Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**x****     ****Quarterly Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**For the quarterly period ended June 30, 2009**

 

**OR**

** **

**o****        ****Transition Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**For the transition periodfrom               to               **

 

**CommissionFile Number: 0-24081**

 

**EVOLVINGSYSTEMS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

**(303) 802-1000**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes x No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yes o No o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer”, “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

As of July 31, 2009there were 9,785,640 shares outstanding of Registrant’s Common Stock (par value$0.001 per share).

 

 

 

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**EVOLVINGSYSTEMS, INC.**

**QuarterlyReport on Form 10-Q**

**June 30,2009**

**Table ofContents**

 
| **PART I —  FINANCIAL INFORMATION** |                                                                                                                                                                |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1                                        | Financial  Statements                                                                                                                                               |   |
|                                          | Condensed  Consolidated Balance Sheets as of June  30, 2009 and December 31,  2008 (Unaudited)                                                            |   |
|                                          | Condensed Consolidated  Statements of Operations for the Three and Six Months Ended June 30,  2009 and 2008 (Unaudited)                                        |   |
|                                          | Condensed Consolidated Statements of Changes In  Stockholders’ Equity and Comprehensive Income (Loss) for the Six Months Ended  June 30, 2009 (Unaudited) |   |
|                                          | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2009 and 2008 (Unaudited)                                                  |   |
|                                          | Notes to  Unaudited Condensed Consolidated Financial Statements                                                                                                     |   |
| Item 2                                        | Management’s Discussion and Analysis  of Financial Condition and Results of Operations                                                                         |   |
| Item 3                                        | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                         |   |
| Item 4                                        | Controls and  Procedures                                                                                                                                            |   |
|                                          |                                                                                                                                                                |   |
| **PART II — OTHER  INFORMATION**    |                                                                                                                                                                |
| Item 1                                        | Legal Proceedings                                                                                                                                                   |   |
| Item 1A                                       | Risk Factors                                                                                                                                                        |   |
| Item 2                                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                        |   |
| Item 3                                        | Defaults  upon Senior Securities                                                                                                                                    |   |
| Item 4                                        | Submission  of Matters to a Vote of Security Holders                                                                                                                |   |
| Item 5                                        | Other Information                                                                                                                                                   |   |
| Item 6                                        | Exhibits                                                                                                                                                            |   |
|                                          |                                                                                                                                                                |   |
| Signature                                     |                                                                                                                                                                |   |

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**EVOLVING SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(in thousands except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **        |       |                  |       |
| Current assets:                                                                                                                                                                               |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                     |       | $                 | 4,995      |                  | $          | 5,783 |   |
| Contract receivables, net of allowance for doubtful  accounts of $534 at June 30, 2009 and December 31, 2008                                                                        |       | 9,002             |       | 11,484                |       |
| Unbilled work-in-progress                                                                                                                                                                     |       | 2,251             |       | 1,910                 |       |
| Deferred income taxes                                                                                                                                                                         |       | 5                 |       | 5                     |       |
| Prepaid and other current assets                                                                                                                                                              |       | 1,551             |       | 1,304                 |       |
| Total current assets                                                                                                                                                                          |       | 17,804            |       | 20,486                |       |
| Property and equipment, net                                                                                                                                                                   |       | 1,285             |       | 1,277                 |       |
| Amortizable intangible assets, net                                                                                                                                                            |       | 2,314             |       | 2,374                 |       |
| Goodwill                                                                                                                                                                                      |       | 22,898            |       | 20,811                |       |
| Long-term restricted cash                                                                                                                                                                     |       | 100               |       | 100                   |       |
| Long-term deferred income taxes                                                                                                                                                               |       | 12                |       | 56                    |       |
| Other long-term assets                                                                                                                                                                        |       | 182               |       | 307                   |       |
| Total assets                                                                                                                                                                                  |       | $                 | 44,595     |                  | $          | 45,411 |   |
|                                                                                                                                                                                          |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                          |       |              |       |                  |       |
| Current portion of capital lease obligations                                                                                                                                                  |       | $                 | 23         |                  | $          | 21 |   |
| Current portion of long-term debt                                                                                                                                                             |       | 1,333             |       | 2,000                 |       |
| Accounts payable and accrued liabilities                                                                                                                                                      |       | 4,365             |       | 5,198                 |       |
| Deferred income taxes                                                                                                                                                                         |       | 56                |       | 20                    |       |
| Unearned revenue                                                                                                                                                                              |       | 9,960             |       | 11,445                |       |
| Total current liabilities                                                                                                                                                                     |       | 15,737            |       | 18,684                |       |
| Long-term liabilities:                                                                                                                                                                        |       |              |       |                  |       |
| Capital lease obligations, net of current portion                                                                                                                                             |       | 47                |       | 59                    |       |
| Other long-term obligations                                                                                                                                                                   |       | 246               |       | 1,402                 |       |
| Long-term debt, net of current portion                                                                                                                                                        |       | 2,977             |       | 4,883                 |       |
| Deferred income taxes                                                                                                                                                                         |       | 388               |       | 441                   |       |
| Total liabilities                                                                                                                                                                             |       | 19,395            |       | 25,469                |       |
|                                                                                                                                                                                          |       |              |       |                  |       |
| Commitments and contingencies (Note 10)                                                                                                                                                       |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                    |       |              |       |                  |       |
| Preferred stock, $0.001 par value; 2,000,000 shares  authorized; no shares issued and outstanding as of June 30, 2009 and  December 31, 2008                                        |       |              |       |                  |       |
| Common stock, $0.001 par value; 40,000,000 shares  authorized; 9,777,114 and 9,753,393 shares issued and outstanding as of  June 30, 2009 and December 31,  2008, respectively |       | 10                |       | 10                    |       |
| Additional paid-in capital                                                                                                                                                                    |       | 82,284            |       | 81,824                |       |
| Accumulated other comprehensive loss                                                                                                                                                          |       | (2,543            | )          | (5,270                | )          |
| Accumulated deficit                                                                                                                                                                           |       | (54,551           | )          | (56,622               | )          |
| Total stockholders’ equity                                                                                                                                                               |       | 25,200            |       | 19,942                |       |
| Total liabilities and stockholders’ equity                                                                                                                                               |       | $                 | 44,595     |                  | $          | 45,411 |   |

