concentration of Credit Risk**

 

For the three months ended June 30, 2004, the Companyrecognized 70% (20%, 16%, 13%, 11% and 10%) of total revenue from fivesignificant customers (defined as contributing at least 10%), all in thetelecommunications industry.  For thethree months ended June 30, 2003, the Company recognized 78% (27%, 24%, 15% and12%), respectively, of total revenue from four significant customers, all inthe telecommunications industry.

 

For the six months ended June 30, 2004 and 2003, theCompany recognized 68% (23%, 19%, 14% and 12%) and 75% (27%, 22%, 15% and 11%),respectively, of total revenue from four significant customers, all in thetelecommunications industry.

 

As of June 30, 2004, four significant customers accounted forapproximately 87% (26%, 24%, 22% and 15%) of contract receivables.  At December 31, 2003, three significantcustomers accounted for approximately 75% (34%, 29% and 12%) of contractreceivables.

 

**(5)  Income Taxes**

 

Asof June 30, 2004 and December 31, 2003, the Company continued to maintain a full valuation allowance on the balance of itsnet deferred tax asset due to the uncertainties related to the Company’s abilityto utilize its net deferred tax asset. The Company’s assessment of this valuation allowance was made using allavailable evidence, both positive and negative. In particular, the Companyconsidered both its historical results and its projections of profitability.  The Company’s realization of its recorded netdeferred tax assets is dependent on future taxable income and, therefore, theCompany is not assured that such benefits will be realized on a more likelythan not basis.

 

**(6)  Restructuring and Other Expenses**

 

In early 2002, management implemented arestructuring plan (the “Plan”) due to the downturn in the telecommunicationsindustry, the Company’s sharp decline in revenue, the FCC’s delay in ruling onwireless number portability and other factors. The Plan included workforce reductions, restructuring of the Company’sheadquarters building lease, the closure of its satellite field offices and thewrite down of certain fixed assets, all of which were executed in 2002. At June30, 2004 and December 31, 2003, the remaining accrual related to the closure ofthe satellite offices.

 

*Closureof satellite offices.*  The Company closed all of itssatellite field offices during 2002. Because the costs to sublease or terminate these lease commitments arebased on estimates, the Company may incur additional costs related to thesatellite office closures.  As of June30, 2004 approximately $100,000 was included in accounts payable and accruedliabilities, and approximately $29,000 was included in long-term obligations,related to the closure of the satellite offices.

 

The following table summarizes the change inthe accrual balance since December 31, 2003 (in thousands):

 

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| ** **                        | ** ** | **Closure of  Satellite  Offices** | ** ** |
|-----------------------------------|------------|------------------------------------|------------|
| Accrual balance December 31, 2003 |       | $                                  | 175        |   |
| 1st quarter cash payments, net    |       | (19                                | )          |
| Accrual balance March 31, 2004    |       | 156                                |       |
| 2nd quarter cash payments, net    |       | (27                                | )          |
| Accrual balance June 30, 2004     |       | $                                  | 129        |   |

 

**(7)  Segment Information**

 

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” the Company defines operating segments as components ofan enterprise for which separate financial information is available.  This information is reviewed regularly by thechief operating decision-maker, or decision-making group, to evaluateperformance and to make operating decisions. The Company has identified itsChief Executive Officer and Chief Financial Officer as its chief operatingdecision makers. These chief operating decision makers review revenues bysegment and review overall results of operations.

 

TheCompany currently operates its business as two operating segments based onrevenue type: license fees/services revenue and customer support revenue (asshown on the Consolidated Statements of Operations).  Licensefees and services revenue represents the fees received from the license ofsoftware products and those services directly related to the delivery of thelicensed products as well as custom development, integration services and timeand materials work.  Customer support revenue includes annual support fees, recurringmaintenance fees, fees for maintenance upgrades andwarranty fees.  Warranty fees aregenerally withheld from license fees and are recognized ratably over the warrantyperiod. The Company provides products and services solely within theUnited States geographic area, although it does have a product developmentfacility in Bangalore, India.  Totalassets by segment have not been specified because the information is notavailable to the chief operating decision-making group.

 

Revenueand costs of revenue information by segments are as follows (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenue**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                            |       |                          |       |   |   |   |   |
| License fees and services                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | $                               | 2,383      |                          | $          | 3,181 |   | $ | 5,602 |   | $ | 8,185 |   |
| Customer support                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | 2,878                           |       | 3,258                         |       | 5,425 |   | 6,845 |   |
|                                                                                   |       | $                               | 5,261      |                          | $          | 6,439 |   | $ | 11,027 |   | $ | 15,030 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       |                            |       |                          |       |   |   |   |   |
| **Segment profit, excluding depreciation**                                                                                                                                                                                                                                                                                                                                                                                                                                                             |       |                            |       |                          |       |   |   |   |   |
| License fees and services                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | $                               | 1,249      |                          | $          | 1,893 |   | $ | 3,391 |   | $ | 5,004 |   |
| Customer support                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | 857                             |       | 1,591                         |       | 1,530 |   | 3,871 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       | 2,106                           |       | 3,484                         |       | 4,921 |   | 8,875 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       |                            |       |                          |       |   |   |   |   |
| Other operating expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       | 2,076                           |       | 2,035                         |       | 4,438 |   | 3,932 |   |
| Depreciation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | 265                             |       | 319                           |       | 539 |   | 649 |   |
| Restructuring and other expense (benefit)                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | —                          |       | (80                           | )          | — |   | 38 |   |
| Income (loss) from operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       | $                               | (235       | )                             | $          | 1,210 |   | $ | (56 | ) | $ | 4,256 |   |

 

**(8)  Commitments and Contingencies**

 

As permitted under Delaware law, the Companyhas agreements with its officers and directors under which it agrees toindemnify them for certain events or occurrences while the officer or directoris, or was, serving at our request in this capacity.  The term of the indemnification period isindefinite.  There is no limit on theamount of future payments the Company could be required to make under theseindemnification agreements; however, it maintains Directors’ and Officers’insurance policies, as well as an Employment Practices Liability InsurancePolicy, that may enable it to recover a portion of any future amounts paid. Asa result of the Company’s insurance policy coverage, it believes the estimatedfair value of these indemnification agreements is minimal.  Accordingly, the Company has no liabilitiesrecorded for these agreements as of June 30, 2004.