 

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

 

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**EVOLVINGSYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(inthousands except per share data)**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| **REVENUE**                                                                  |       |                                 |       |                               |       |   |   |   |   |
| License  fees and services                                                   |       | $                                    | 5,359      |                               | $          | 5,342 |   | $ | 10,104 |   | $ | 10,174 |   |
| Customer  support                                                            |       | 4,270                                |       | 4,303                              |       | 8,368 |   | 8,598 |   |
| Total  revenue                                                               |       | 9,629                                |       | 9,645                              |       | 18,472 |   | 18,772 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                 |       |                               |       |   |   |   |   |
| Costs  of license fees and services, excluding depreciation and amortization |       | 2,065                                |       | 1,902                              |       | 3,742 |   | 4,126 |   |
| Costs  of customer support, excluding depreciation and amortization          |       | 1,401                                |       | 1,632                              |       | 2,834 |   | 3,125 |   |
| Sales  and marketing                                                         |       | 1,942                                |       | 2,194                              |       | 3,829 |   | 4,381 |   |
| General  and administrative                                                  |       | 1,399                                |       | 1,236                              |       | 2,832 |   | 2,661 |   |
| Product  development                                                         |       | 686                                  |       | 950                                |       | 1,381 |   | 2,018 |   |
| Depreciation                                                                 |       | 158                                  |       | 252                                |       | 314 |   | 482 |   |
| Amortization                                                                 |       | 183                                  |       | 379                                |       | 354 |   | 759 |   |
| Total  costs of revenue and operating expenses                               |       | 7,834                                |       | 8,545                              |       | 15,286 |   | 17,552 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Income  from operations                                                      |       | 1,795                                |       | 1,100                              |       | 3,186 |   | 1,220 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Other  income (expense)                                                      |       |                                 |       |                               |       |   |   |   |   |
| Interest  income                                                             |       | 18                                   |       | 39                                 |       | 23 |   | 117 |   |
| Interest  expense                                                            |       | (161                                 | )          | (283                               | )          | (418 | ) | (619 | ) |
| Loss  on extinguishment of debt                                              |       | —                               |       | —                             |       | — |   | (290 | ) |
| Foreign  currency exchange gain (loss)                                       |       | (497                                 | )          | 32                                 |       | (662 | ) | 142 |   |
| Other  expense, net                                                          |       | (640                                 | )          | (212                               | )          | (1,057 | ) | (650 | ) |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Income  before income taxes                                                  |       | 1,155                                |       | 888                                |       | 2,129 |   | 570 |   |
| Income  tax expense                                                          |       | 53                                   |       | 113                                |       | 58 |   | 39 |   |
| Net  income                                                                  |       | $                                    | 1,102      |                               | $          | 775 |   | $ | 2,071 |   | $ | 531 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Basic  income per common share                                               |       | $                                    | 0.11       |                               | $          | 0.08 |   | $ | 0.21 |   | $ | 0.05 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Diluted  income per common share                                             |       | $                                    | 0.11       |                               | $          | 0.08 |   | $ | 0.21 |   | $ | 0.05 |   |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Weighted  average basic shares outstanding                                   |       | 9,777                                |       | 9,687                              |       | 9,771 |   | 9,684 |   |
| Weighted  average diluted shares outstanding                                 |       | 10,087                               |       | 9,922                              |       | 9,992 |   | 9,920 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**EVOLVINGSYSTEMS, INC.**