 

The Company subcontracts some of thedevelopment of deliverables under its customer contracts and it could berequired to indemnify its customers for work performed by its subcontractors.Depending upon the nature of the customer indemnification, the potential amountof future payments the Company could be required to make under theseindemnification agreements may be unlimited. The Company may be able to recoverdamages from a subcontractor if the indemnification to its customers resultsfrom the subcontractor’s failure to perform. To the extent the Company isunable to recover damages from its subcontractors, it could be required 

 

7

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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.

 

TheCompany’s software arrangements generally include a product indemnificationprovision that will indemnify and defend a customer in actions brought againstthe customer 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, and as a result,does not maintain a reserve for such exposure.

 

The Company enters into standardindemnification terms with its customers in the ordinary course of businessunder which it agrees to indemnify its customers for certain claims arisingfrom performance under its contracts.  Asthese represent guarantees of its own performance, no liability has beenrecognized under FASB Interpretation (“FIN”) 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.”

 

**(9) Business Combination**

 

On November 3, 2003, the Company acquired allof the outstanding shares of privately-held CMS Communications, Inc. (“CMS”) ofColumbus, Ohio in exchange for 732,773 shares of Evolving Systems’ common stock. The acquisition was accounted for using the purchase method ofaccounting and accordingly, the assets acquired and liabilities assumed wererecorded at their respective fair values as of the acquisition date.  The results of CMS’ operations have beenincluded in the consolidated financial statements since the purchase date.

 

CMS was a provider of network managementoperations support software for major telecommunications carriers.  In addition to adding complementary productsand sharing many common customers, CMS brought a workforce that is familiarwith complex tier one telecommunications solutions.  CMS’ network management products fit theCompany’s solutions business model and provide the Company with additionalopportunities to provide solutions to its tier one customers.

 

The aggregate purchase price of approximately$11.2 million included the issuance of 732,773 shares of Evolving Systems, Inc.common stock in exchange for all outstanding shares of CMS.  The fair value of Evolving Systems’ commonstock was determined using an average price of approximately $14.98 inaccordance with EITF 99-12, “Determination of the Measurement Date for theMarket Price of Acquirer Securities Issued in a Purchase Business Combination,”which was the average closing price a few days before and after the mergeragreement.

 

**Pro FormaFinancial Information**

 

Thefinancial information in the table below summarizes the combined results ofoperations of Evolving Systems and CMS, on a pro forma basis, as though thecompanies had been combined as of the beginning of the period presentedbelow.  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 the acquisitionactually taken place as of the beginning of the period presented below.  The following amounts are in thousands,except per share amounts.

 

 
| ** **                                  | ** ** | **Three Months  Ended June 30,  2003** | ** ** | **Six Months Ended  June 30,  2003** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| Revenue                                     |       | $                                      | 7,191      |                                 | $          | 16,764 |   |
| Net income                                  |       | $                                      | 1,101      |                                 | $          | 4,205 |   |
|                                        |       |                                   |       |                                 |       |
| Weighted average basic shares outstanding   |       | 14,617                                 |       | 14,394                               |       |
| Weighted average diluted shares outstanding |       | 16,052                                 |       | 15,621                               |       |
|                                        |       |                                   |       |                                 |       |
| Basic income per share                      |       | $                                      | 0.08       |                                 | $          | 0.29 |   |
| Diluted income per share                    |       | $                                      | 0.07       |                                 | $          | 0.27 |   |

 

**(10)  Goodwill**

 

During 2003,the Company acquired goodwill and intangible assets as a result of itsacquisition of CMS.  Amortization of identifiable intangibles isexpensed as “costs of license fees and services, excluding depreciation” and“costs of customer support, excluding depreciation”. As of June 30, 2004 goodwill was $7.0 million and in accordance with SFASNo. 142, will not be amortized but is subject to an annual impairment test toensure that an impairment of the carrying amount of the goodwill has notoccurred.  The 

 

8

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goodwill is assessed forimpairment on an annual basis at the reporting unit level by applying afair-value-based test. The Company’s annual impairment test is conducted in itsthird fiscal quarter. Additionally, goodwill is assessed for impairment at eachreporting period end if certain events have occurred indicating that an impairment may have occured. Goodwill was reduced by$41,000 during the six months ended June 30, 2004, due primarily todistribution of the cash escrow account to the Company in accordance with theacquisition agreement with CMS.

 

ITEM 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

*This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements that have been made pursuant to the provisions of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations,estimates, and projections about Evolving Systems’ industry, management’sbeliefs, and certain assumptions made by management.  Forward-looking statements include ourexpectations regarding product, services, and maintenance revenue, annualsavings associated with the organizational changes effected in prior years, andshort- and long-term cash needs.  In some cases, words such as “anticipates”,expects”, “intends”, “plans”, “believes”, “estimates”, variations of thesewords, and similar expressions are intended to identify forward-lookingstatements.  The statements are notguarantees of future performance and are subject to certain risks,uncertainties, and assumptions that are difficult to predict; therefore, actualresults may differ materially from those expressed or forecasted in anyforward-looking statements.  Risks anduncertainties of our business include those set forth in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003 under “Risk Factors” onpages 8 through 13 as well as additional risks described in this Form10-Q.  Unless required by law, weundertake no obligation to update publicly any forward-looking statements,whether as a result of new information, future events, or otherwise.  However, readers should carefully review 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 and cost-effective software solutionsto tier one telecommunications companies. We maintain long-standingrelationships with many of the largest wireline and wireless telecommunicationsproviders in the United States. Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, highly reliable software solutions fora range of Operations Support Systems (OSS) and Network Support Systems (NSS).Our customers include four of the largest wireline carriers in North America,representing approximately 90 percent of U.S. access lines, and four wirelesscarriers, representing more than 20 percent of U.S. wireless subscribers. Weoffer software products and solutions that enable our customers to comply withgovernment-mandated requirements regarding local number portability (LNP) forwireline, and wireless number portability (WNP). We also offer inventory andassignment software which supports carriers’ compliance with the governmentphone number conservation mandates. In addition, we offer a variety of networkassurance and fulfillment solutions that were added to our portfolio when weacquired CMS Communications Inc. (“CMS”) in November 2003. We are uniquely positionedas a provider of both OSS, NSS and comprehensivesystems integration capabilities because these complementary competenciesenable us to address and implement solutions across a customer’sinfrastructure.

 

Founded in 1985, we initially focused on providingcustom software development and professional services to a limited number oftelecommunications companies. In 1996, concurrent with the passage of theTelecommunications Act of 1996 (the Telecom Act), we made a strategic decisionto add software products to our established professional services offerings.Since that time we have built and acquired a strong product portfolio thatincludes, but is not limited to, LNP and WNP OSS software that enables carriersto meet Federal Communications Commission (FCC) requirements that consumers bepermitted to retain their phone numbers when changing service providers; numberinventory and conservation software that addresses FCC mandates to extend thelife of the North American Numbering Plan; and a solution for collectingtraffic data off of network elements which supports both service assurancerequirements and network planning activities. Number portability is mandatedand implemented for U.S. wireline carriers today and was implemented by allU.S. wireless carriers for top-tier markets on November 24, 2003, with allremaining markets implemented on May 24, 2004. Number conservation, or number pooling, has been mandatory for all U.S.carriers since November 2002, and is implemented for both U.S. wireline and wirelesscarriers today.

 

Historically, we have helped our customersintegrate our products into their existing OSS environments. In 2002, weinitiated a restructuring plan, which, in addition to significant operationalcost reductions and greater leverage of offshore development, included thereengineering of our business model to a solutions strategy.  The solutions business model reflects a morebalanced mix of services and products, as well as integration and productenhancements for our customers’ back office to meet the specific requirementsof each customer. Solutions which include our intellectual property andextensions, enhancements and integration are typically licensed to our 

 

9

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customers and supported by us. We branded the integrationand development methodology that supports our new business strategy **ServiceXpress**TM.

 

***ServiceXpress* Strategy**

 

Our ***ServiceXpress*** strategy is a solutions modelthat focuses on providing our customers with high quality solutions that meettheir specific needs, as quickly as feasible, at the lowest possible price. Wework with our customers using our domain knowledge to identify precisely whatthey want. We minimize the cost and maximize the speed of delivery by using low-costoffshore development, incorporating our products and ***ServiceXpress*** toolsinto the solution, as well as third party products and tools. We also provideefficient lifecycle support. We achieve high quality by following our ***ServiceXpress***methodology that defines a repeatable process for developing, delivering andsupporting high quality solutions. Most of our solutions are provided for afixed price which allows our customers to benefit from the savings we achievewhile providing us with what we think is a fair margin. We strive to be apremier low-cost provider of high-quality, mission-critical software solutionsfor wireline and wireless telecommunications carriers.

 

After we deliver a solution to a customer, wetypically pursue follow-on business that includes software developmentservices, software enhancements to our products and related integration, aswell as customer support and maintenance services. Because the solutions weprovide usually perform functions that are required for the operation of ourcustomer’s business, we expect follow-on revenue to occur for several yearsafter an initial sale.

 

While providing support and maintenanceservices, we may also become aware of new opportunities with our customers.This allows us to expand our product portfolio and ***ServiceXpress*** toolsto solve our customers’ needs, generally in their back office systemsenvironment.  Our ***ServiceXpress***strategy is currently used in support of most of our customer engagements.

 

**Critical Accounting Policies**

 

Management’s Discussion and Analysis ofFinancial Condition and Results of Operations is based on our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America, or GAAP. We reviewthe accounting policies we use in reporting our financial results on a regularbasis. The preparation of our consolidated financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenue and expenses, and related disclosure of contingent assetsand liabilities. In many cases, the accounting treatment of a particulartransaction is specifically dictated by GAAP and does not require our judgmentin its application.  Our seniormanagement has reviewed these critical accounting policies and relateddisclosures with our Audit Committee.  Wehave identified the policies below as critical to our business operations andthe understanding of our results of operations.

 

•                  Revenue recognition

 

•                  Allowance for doubtful accounts

 

•                  Income taxes

 

•                  Goodwill and intangible assets

 

For a detailed discussion on the application of these accountingpolicies, see “Item 7: Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in our Annual Report on Form 10-K for theyear ended December 31, 2003.

 

**Recent Developments**

 

**Customer Support Revenue Deferral**

 

During the first and second quarter of 2004, we deferred therecognition of customer support revenue for one of our largest customers. Underthis maintenance arrangement, the customer purchased services, specifiedlicensed software upgrades and support services.  Since fair value of the undelivered specifiedlicensed software upgrades did not exist, all of the revenue related to this contracthas been deferred until the specified licensed software upgrades are deliveredand accepted.  We expect this will occurin the first quarter of 2005, unless we are able to obtain acceptance of thespecified licensed software upgrades prior to year-end. The costs associatedwith this contract are being expensed as incurred.

 

**Offshore Development**

 

In February 2004, we formed Evolving SystemsNetworks India Private Limited, a wholly owned subsidiary of Evolving Systems(Evolving Systems India).  For severalyears, offshore development, through a subcontractor, has been a key aspect ofour low-

 

10

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cost, accelerated-deployment strategy.  With the formation of Evolving Systems Indiawe expect to have more control and flexibility and lower costs than ourprevious outsourced development approach using an offshore third partycontractor. For the six months ended June 30, 2004, we incurred costs ofapproximately $249,000 primarily related to recruitment and training ofsoftware development employees. All of these costs were expensed as productdevelopment. During the second quarter we estimate that we saved approximately$150,000 versus the first quarter of 2004 as a result of transitioning ourdevelopment work from our third-party subcontractor to our Indian developmentteam. We expect to realize additional savings during the third quarter as wetransfer all development work from our third-party subcontractor to our Indiandevelopment team.