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

**ANDCOMPREHENSIVE INCOME (LOSS)**

**(inthousands, except share data)**

**(unaudited)**

 
| ** **                                                        | ** ** | ** **        | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated**    | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|-------------------|------------|-------------|------------|-------------------|------------|--------------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**          | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated**    | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income  (Loss)** | ** ** | **(Deficit)**          | ** ** | **Equity** | ** ** |
| **Balance at December 31, 2008**                             | ** ** | **9,753,393**     | ** ** | **$**       | **10**     | ** **        | **$**      | **81,824**         | ** ** | **$**                  | **(5,270** | **)**      | **$**      | **(56,622** | **)** | **$** | **19,942** | ** ** |
| Stock  option exercises                                           |       | 563               |       | —      |       | 1                 |       | —             |       | —                 |       | 1          |       |
| Common  Stock issued pursuant to the Employee Stock Purchase Plan |       | 23,158            |       | —      |       | 33                |       | —             |       | —                 |       | 33         |       |
| Stock-based  compensation expense                                 |       | —            |       | —      |       | 426               |       | —             |       | —                 |       | 426        |       |
| Comprehensive  income (loss):                                     |       |              |       |        |       |              |       |               |       |                   |       |       |       |
| Net  income                                                       |       | —            |       | —      |       | —            |       | —             |       | 2,071                  |       |       |       |
| Foreign  currency translation adjustment                          |       | —            |       | —      |       | —            |       | 2,727              |       | —                 |       |       |       |
| Comprehensive  loss                                               |       |              |       |        |       |              |       |               |       |                   |       | 4,798      |       |
| **Balance at June 30, 2009**                                 | ** ** | **9,777,114**     | ** ** | **$**       | **10**     | ** **        | **$**      | **82,284**         | ** ** | **$**                  | **(2,543** | **)**      | **$**      | **(54,551** | **)** | **$** | **25,200** | ** ** |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         |       |                               |       |   |   |
| Net income                                                                         |       | $                                  | 2,071      |   | $ | 531 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                               |       |   |   |
| Depreciation                                                                       |       | 314                                |       | 482 |   |
| Amortization of intangible assets                                                  |       | 354                                |       | 759 |   |
| Amortization of debt issuance costs                                                |       | 67                                 |       | 78 |   |
| Stock based compensation                                                           |       | 426                                |       | 456 |   |
| Loss on extinguishment of debt                                                     |       | —                             |       | 290 |   |
| Unrealized foreign currency transaction (gains) and  losses, net                   |       | 662                                |       | (142 | ) |
| Benefit from foreign deferred income taxes                                         |       | (28                                | )          | (127 | ) |
| Change in operating assets and liabilities:                                        |       |                               |       |   |   |
| Contract receivables                                                               |       | 2,324                              |       | 5,054 |   |
| Unbilled work-in-progress                                                          |       | (100                               | )          | (339 | ) |
| Prepaid and other assets                                                           |       | (162                               | )          | (479 | ) |
| Accounts payable and accrued liabilities                                           |       | (1,112                             | )          | (386 | ) |
| Unearned revenue                                                                   |       | (2,047                             | )          | (1,807 | ) |
| Other long-term obligations                                                        |       | (1,157                             | )          | (433 | ) |
| Net cash provided by operating activities                                          |       | 1,612                              |       | 3,937 |   |
|                                                                               |       |                               |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         |       |                               |       |   |   |
| Purchase of property and equipment                                                 |       | (284                               | )          | (393 | ) |
| Net cash used in investing activities                                              |       | (284                               | )          | (393 | ) |
|                                                                               |       |                               |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         |       |                               |       |   |   |
| Capital lease payments                                                             |       | (10                                | )          | (9 | ) |
| Principal payments on long-term debt                                               |       | (2,573                             | )          | (7,298 | ) |
| Proceeds from issuance of long-term debt                                           |       | —                             |       | 4,000 |   |
| Payments for debt issuance costs                                                   |       | —                             |       | (282 | ) |
| Proceeds from the issuance of stock                                                |       | 34                                 |       | 36 |   |
| Net cash used in financing activities                                              |       | (2,549                             | )          | (3,553 | ) |
|                                                                               |       |                               |       |   |   |
| Effect of exchange rate changes on cash                                            |       | 433                                |       | (13 | ) |
|                                                                               |       |                               |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (788                               | )          | (22 | ) |
| Cash and cash equivalents at beginning of year                                     |       | 5,783                              |       | 7,271 |   |
| Cash and cash equivalents at end of year                                           |       | $                                  | 4,995      |   | $ | 7,249 |   |
|                                                                               |       |                               |       |   |   |
| Supplemental disclosure of other cash and non-cash  financing transactions:        |       |                               |       |   |   |
| Interest paid                                                                      |       | $                                  | 1,514      |   | $ | 1,095 |   |
| Income taxes paid                                                                  |       | 485                                |       | 294 |   |
| Conversion of preferred stock into common stock                                    |       | —                             |       | 5,587 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

**Organization -**We are a provider of software solutionsand services to the wireless, wireline and IP carrier markets. We maintainlong-standing relationships with many of the largest wireline, wireless andcable companies worldwide. Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, highly reliable software solutions fora range of Operations Support Systems (“OSS”). We offer software products and solutions in four core areas:  service activation solutions used toactivate complex bundles of voice, video and data services for traditional andnext generation wireless and wireline networks; numbering solutions that enable carriers to comply withgovernment-mandated requirements regarding number portability as well asproviding phone number management and assignment capabilities; SIM cardactivation solutions used to dynamically allocate and assign resources to awireless device when it is first used, and mediation solutionssupporting data collection for both service assurance and billing applications.

 

**InterimConsolidated Financial Statements** – The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) and inconformity with the instructions to Form 10-Q and Article 10 ofRegulation S-X and the related rules and regulations of the Securities andExchange Commission (“SEC”). Accordingly, certain information and note disclosures normally includedin financial statements prepared in accordance with GAAP have been condensed oromitted pursuant to such rules and regulations. However, we believe thatthe disclosures included in these financial statements are adequate to make theinformation presented not misleading. The unaudited condensed consolidatedfinancial statements included in this document have been prepared on the samebasis as the annual consolidated financial statements, and in our opinion,reflect all adjustments, which include normal recurring adjustments necessaryfor a fair presentation in accordance with GAAP and SEC regulations for interimfinancial statements. The results for the six months ended June 30, 2009are not necessarily indicative of the results that we will have for anysubsequent period.  These unauditedcondensed consolidated financial statements should be read in conjunction withthe audited consolidated financial statements and the notes to those statementsfor the year ended December 31, 2008 included in our Annual Report on Form 10-K.