 

**Accelerated Filer Status**

 

Companies considered accelerated filers under Securities Exchange ActRule 12b-2, are required to comply with the internal control reporting anddisclosure requirements of Section 404 of the Sarbanes-Oxley Act of 2002, forfiscal years ending on or after November 15, 2004. An accelerated filer isdefined as a company that meets the following conditions as of the end of itsfiscal year:

 

•                  Itscommon equity public float was $75 million or more as of the lastbusiness day of its most recently completed second fiscal quarter;

•                  The company has been subject to thereporting requirements of Section 13(a) or 15(d) of the Exchange Act for aperiod of at least 12 calendar months;

•                  The company has previously filed atleast one annual report pursuant to Section 13(a) or 15(d) of the Exchange Act;and

•                  The company is not eligible to useForms 10-KSB and 10-QSB.

 

As of the last business day of our most recently completed secondfiscal quarter, June 30, 2004, our common equity public float was less than $75million, therefore we are not an accelerated filer, as defined in SecuritiesExchange Act Rule 12b-2, and are not required to comply with the managementreporting on internal control over financial reporting for the year endingDecember 31, 2004. Since we are not an accelerated filer in 2004 we must begincomplying with the internal control reporting and disclosure requirements forour fiscal year ending December 31, 2005.

 

**Results ofOperations**

 

Thefollowing table presents the Company’s Consolidated Statements of Operationsreflected as a percentage of total revenue.

 
| ** **                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUE**                                                 |       |                            |       |                          |       |   |   |   |   |
| License fees and services                                   |       | 45                              | %          | 49                            | %          | 51 | % | 54 | % |
| Customer support                                            |       | 55                              | %          | 51                            | %          | 49 | % | 46 | % |
| Total revenue                                               |       | 100                             | %          | 100                           | %          | 100 | % | 100 | % |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                 |       |                            |       |                          |       |   |   |   |   |
| Costs of license fees and services,  excluding depreciation |       | 22                              | %          | 20                            | %          | 20 | % | 21 | % |
| Costs of customer support, excluding  depreciation          |       | 38                              | %          | 26                            | %          | 35 | % | 20 | % |
| Sales and marketing                                         |       | 17                              | %          | 11                            | %          | 17 | % | 10 | % |
| General and administrative                                  |       | 18                              | %          | 14                            | %          | 17 | % | 13 | % |
| Product development                                         |       | 4                               | %          | 6                             | %          | 6 | % | 4 | % |
| Depreciation                                                |       | 5                               | %          | 5                             | %          | 5 | % | 4 | % |
| Restructuring and other expenses (benefit)                  |       | 0                               | %          | (1                            | )%         | 0 | % | 0 | % |
| Total costs of revenue and operating  expenses              |       | 104                             | %          | 81                            | %          | 100 | % | 72 | % |
|                                                        |       |                            |       |                          |       |   |   |   |   |
| Income (loss) from operations                               |       | (4                              | )%         | 19                            | %          | 0 | % | 28 | % |
| Other income, net                                           |       | 1                               | %          | 1                             | %          | 1 | % | 1 | % |
| Income (loss) before income taxes                           |       | (3                              | )%         | 20                            | %          | 1 | % | 29 | % |
| Benefit from income taxes                                   |       | 0                               | %          | 0                             | %          | 0 | % | 0 | % |
| Net income (loss)                                           |       | (3                              | )%         | 20                            | %          | 1 | % | 29 | % |

 

**The three and six months ended June 30, 2004 comparedto the three and six months ended June 30, 2003**

 

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**Revenue**

 

Revenue is comprised of license fees/servicesand customer support.  License fees andservices revenue represent the fees we receive from the license of our softwareproducts and those services directly related to the delivery of the licensedproduct as well as integration services and time and materials work.  Customer support revenue includesannual support fees, recurring maintenance fees,  maintenance upgrades and warrantyfees.  Warranty fees are generallywithheld from license fees and are recognized ratably over the warranty period. Total revenue was $5.3 million and$6.4 million for the three months ended June 30, 2004 and 2003,respectively, and $11.0 million and $15.0 million for the six months ended June30, 2004, respectively. The following table presents the Company’srevenue by product (in thousands).

** **
| ** **                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Number portability              |       | $                               | 2,663      |                          | $          | 3,688 |   | $ | 5,521 |   | $ | 9,247 |   |
| Number inventory and assignment |       | 1,258                           |       | 2,189                         |       | 3,166 |   | 4,597 |   |
| Network assurance               |       | 1,014                           |       | —                        |       | 1,678 |   | — |   |
| Other                           |       | 326                             |       | 562                           |       | 662 |   | 1,186 |   |
|                            |       | $                               | 5,261      |                          | $          | 6,439 |   | $ | 11,027 |   | $ | 15,030 |   |

 

**LicenseFees and Services**

 

Licensefees and services revenue decreased 25% to $2.4 million for the three monthsended June 30, 2004, from $3.2 million for the three months ended June 30,2003.  The decrease in license fees andservices revenue is mainly due to the mature market for LNP and numberinventory and assignment software, which has resulted in a decrease in initiallarge license sales, although we continue to make smaller sales of LNP andnumber inventory and assignment enhancements and features.

 

Licensefees and services revenue decreased 32% to $5.6 million for the six monthsended June 30, 2004, from $8.2 million for the six months ended June 30,2003.  The decrease in license fees andservices revenue is due to not having a contract in 2004 similar to a large LNPproject that was completed during the six months ended June 30, 2003 ofapproximately $1.6 million and the aforementioned maturity of the LNP andnumber inventory and assignment markets.

** **

**CustomerSupport**

 

Customersupport revenue decreased 12% to $2.9 million for the three months ended June30, 2004, from $3.3 million for the three months ended June 30, 2003.  The decrease in customer support revenue forthe three months ended June 30, 2004 is primarily due to the aforementioneddeferral of revenue related to a large LNP arrangement, as well as pricingpressures from customers, partially offset by increased network assurancesupport revenue on products acquired in the CMS acquisition.

 

Customersupport revenue decreased 21% to $5.4 million for the six months ended June 30,2004, from $6.8 million for the six months ended June 30, 2003.  The decrease in customer support revenue forthe six months ended June 30, 2004 is primarily due to the aforementioneddeferral of revenue related to a large LNP arrangement, as well as pricingpressures from customers, partially offset by increased network assurancesupport revenue on products acquired in the CMS acquisition.

** **

**Costs of Revenue, Excluding Depreciation**

 

Costs of revenue, excluding depreciation,consist primarily of personnel costs, including employees of Evolving SystemsIndia, offshore development subcontractor costs, facilities costs, the costs ofthird-party software and all other direct costs associated with thesepersonnel. Total costs of revenue, excluding depreciation, were$3.2 million and $3.0 million for the three months ended June 30,2004 and 2003, respectively, and $6.1 million and $6.2 million for the sixmonths ended June 30, 2004 and 2003, respectively.

** **

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

 

Costs of license fees and services, excludingdepreciation, were $1.1 million and $1.3 million for the three monthsended June 30, 2004 and 2003, respectively. The decrease of $154,000, or 12%, was due to a reduction of labor hoursspent on license related software and services, as a result of fewer licenseand services projects. As a percentage of license fees and services revenue,costs of license fees and services, excluding depreciation, increased to 48%for the three months ended June 30, 2004 from 40% for the three months endedJune 30, 2003.  The increase as apercentage of license fees and services revenues was due to a decrease in revenuewhich exceeded the decrease in costs during the three months ended June 30,2004.

 

Costs of license fees and services, excludingdepreciation, were $2.2 million and $3.2 million for the six monthsended June 30, 2004 and 2003, respectively. The decrease of $1.0 million, or 31%, was due to a reduction of laborhours spent on license related software and services, as a result of fewerlicense and services projects.  As apercentage of license fees and services revenue, costs of license fees andservices, excluding depreciation, was 39% for the six months ended June 30,2004 and 2003.  The constant as a 

 

12

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percentage of license fees and services revenues was due tothe decreased costs that were offset by decreased revenue during the six monthsended June 30, 2004.

** **

**Costs of Customer Support, ExcludingDepreciation**

 

Costs of customer support, excludingdepreciation, were $2.0 million and $1.7 million for the three monthsended June 30, 2004 and 2003, respectively. The increase of $354,000, or 21%, is due to amortization of intangiblesrelated to our acquisition of CMS in November 2003 and increased hours workedon customer support projects to support the network assurance product acquiredfrom CMS.  As a percentage of customersupport revenue, costs of customer support, excluding depreciation, increasedto 70% for the three months ended June 30, 2004 from 51% for the three monthsended June 30, 2003.  The increase as apercentage of customer support revenue in the second quarter of 2004 comparedto 2003 is due to the increased costs as well as decreased revenues, due to theaforementioned deferral of revenue from a large LNP contract.

 

Costs of customer support, excludingdepreciation, were $3.9 million and $3.0 million for the six monthsended June 30, 2004 and 2003, respectively. The increase of $920,000, or 31%, is due to amortization of intangiblesrelated to our acquisition of CMS in November 2003 and increased hours workedon customer support projects to support the network assurance product acquiredfrom CMS.  As a percentage of customersupport revenue, costs of customer support, excluding depreciation, increasedto 72% for the six months ended June 30, 2004 from 43% for the six months endedJune 30, 2003.  The increase as apercentage of customer support revenue in the first half of 2004 compared to2003 is due to the increased costs as well as decreased revenues, due to theaforementioned deferral of revenue from a large LNP contract.

 

**Sales and Marketing**

 

Sales and marketing expenses primarilyconsist of compensation costs, including bonuses and commissions, travelexpenses, advertising and occupancy expenses. Sales and marketing expenses were $901,000 and $720,000 for the threemonths ended June 30, 2004 and 2003, respectively. The increase of $181,000, or25%, is due to increased employee-related costs as well as travel expensesrelated to our acquisition of CMS in November 2003, increased headcount relatedto our ongoing effort to ramp up our sales staff and relocation costs.  As a percentage of total revenue, sales andmarketing expenses increased to 17% for the three months ended June 30, 2004from 11% for the three months ended June 30, 2003.  The increase as a percentage of revenue isdue to the aforementioned increase in expenses and decreased revenue in thesecond quarter of 2004 compared to 2003.

 

Sales and marketing expenses were $1.8million and $1.4 million for the six months ended June 30, 2004 and 2003,respectively. The increase of $412,000, or 29%, is primarily due to increasedemployee-related costs and travel expenses related to our acquisition of CMS inNovember 2003.  As a percentage of totalrevenue, sales and marketing expenses increased to 17% for the six months endedJune 30, 2004 from 10% for the six months ended June 30, 2003.  The increase as a percentage of revenue isdue to the aforementioned increase in expenses and decreased revenue in thefirst half of 2004 compared to 2003.

** **

**General and Administrative**

 

General and administrative expenses consistprincipally of employee related costs and professional fees for the followingdepartments; facilities, finance, legal, human resources, and executivemanagement.  General and administrativeexpenses were $934,000 and $935,000 for the three months ended June 30,2004 and 2003, respectively.  Costsremained relatively the same during the period as increased salary expense andprofessional fees were offset by decreased bonus expense.  As a percentage of total revenue, general andadministrative expenses increased to 18% for the three months ended June 30,2004 from 14% for the three months ended June 30, 2003.  The increase as a percentage of revenue ismainly due to decreased revenue in the second quarter of 2004 compared to 2003.

 

General and administrative expenses were$1.9 million for the six months ended June 30, 2004 and 2003.  Costs remained relatively the same during theperiod as increased salary expense and professional fees were offset bydecreased bonus expense.  As a percentageof total revenue, general and administrative expenses increased to 17% for thesix months ended June 30, 2004 from 13% for the six months ended June 30,2003.  The increase as a percentage ofrevenue is mainly due to decreased revenue in the first half of 2004 comparedto 2003.