 

**Use ofEstimates -**Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the U.S. requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities, at the date of the financial statements, aswell as the reported amounts of revenue and expenses during the reportingperiod. We made estimates with respect to revenue recognition for estimatedhours to complete projects accounted for using the percentage-of-completionmethod, allowance for doubtful accounts, income tax valuation allowance, fairvalues of long-lived assets, valuation of intangible assets and goodwill,useful lives for property, equipment and intangible assets, business combinations,capitalization of internal software development costs and fair value ofstock-based compensation amounts.  Actualresults could differ from these estimates.

 

**Earnings Per Share** - On July 1, 2009, we announced thatour Board of Directors approved a one-for-two reverse split of our commonstock, as previously authorized and approved by our stockholders at the June 9,2009 annual meeting, which took effect at 11:59 p.m. (Eastern time) on July 20,2009 (the “Effective Time”). Our common stock began trading on a post-splitbasis on July 21, 2009. As a result of the reverse stock split, every twoshares of our common stock was combined into one share of common stock. Thereverse stock split affects all of our common stock outstanding immediatelyprior to the Effective Time of the reverse stock split as well as the number ofshares of common stock available for issuance under our equity incentive plans.In addition, the reverse stock split reduced the number of shares of commonstock issuable upon the exercise of stock options. Our common stock outstandingat June 30, 2009 was approximately19.6 million shares. Adjusting forthe reverse stock split, the common stock outstanding at June 30, 2009 wasreduced to approximately 9.8 million shares. The number of authorizedshares of common stock remained at 40.0 million. The reverse split did notaffect the par value of our common stock and will remain at $0.001. As a resultof the reverse stock split, the stated capital on our balance sheetattributable to our common stock was reduced in proportion to the size of thereverse stock split. Common stock and additional paid-in capital balances, allshare amounts, stock option amounts and per share/option prices appearing inthis Quarterly Report on Form 10-Q reflect the reverse stock split for allperiods presented.

 

**ForeignCurrency Translation -**Our functional currency is the U.S. dollar.  The functional currency of our foreignoperations is the respective local currency for each foreign subsidiary.  Assets and liabilities of foreign operationsdenominated in local currencies are translated at the spot rate in effect atthe applicable reporting date.  Ourconsolidated statements of operations are translated at the weighted averagerate of exchange during the applicable period. The resulting unrealized cumulative translation adjustment, net ofapplicable income taxes, is recorded as a component of accumulated othercomprehensive income (loss) in stockholders’ equity.  Realized and unrealized transaction gains andlosses generated by transactions denominated in a currency different from thefunctional currency of the applicable entity are recorded in other income(loss) in the period in which they occur.

 

**Principlesof Consolidation -**The consolidated financial statements include the accounts of EvolvingSystems and subsidiaries, all of which are wholly owned.  All significant intercompany transactions andbalances have been eliminated in consolidation.

 

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**Goodwill-**Goodwillis the excess of acquisition cost of an acquired entity over the fair value ofthe identifiable net assets acquired. Goodwill is not amortized, but tested for impairment annually orwhenever indicators of impairment exist. These indicators may include asignificant change in the business climate, legal factors, operatingperformance indicators, competition, sale or disposition of a significantportion of the business or other factors. For purposes of the goodwillevaluation, we compare the fair value of each of our reporting units to itsrespective carrying amount. If the carrying value of a reporting unit were toexceed its fair value, we would then compare the fair value of the reportingunit’s goodwill to its carrying amount, and any excess of the carrying amountover the fair value would be charged to operations as an impairment loss.

 

**IntangibleAssets -**Amortizableintangible assets consist primarily of purchased software and licenses,customer contracts and relationships, trademarks and tradenames, and businesspartnerships acquired in conjunction with our purchases of CMS Communications, Inc.(“CMS”), Telecom Software Enterprises, LLC (“TSE”) and Tertio Telecoms Ltd. (“EvolvingSystems U.K.”).  These definite lifeassets are amortized using the straight-line method over their estimated lives.

 

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

 

·                  Significant under-performance relative tohistorical or projected future operating results;

 

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

 

·                  Significant negative industry or economictrends; and/or

 

·                  Significant decline in our stock pricefor a sustained period.

 

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

 

**FairValue of Financial Instruments -**The carrying amounts for certain financialinstruments, including cash and cash equivalents, contract receivables andaccounts payable, approximate fair value due to their short maturities.  We estimate the fair value of our debt basedon current rates offered to us for debt of the same remaining maturities, ifavailable, or if not available, based on discounted future cash flows usingcurrent market interest rates.  As of June 30,2009, we estimated the fair value of our fixed rate senior term loan and subordinatednotes was $1.4 million and $3.4 million, respectively. As of December 31,2008, we estimated the fair value of our fixed rate senior term loan andsubordinated notes was $2.4 million and $6.0 million, respectively.

 

**RevenueRecognition -**Werecognize revenue from two primary sources: license fees and services, andcustomer support, in accordance with Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition,” as amended and interpreted by SOP 98-9, “Modification ofSOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.”  Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition,” provides further interpretive guidance for publiccompanies on the recognition, presentation and disclosure of revenue in financialstatements.  In addition to the criteriadescribed below, we generally recognize revenue when an agreement is signed,the fee is fixed or determinable and collectability is reasonably assured. Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting, in accordance with SOP97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.”  We estimate the percentage-of-completion foreach contract based on the ratio of direct labor hours incurred to totalestimated direct labor hours.  Sinceestimated direct labor hours, and changes thereto, can have a significantimpact on revenue recognition, these estimates are critical and we review themregularly.  We record amounts billed inadvance of services being performed as unearned revenue. Unbilledwork-in-progress represents revenue earned but not yet billable under the termsof the fixed-price contracts. All such amounts are expected to be billed andcollected within 12 months.