** **

**Product Development**

 

Product development expenses consistprimarily of employee related costs, offshore development subcontractorexpenses and costs to start up our offshore Indian facility.  Product development expenses were $241,000and $380,000 for the three months ended June 30, 2004 and 2003, respectively.The decrease of $139,000, or 37%, is due to decreased hours spent ondevelopment of our ***ServiceXpress*** toolkit andother new features, partially offset by training and recruiting costs relatedto the start up of our newly formed Bangalore, India subsidiary.  As a percentage of revenue, productdevelopment expenses decreased to 4% for the three months ended June 30, 2004from 6% for the three months ended June 30, 2003.  The decrease as a percentage of revenue isdue to the decreased hours worked on product development initiatives in thesecond quarter of 2004 compared to 2003.

 

Product development expenses were $732,000and $656,000 for the six months ended June 30, 2004 and 2003, respectively. Theincrease of $76,000, or 12%, is mainly due to training and recruiting costsrelated to our newly formed Bangalore, India subsidiary.  As a percentage of revenue, productdevelopment expenses increased to 6% for the six months ended June 30, 2004from 4% for the six 

13

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months ended June 30, 2003.  The increase as a percentage of revenue isdue to the increased costs and decreased revenue in the first half of 2004compared to 2003.

** **

**Restructuring and Other Expense**

 

Restructuring and other expenses (benefits) of ($80,000) and $38,000were recorded for the three and six months ended June 30, 2003, respectively,in accordance with the Company’s restructuring plan, as follows:

 

•                  *Work force reductions.* All work force reductions related to our restructuring plan werecompleted in 2002. During the three and six months ended June 30, 2003, werecorded benefits of $80,000 and $13,000, respectively, related to the settlementof severance liabilities.  At June 30,2004 there was no remaining liability related to these workforce reductions.

 

•                  *Closure of satellite offices.*  We closed all of oursatellite field offices during the six months ended June 30, 2002.  Estimated costs to sublease or terminate thelease commitments of $131,000 were recorded in the three months ended March 31,2003; the 2003 expense is related to an adjustment of our estimate of ouroffice closure liability due to lower than expected sublease income.  At June 30, 2004, approximately $100,000 wasincluded in accounts payable and accrued liabilities, and approximately $29,000was included in long-term obligations related to these office closures, whichwill be paid over the remaining lease terms, ranging from 4 months to 22months.

 

**OtherIncome, Net**

 

Otherincome, net, was $67,000 and $49,000 for the three months ended June 30, 2004and 2003, respectively.  The increase isdue to higher interest income as a result of increased cash balances for thethree months ended June 30, 2004 compared to the comparable period in 2003.

 

Other income, net, was $124,000 and $96,000 for the six months endedJune 30, 2004 and 2003, respectively. The increase is due to higher interest income as a result of increasedcash balances for the six months ended June 30, 2004 compared to the comparableperiod in 2003.

 

**Income Taxes**

 

There was no income tax expense forthree months ended June 30, 2004, due to the net loss for the period and ourexpected 2004 effective tax rate.

 

There was an income tax benefit of $8,000 for the six months ended June 30, 2004, due to a refund that wascollected on a prior year amended tax return, partially offset by the estimatedyear-to-date tax expense.

 

**Liquidity and Capital Resources**

#### ** **

We have historically financed operationsthrough cash flows from operations and equity transactions.  At June 30, 2004, our principal source ofliquidity was $22.5 million in cash and cash equivalents, representing 58% oftotal assets.  Working capital at June30, 2004 was $14.5 million compared to $13.8 million at December 31, 2003.

 

During the six months ended June 30, 2004 ourcash and cash equivalents increased to $22.5 million from $18.0 million atDecember 31, 2003.  This increase isprimarily a result of approximately $4.9 million in cash provided by operationsfor the six months ended June 30, 2004. The cash generated from operating activities is mainly due tocollections of our contract receivables. The cash flow generated from the collection of contract receivables waspartially offset by a decrease in our unearned revenue balance due torecognition of revenue on our annual customer support agreements and deliveryof licensed software and services.  Cashused by investing activities of $756,000 was primarily due to capital expendituresfor domestic internal hardware that improved performance and reliability of ourproduct development environment, as well as servers and computers for EvolvingSystems India. Cash provided by financing activities of $326,000 includedproceeds related to the exercise of approximately 165,000 stock options.

 

We believe that our current cash and cashequivalents, together with anticipated cash flows from operations will besufficient to meet our working capital and capital expenditure requirements forat least the next twelve months. In making this assessment we considered thefollowing:

 

•                  Ourcash and cash equivalents balance at June 30, 2004 of $22.5 million.

•                  Ourcumulative profitability over the last eight quarters and anticipatedprofitability for the calendar year 2004.

•                  Ourcurrent expense run rate.

 

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•                  Ourbacklog of approximately $10.2 million, including $900,000 in license fees andservices and $9.3 million in customer support at June 30, 2004.

 

Notwithstanding these assessments, we mayrequire additional funds to support our business objectives through equity ordebt financing. Specifically, additional funds may be needed to support ourgrowth through merger and acquisition. There can be no assurance thatadditional financing will be available at all or that if available, suchfinancing will be obtainable on terms favorable to us and would not bedilutive.

 

**Factors That Might Affect Operating Results**

 

These results should be read in conjunction with the risk factorsdefined in the Company’s Annual Report on Form 10-K for the year ended December31, 2003. Statements contained in this Quarterly Report with respect to futurerevenue and expenses are “forward-looking statements” within the meaning ofSection 21E of the Securities Exchange Act of 1934, as amended. Actual resultsmay differ. Among the factors that could cause actual results to differ arethose described below and in more detail in our Annual Report on Form 10-K.

 

Our operating results have fluctuatedsignificantly in the past and are likely to continue to fluctuate significantlyin the future. Fluctuations in operating results may cause volatility in theprice of our common stock. These quarterly fluctuations may result from a numberof factors, including:

 

•                  *Reliance on few customers.* A significant portion of our revenue and contracts receivable has beenand is expected to continue to be derived from a small number of customers.Accordingly, the loss of any significant customer, delays in collections,delivery or acceptance of any of our products or delays in the performance ofservices could have a material adverse effect on our business, financialcondition and results of operations.

 

•                  *Adverse trends in the telecommunications industry.*  Due to a major downturn in thetelecommunications industry which began in the second half of 2000 (andcontinues to the present), many of the companies in the telecommunicationsindustry have declared bankruptcy, delayed payments to their suppliers ordelayed additional purchases.

 

•                  *Mature market for number portability products.*  The market for our number portabilityproducts is mature and there can be no assurances that we will successfullyidentify new product opportunities or will achieve market acceptance of newproducts brought to the market.  If ourproducts do not perform satisfactorily, or if we have delays in productdevelopment, our business, financial condition and results of operations couldbe materially harmed.

 

•                  *QuarterlyFluctuations in Revenue as a Result of Revenue Recognition Rules.*Many of our contracts are for large, complexprojects where software and services are provided over a period of manymonths.  Recently, our customers havebeen requesting more customization of our software and services to their exactneeds.  As a result, revenue recognitionunder our contracts may vary depending upon the particular software revenuerecognition rule that applies.  Forexample, we recently entered into a contract which contains customer support,services and software releases. Because of the applicability of certainaccounting rules, we are required to defer the revenue under that contractuntil the software is accepted by the customer; the expenses incurred, however,must be accounted for as they occur. This accounting treatment has had, and will continue to have asignificant impact on our quarterly results of operations.

 

•                  *Shiftingin customer spending.* Whilecarriers are projected to spend more on systems for data services they are planningon spending less on support services for voice services. As we extend ourproducts to address more data and next generation services it could impactresults in the near term.

 

•                  *Integration of future acquisitions.* The integration offuture acquisitions may present risks and we may be unable to achieve theproduct, financial or strategic goals intended at the time of any acquisition.The risks we may encounter in such transactions include:

 

•                  we may have difficulty assimilating the operationsand personnel of the acquired company;

 

•                  we may have difficulty effectively integrating theacquired technologies or products with our current products and technologies;

 

•                  we may have difficulty in maintaining controls,procedures and policies during the transition and integration;

 

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•                  customers of the acquired company may decide not to renewtheir contracts with the combined entity and other ongoing business may bedisrupted by transition and integration issues;

 

•                  the financial and strategic goals for the acquiredand combined businesses may not be achieved;

 

•                  due diligence processes may fail to identifysignificant issues with product quality, intellectual property ownership,product architecture, legal and financial contingencies, and productdevelopment;

 

•                  significant exit charges may be sustained if productsacquired in business combinations are unsuccessful;

 

•                  acquisitions require considerable time and commitment ofmanagement, which can distract management from day-to day operations and resultin additional costs which reduce profits;

 

•                  we do not know if we will be able to identify andpurchase assets and/or companies that will complement our business;

 

•                  we do not know if we will be able to finance futureacquisitions;

 

•                  certain management and other employees of an acquiredentity may be critical to the success of the acquired company, and we do notknow if we will be successful in retaining these individuals in the combinedcompanies;

 

•                  we may incur impairment charges in the futurerelated to our goodwill and intangible assets if we do not achieve our expectedcash flows or growth rates;

 

•                  the price of our stock may go down as stockholdersreceiving stock in connection with the transaction, elect to sell their shares,or the marketplace does not favorably view the transaction.

 

•                  *Risks Associated with Offshore Development.*  We are currently in the process of staffingour Indian subsidiary to provide software development services and maintenanceservices.  Any failure by us totransition the work currently being performed by our Indian subcontractor toour subsidiary or to otherwise manage our offshore development process couldnegatively impact our ability to satisfy our customer contracts.

 

Other factors that might affect operating results:

 

•                  the size of new contracts and when they are signed; our rateof progress under our contracts;

•                  the timing of customer and market acceptance of our productsand service offerings;

•                  actual or anticipated changes in government laws andregulations related to the telecommunications market;

•                  judicial or administrative actions about these laws orregulations;

•                  the nature and pace of enforcement of the TelecommunicationsAct of 1996;

•                  product lifecycles;

•                  the mix of products and services sold;

•                  changes in demand for our products and services;

•                  the timing of third-party contractors’ delivery of softwareand hardware;

•                  budgeting cycles of our customers;

•                  changes in the renewal rate of support agreements;

•                  level and timing of expenses for product development andsales, general and administrative expenses;

•                  competition by existing and emerging competitors in thetelecommunications software markets;

•                  our success indeveloping and selling new products, controlling cost, attracting and retainingqualified personnel and expanding our sales and customer focused programs;

•                  software defects and other product quality problems;

•                  changes in our strategy;

•                  the extent of industry consolidation; and

•                  general economic conditions.

 

Our expense levels are based in significant part on our expectationsregarding future revenue. Our revenue is difficult to forecast as the marketfor our products and services is rapidly evolving, and our sales cycle and thesize and timing of significant contracts vary substantially among customers.Accordingly, we may be unable to adjust spending in a timely manner tocompensate for any unexpected shortfall in revenue. Any significant shortfallfrom anticipated levels of demand for our products and services could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

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Based on all of the foregoing, we believe it is possible for futurerevenue, expenses and operating results to vary significantly from quarter toquarter. As a result, quarter-to-quarter comparisons of operating results arenot necessarily meaningful or indicative of future performance. Furthermore, webelieve that it is possible that in any given quarter, including the currentquarter, our operating results could differ from the expectations of publicmarket analysts or investors. In such event, or in theevent that adverse conditions prevail, or are perceived to prevail, withrespect to our business or generally, the market price of our common stockwould likely go down.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE MARKET RISKDISCLOSURES

 

**Foreign Exchange Risk**

 

Our international business in India is subject to risks, including, butnot limited to, unique economic conditions, changes in political climate,differing tax structures, other regulations and restrictions, and foreignexchange rate volatility.  Accordingly,our future results could be adversely impacted by changes in these or otherfactors.

** **

**Interest Rate Risk**

 

In the ordinary course of business we are exposed to the risk ofchanges in interest rates.  Our cashbalances are subject to interest rate fluctuations and as such, interest incomeamounts may fluctuate from current levels.