 

We may encounter budgetand schedule overruns on fixed price contracts caused by increased laboror overhead costs. We make adjustments to cost estimates in the periods inwhich the facts requiring such revisions become known. We record estimatedlosses, if any, in the period in which current estimates of total contractrevenue and contract costs indicate a loss. If revisions to cost estimates areobtained after the balance sheet date but before the issuance of the interim orannual financial statements, we make adjustments to the interim or annualfinancial statements accordingly.

 

In arrangementswhere the services are not essential to the functionality of the deliveredsoftware, we recognize license revenue when a license agreement has been signed,delivery has occurred, the fee is fixed or determinable and collectability isreasonably assured. Where applicable, we unbundle and record as revenue feesfrom multiple element arrangements as the elements are delivered to the extent

 

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that vendorspecific objective evidence (“VSOE”) of fair value of the undelivered elementsexist. If VSOE for the undelivered elements does not exist, we defer fees fromsuch arrangements until the earlier of the date that VSOE does exist on theundelivered elements or all of the elements have been delivered.

 

We recognize revenue fromfixed-price service contracts using the proportional performance method ofaccounting, which is similar to the percentage of completion method describedabove. We recognize revenue from professional services provided pursuant totime-and-materials based contracts and training services as the services areperformed, as that is when our obligation to our customers under sucharrangements is fulfilled.

 

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

 

**Stock-based Compensation -** We account for stock-based compensationunder Statement of Financial Accounting Standards No. 123(Revised), “Share-BasedPayment” (“SFAS 123R”).  This statementreplaced SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS123”) and superseded APB Opinion No. 25, “Accounting for Stock Issued toEmployees.”  Under SFAS 123R, we apply afair-value-based measurement method to account for share-based paymenttransactions with employees and directors and record compensation cost for allstock awards granted after January 1, 2006 and awards modified,repurchased, or cancelled after that date. We record compensation costsassociated with the vesting of unvested options on a straight-line basis overthe vesting period using the guidance under SFAS 123R.  Stock-based compensation is a non-cashexpense because we settle these obligations by issuing shares of our commonstock instead of settling such obligations with cash payments.   Effective January 1, 2006, we accountedfor stock option grants and employee stock purchase plan purchases under SFAS123R.  We used the Black-Scholes model toestimate the fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**IncomeTaxes**- Weaccount for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes” (“SFAS 109”). We record deferred tax assets and liabilities forthe estimated future tax effects of temporary differences between the tax basesof assets and liabilities and amounts reported in the accompanying consolidatedbalance sheets, as well as operating loss and tax credit carry-forwards. Wemeasure deferred tax assets and liabilities using enacted tax rates expected tobe applied to taxable income in the years in which those temporary differencesare expected to be recovered or settled. We reduce deferred tax assets by a valuation allowance if, based onavailable evidence, it is more likely than not that these benefits will not berealized.  We evaluate tax benefitsrecorded in our consolidated financial statements and record accruals for anyamounts deemed not probable of being sustained.

 

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

 

As of June 30,2009 and December 31, 2008, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes to our unrecognized tax positions over the next twelvemonths.

 

**RecentAccounting Pronouncements -**In June 2008, the Financial Accounting StandardsBoard (“FASB”) issued FASB Staff Position (FSP) Emerging Issues Task Force(EITF) 03-6-1, “Determining Whether Instruments Granted in Share-Based PaymentTransactions Are Participating Securities.”  This FSP provides that unvestedshare-based payment awards that contain non-forfeitable rights to dividends ordividend equivalents, whether paid or unpaid, are participating securities andshall be included in the computation of both basic and diluted earnings pershare.  We adopted the provisions of FSP EITF 03-6-1 on January 1,2009. There was no impact on earnings per share upon adoption. See Note 3 foradditional information.

 

In April 2009, theFinancial Accounting Standards Board issued FASB Staff Position FSP FAS 107-1and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,”to require, on an interim basis, disclosures about the fair value of financialinstruments for public entities. FSP FAS 107-1 and APB 28-1 is effective forinterim and annual periods ending after June 15, 2009, with early adoptionpermitted for periods ending after March 15, 2009. An entity may earlyadopt this FSP only if it concurrently adopts both FSP FAS 157-4, “DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly,”and FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation ofOther-Than-Temporary Impairments.” We adopted FSP FAS 107-1 and APB 28-1effective June 30, 2009. The adoption of FSP FAS 107-1 and APB 28-1 had noimpact on the financial statements.

 

In May 2009, theFASB issued Statement 165 “Subsequent Events,” to incorporate the accountingand disclosure requirements for subsequent events into GAAP. Statement 165introduces new terminology, defines a date through which 

 

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management must evaluatesubsequent events, and lists the circumstances under which an entity mustrecognize and disclose events or transactions occurring after the balance sheetdate. We adopted Statement 165 as of June 30, 2009, which was the requiredeffective date.

 

**NOTE 2 –GOODWILL AND INTANGIBLE ASSETS**

 

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

 

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

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|----------------------|------------|-----------|------------|
| ** **                                             | ** ** | **US**                   | ** ** | **UK**               | ** ** | **US**    | ** ** | **UK** | ** ** | **Goodwill** | ** ** |
| Balance  as of December 31, 2008                  |       | $                        | —     |                 | $          | 6,611     |       | $ | 6,033 |   | $ | 8,167 |   | $ | 20,811 |   |
| Effects  of changes in foreign currency exchange rates |       | —                   |       | 934                  |       | —    |       | 1,153 |   | 2,087 |   |
| Balance  as of June 30, 2009                      |       | $                        | —     |                 | $          | 7,545     |       | $ | 6,033 |   | $ | 9,320 |   | $ | 22,898 |   |

 

We conducted our annual goodwill impairment test as of July 31,2008, and we determined that goodwill was not impaired as of the test date.From July 31, 2008 through June 30, 2009, no events have occurredthat we believe may have impaired goodwill.

 

We amortized identifiable intangible assets on a straight-line basis overestimated lives ranging from one to seven years and include the cumulativeeffects of foreign currency exchange rates. As of June 30, 2009 and December 31, 2008, identifiableintangibles were as follows (in thousands):

 
| ** **                 | ** ** | **June 30, 2009** | ** ** | **December 31, 2008**    | ** ** | **Weighted-**             | ** ** |
|----------------------------|------------|------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average  Amortization  Period** | ** ** |
| Purchased  software        |       | $                      | 1,765      |                          | $          | 1,164                     |       | $ | 601 |   | $ | 1,583 |   | $ | 902 |   | $ | 681 |   | 4.6 yrs |   |
| Purchased  licenses        |       | 227                    |       | 227                           |       | —                    |       | 227 |   | 227 |   | — |   | 2.3 yrs |   |
| Trademarks  and tradenames |       | 741                    |       | 317                           |       | 424                       |       | 649 |   | 232 |   | 417 |   | 7.0 yrs |   |
| Business  partnerships     |       | 121                    |       | 73                            |       | 48                        |       | 106 |   | 53 |   | 53 |   | 5.0 yrs |   |
| Customer  relationships    |       | 3,255                  |       | 2,014                         |       | 1,241                     |       | 2,986 |   | 1,763 |   | 1,223 |   | 5.3 yrs |   |
|                       |       | $                      | 6,109      |                          | $          | 3,795                     |       | $ | 2,314 |   | $ | 5,551 |   | $ | 3,177 |   | $ | 2,374 |   | 5.2 yrs |   |

 

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(1)  Changesin intangible values as of June 30, 2009 compared to December 31,2008 are the direct result of changes in foreign currency exchange rates forthe periods then ended.

 

Amortizationexpense of identifiable intangible assets was $0.2 and $0.4 million for thethree and six months ended June 30, 2009, respectively, and $0.4 and $0.8million for the three and six months ended June 30, 2008,respectively.  As Evolving Systems U.K.uses the British Pound Sterling as its functional currency, the amount offuture amortization actually recorded will be based upon exchange rates ineffect at that time. Expected future amortization expense related toidentifiable intangibles based on our carrying amount as of June 30, 2009was as follows (in thousands):

 
| **Twelve months ending June 30,** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|
| 2010                                   |       | $          | 748        |   |
| 2011                                   |       | 734        |       |
| 2012                                   |       | 416        |       |
| 2013                                   |       | 416        |       |
|                                   |       | $          | 2,314      |   |

 

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**NOTE 3 –EARNINGS PER COMMON SHARE**

 

Wecompute basic earnings per share (“EPS”) by dividing net income or lossavailable to common stockholders by the weighted average number of sharesoutstanding during the period (see Note 12), including common stock issuableunder participating securities, such as the previously outstanding Series BConvertible Redeemable Preferred Stock (“Series B Preferred Stock”). Wecompute diluted EPS using the weighted average number of shares outstanding,including participating securities, plus all potentially dilutive common stockequivalents. Common stock equivalents consist of stock options.

 

On January 1, 2009,we adopted Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”)Emerging Issues Task Force (“EITF”) 03-6-1, “Determining Whether InstrumentsGranted in Share-Based Payment Transactions Are Participating Securities.” ThisFSP provides that unvested share-based payment awards that containnon-forfeitable rights to dividends or dividend equivalents, whether paid orunpaid, are participating securities and shall be included in the computationof both basic and diluted earnings per share.   Upon adoption,both basic and diluted income per share for the first and second quarter of2009 and full year 2008 remained unchanged.

 

Thefollowing is the reconciliation of the denominator of the basic and diluted EPScomputations (in thousands):

 
| ** **                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Basic  income per common and preferred share:              | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  income available to common and preferred shareholders |       | $                                    | 1,102      |                               | $          | 775 |   | $ | 2,071 |   | $ | 531 |   |
| Weighted  average common shares outstanding                |       | 9,777                                |       | 9,687                              |       | 9,771 |   | 9,560 |   |
| Participating  securities                                  |       | —                               |       | —                             |       | — |   | 124 |   |
| Basic  weighted average shares outstanding                 |       | 9,777                                |       | 9,687                              |       | 9,771 |   | 9,684 |   |
| Basic  income per common and preferred share               |       | $                                    | 0.11       |                               | $          | 0.08 |   | $ | 0.21 |   | $ | 0.05 |   |
|                                                       |       |                                 |       |                               |       |   |   |   |   |
| Diluted  income per common and preferred share:            |       |                                 |       |                               |       |   |   |   |   |
| Net  income available to common and preferred shareholders |       | $                                    | 1,102      |                               | $          | 775 |   | $ | 2,071 |   | $ | 531 |   |
| Weighted  average common shares outstanding                |       | 9,777                                |       | 9,687                              |       | 9,771 |   | 9,560 |   |
| Participating  securities                                  |       | —                               |       | —                             |       | — |   | 124 |   |
| Effect  of dilutive securities – options              |       | 310                                  |       | 235                                |       | 221 |   | 236 |   |
| Diluted  weighted average shares outstanding               |       | 10,087                               |       | 9,922                              |       | 9,992 |   | 9,920 |   |
| Diluted  income per common and preferred share             |       | $                                    | 0.11       |                               | $          | 0.08 |   | $ | 0.21 |   | $ | 0.05 |   |