 

For additional information about Evolving Systems’ risk factors seeEvolving Systems’ Annual Report on Form 10-K for the year ended December 31,2003.

##### ** **

ITEM 4.  CONTROLS AND PROCEDURES 

 

(a) Evaluation of disclosure controls and procedures. As of June 30, 2004, 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 is 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.

##### ** **

##### **PART II**.  OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

From time to time we are involved in various legal proceedings arisingin the normal course of business operations. We are currently not aware of any legal proceedings that would have amaterial effect on our business, financial condition or results of operations.

 

ITEM 2.CHANGES IN SECURITIES

 

None

 

ITEM 3.DEFAULTS ON SENIOR SECURITIES

 

None

 

ITEM 4.SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS

 

The Company held its Annual Meeting of Stockholders on May 13,2004.  According to the final proxy tallyreceived from the Company’s transfer agent, the results of the voting onProposals 1-5, as described in the Company’s Proxy Statement, were as follows:

 

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| **Proposal  #** | ** ** | **Description of Proposal**                                              | ** ** | **Votes For** | ** ** | **Votes  Against** | ** ** | **Abstentions** | ** ** | **Broker  Non-Votes** | ** ** | **Results  (See notes)** | ** ** |
|-----------------|------------|--------------------------------------------------------------------------|------------|---------------|------------|--------------------|------------|-----------------|------------|-----------------------|------------|--------------------------|------------|
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #1              |       | Proposal to Re-elect Stephen K. Gartside,  Jr. to the Board of Directors |       | 13,740,093    |       | 457,029            |       |            |       |                  |       | Approved                 |       |
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #1              |       | Proposal to Re-elect Brendan F. Reidy to  the Board of Directors         |       | 13,680,715    |       | 516,407            |       |            |       |                  |       | Approved                 |       |
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #2              |       | Proposal to Increase Authorized Common  Shares                           |       | 3,760,368     |       | 896,610            |       | 28,590          |       | 9,511,554             |       | Not  Approved            |       |
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #3              |       | Proposal to Increase Authorized Shares in  Stock Option Plan             |       | 3,007,963     |       | 1,615,939          |       | 61,666          |       | 9,511,554             |       | Approved                 |       |
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #4              |       | Employee Stock Purchase Plan Proposal                                    |       | 3,897,378     |       | 747,947            |       | 40,243          |       | 9,511,554             |       | Approved                 |       |
|            |       |                                                                     |       |          |       |               |       |            |       |                  |       |                     |       |
| #5              |       | Ratification of PricewaterhouseCoopers as  Independent Auditors for 2004 |       | 13,586,872    |       | 587,145            |       | 23,104          |       | 1                     |       | Approved                 |       |

 

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Notes:

 

(1)                                  Proposal #1 asked thestockholders to elect two directors. Directors must be elected by a plurality of votes.

 

(2)                                  Proposal #2 asked thestockholders to approve an amendment to the Company’s Certificate ofIncorporation increasing the number of authorized shares of common stock from25,000,000 to 50,000,000.  This proposalrequired the affirmative vote of a majority of the Company’s outstanding sharesto pass.  As of March 18, 2004, therecord date for the meeting, there were 15,885,235 shares of the Company’scommon stock outstanding, meaning that this proposal required at least7,942,618 “yes” votes to pass.  On thisproposal, abstention and broker non-votes were counted as “no” votes.

 

(3)                                  Proposal #3 asked theCompany’s stockholders to approve an amendment of the Company’s Amended andRestated Stock Option Plan to increase the total number of shares of commonstock authorized for issuance under the plan by 1,500,000.  Approval of this proposal required a majorityof the total votes cast for, against or abstaining.  Abstentions were counted as “no” votes.Broker non-votes had no effect on the voting and were not counted.  Accordingly, a majority of the 4,685,568votes cast on this proposal, or 2,342,785 votes, was required for this proposalto pass; this proposal passed since 3,007,963 “yes” votes were cast.

 

(4)                                  Proposal #4 asked theCompany’s stockholders to approve an amendment to the Company’s Employee StockPurchase Plan to increase the total number of shares of common stock authorizedfor issuance under the plan by 200,000. Approval of this proposal required amajority of the total votes cast for, against or abstaining.  Abstentions were counted as “no” votes.Broker non-votes had no effect on the voting and were not counted.  Accordingly, a majority of the 4,685,568votes cast on this proposal, or 2,342,785 votes, was required for this proposalto pass; this proposal passed since 3,897,378 “yes” votes were cast.

 

(5)                                  Proposal #5 soughtthe ratification of PricewaterhouseCoopers LLP as independent auditors of theCompany for its fiscal year ending December 31, 2004.  13,586,872 “yes” votes were cast.

 

ITEM 5.OTHER INFORMATION

 

None

 

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ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K

 

(a)   Exhibits

 

Exhibit 31.1 - Certification pursuant to Section 302 of theSarbanes-Oxley Act of 2002

Exhibit 31.2 - Certification pursuant to Section 302 of theSarbanes-Oxley Act of 2002

Exhibit 32.1 - Certification pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

Exhibit 32.2 - Certification pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

(b)   Reportson Form 8-K

 

On April 13, 2004, we furnished a Current Report on Form 8-K updatingthe Company’s revenue guidance for the first quarter of 2004.

 

On May 5, 2004, we furnished a Current Report on Form 8-K announcingfinancial results for the first quarter of 2004.

 

On June 15, 2004, we furnished a Current Report on Form 8-K that SteveB. Warnecke, a member of the Board of Directors of the Company entered into anagreement to sell up to 28,366 common shares of the Company owned by Mr.Warnecke over a period commencing June 15, 2004 and ending June 15, 2005.

 

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###### **SIGNATURE**

 

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

 
| Date: August 10, 2004 | /s/ Brian R. Ervine                                                                 |   |
|-----------------------|-------------------------------------------------------------------------------------|--------|
|                  | Brian R. Ervine                                                                     |
|                  | Senior Vice President, Chief  Financial Officer, Treasurer and  Assistant Secretary |
|                  | (Principal Financial and Accounting Officer)                                        |

 

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