 

Forthe three months ended June 30, 2009 and 2008, 1.8 million and 1.3 millionshares of common stock were excluded from the dilutive stock calculationbecause their exercise prices were greater than the average fair value of ourcommon stock for the period. For the six months ended June 30, 2009 and2008, 1.9 million and 1.3 million shares of common stock were excluded from thedilutive stock calculation because their exercise prices were greater than theaverage fair value of our common stock for the period.

 

**NOTE 4 –SHARE-BASED COMPENSATION**

 

We adopted SFAS 123R effective January 1, 2006 usingthe modified prospective method.  Werecognized $0.2 million for each of the three months ended June 30, 2009and 2008 and $0.4 million and $0.5 million for the six months ended June 30,2009 and 2008, respectively, of compensation expense in the consolidatedstatements of operations, with respect to our stock-based compensation plans.  The following table summarizes stock-basedcompensation expenses recorded in the statement of operations (in thousands):

 
| ** **                                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost  of license fee and services, excluding depreciation and amortization |       | $                                    | 18         |                               | $          | 13 |   | $ | 35 |   | $ | 30 |   |
| Cost  of customer support, excluding depreciation and amortization         |       | 2                                    |       | 2                                  |       | 4 |   | 4 |   |
| Sales  and marketing                                                       |       | 35                                   |       | 41                                 |       | 72 |   | 83 |   |
| General  and administrative                                                |       | 148                                  |       | 152                                |       | 271 |   | 298 |   |
| Product  development                                                       |       | 22                                   |       | 20                                 |       | 44 |   | 41 |   |
|                                                                       |       | $                                    | 225        |                               | $          | 228 |   | $ | 426 |   | $ | 456 |   |

 

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**StockOption Plan**

 

In January 1996,our stockholders approved an Amended and Restated Stock Option Plan (the “OptionPlan”).  Under the Option Plan, asamended, and after the reverse stock split (See Note 12), 4,175,000 shares werereserved for issuance.  Options issuedunder the Option Plan were at the discretion of the Board of Directors,including the vesting provisions of each stock option granted. Options weregranted with an exercise price equal to the closing price of our common stockon the date of grant, generally vest over four years and expire no more thanten years from the date of grant. The Option Plan terminated on January 18,2006; options granted before that date were not affected by the plantermination.  At June 30, 2009 and2008, 1.8 million and 1.9 million options remained outstanding under the OptionPlan, respectively.

 

In March 2007,upon the hiring of our Vice President of World Wide Sales and Marketing, inaccordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv), the Board ofDirectors approved an inducement award under a stand-alone equity incentiveplan.  We granted 50,000 non-qualifiedoptions to purchase shares of our common stock at an exercise price equal tothe closing price of our common stock on the date of grant.  The options vest over four years and expireten years from the date of grant. At June 30, 2009 and 2008, 50,000options remained outstanding under this plan.

 

In June 2007,our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”).  As a result of the reverse stock split on July 21,2009, a maximum of 1,000,000 shares can be issued under the 2007 Stock Plan.Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights,Restricted Stock, Restricted Stock Units, Performance Awards and OtherStock-Based Awards.  Awards issued underthe 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with anexercise price equal to the closing price of our common stock on the date ofgrant, generally vest over four years and expire no more than ten years fromthe date of grant.  At June 30, 2009and 2008, 0.5 million and 0.3 million options remained outstanding under the2007 Stock Plan, respectively.

 

In December 2008,under the 2007 Stock Plan, we awarded a total of 52,500 shares of restrictedstock to members of our Board of Directors and senior management. There were noissuances of restricted stock during either of three or six months ended June 30,2009 or 2008. During the three months ended June 30, 2009 and 2008, 11,000and 7,000 shares of restricted stock vested, respectively.  During the six months ended June 30,2009 and 2008, 21,000 and 14,000 shares of restricted stock vested,respectively. There were no forfeitures of restricted stock during the eitherof the three or six months ended June 30, 2009 and 2008. The fair marketvalue for share-based compensation expensing is equal to the closing price ofour common stock on the date of grant. The restrictions on the stock award arereleased generally over four years for senior management and over one year forboard members.

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesmodel.  The Black-Scholes model uses fourassumptions to calculate the fair value of each option grant.  The expected term of share options granted isderived using the simplified method as prescribed by the SEC Staff AccountingBulletin 107 (“SAB 107”), “Share-Based Payment”, which we adopted in January 2008.The risk-free interest rate is based upon the rate currently available onzero-coupon U.S. Treasury instruments with a remaining term equal to theexpected term of the stock options.  Theexpected volatility is based upon historical volatility of our common stockover a period equal to the expected term of the stock options.  The expected dividend yield is zero and isbased upon historical and anticipated payment of dividends.  The weighted-average assumptions used in thefair value calculations are as follows:

 
| ** **               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected  term (years)   |       | 5.3                                  |       | *                                  |       | 5.3 |   | 6.2 |   |
| Risk-free  interest rate |       | 2.9                                  | %          | *                                  |       | 2.4 | % | 2.7 | % |
| Expected  volatility     |       | 76.9                                 | %          | *                                  |       | 78.0 | % | 101.9 | % |
| Expected  dividend yield |       | 0                                    | %          | *                                  |       | 0 | % | 0 | % |

 

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* - None granted

 

The following is asummary of stock option activity under the plans for the six months ended June 30,2009:

 

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| ** **                                     | ** ** | **Number of  Shares  (in thousands)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value   (in thousands)** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Options  outstanding at December 31, 2008 |       | 2,327                                 |       | $                                       | 5.62       |                                                          |       |                                             | $          | 78 |   |
| Options  granted                               |       | 75                                    |       | $                                       | 3.38       |                                                          |       |                                             |       |   |
| Less  options forfeited                        |       | (5                                    | )          | $                                       | 5.18       |                                                          |       |                                             |       |   |
| Less  options expired                          |       | —                                |       | —                                  |       |                                                          |       |                                             |       |
| Less  options exercised                        |       | (1                                    | )          | $                                       | 1.16       |                                                          |       |                                             |       |   |
| Options  outstanding at June 30, 2009     |       | 2,396                                 |       | $                                       | 5.54       |                                                          | 5.35       |                                             | $          | 2,679 |   |
|                                           |       |                                  |       |                                    |       |                                                          |       |                                             |       |
| Options  exercisable at June 30, 2009     |       | 1,963                                 |       | $                                       | 6.04       |                                                          | 4.61       |                                             | $          | 1,851 |   |

 

·                  All stock option amounts have beenadjusted for the reverse stock split (see Note 12)

 

Theweighted-average grant-date fair value of stock options granted during thethree months ended June 30, 2009 was $4.70. There were no stock optionsgranted during the three months ended June 30, 2008. The weighted-averagegrant-date fair value of stock options granted during the six months ended June 30,2009 and 2008 was $3.37 and $3.34, respectively.

 

As of June 30,2009, there was approximately $1.3 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 2.1 years.

 

The total fairvalue of stock options vested during the three months ended June 30, 2009and 2008 was $0.2 million and $0.3 million, respectively. The total fair valueof stock options vested during the six months ended June 30, 2009 and 2008was $0.4 million and $0.5 million, respectively.

 

The deferredincome tax benefits from stock option expense related to Evolving Systems U.K.totaled approximately $15,000 and $14,000 for the three months ended June 30,2009 and 2008, respectively. The deferred income tax benefits from stock optionexpense related to Evolving Systems U.K. totaled approximately $30,000 and$29,000 for the six months ended June 30, 2009 and 2008, respectively.

 

Cash received fromstock option exercises for the three months ended June 30, 2009 was$1,000. There was no cash received from stock options for any of the otherperiods presented.

 

**EmployeeStock Purchase Plan**

 

Under the EmployeeStock Purchase Plan (“ESPP”), we were previously authorized to issue up to1,100,000 shares of our common stock to full-time employees, nearly all of whomare eligible to participate. After the reverse stock split (see Note 12), weare now authorized to issue up to 550,000 shares under the ESPP. Under theterms of the ESPP, employees may elect to have up to 15% of their grosscompensation withheld through payroll deduction to purchase our common stock,capped at $25,000 annually. The purchase price of the stock is 85% of the lowerof the market price at the beginning or end of each three-month participationperiod. As of June 30, 2009, there were approximately 100,000 sharesavailable for purchase.  For the threemonths ended June 30, 2009 and 2008, we recorded compensation expense of$6,000 and $5,000, respectively, and $11,000 for each of the six month periodsended June 30, 2009 and 2008, associated with grants under the ESPP whichincludes the fair value of the look-back feature of each grant as well as the15% discount on the purchase price.  Thisexpense fluctuates each period based upon employee participation.

 

The fair value ofeach purchase made under our ESPP is estimated on the date of purchase usingthe Black-Scholes model.  TheBlack-Scholes model uses four assumptions to calculate the fair value of eachpurchase.  The expected term of eachpurchase is based upon the three-month participation period of eachoffering.  The risk-free interest rate isbased upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of eachoffering.  The expected volatility isbased upon historical volatility of our common stock.  The expected dividend yield is based uponhistorical and anticipated payment of dividends.  The weighted average assumptions used in thefair value calculations are as follows:

 

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| ** **               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected  term (years)   |       | 0.25                                 |       | 0.25                               |       | 0.25 |   | 0.25 |   |
| Risk-free  interest rate |       | 0.2                                  | %          | 1.9                                | %          | 0.2 | % | 1.6 | % |
| Expected  volatility     |       | 66.0                                 | %          | 68.9                               | %          | 65.6 | % | 69.8 | % |
| Expected  dividend yield |       | 0                                    | %          | 0                                  | %          | 0 | % | 0 | % |

 

Cash received fromemployee stock plan purchases for the three months ended June 30, 2009 and2008 was $18,000 and $20,000, respectively. Cash received from employee stock plan purchases for the six monthsended June 30, 2009 and 2008 was $33,000 and $36,000, respectively.

 

We issued sharesrelated to the ESPP of 12,000 and 6,000 for the three months ended June 30,2009 and 2008, respectively. We issued shares related to the ESPP of 23,000 and11,000 for the six months ended June 30, 2009 and 2008, respectively.

 

**NOTE 5 – CONCENTRATION OF CREDIT RISK**

 

For the three months ended June 30, 2009, two significantcustomers (defined as contributing at least 10%) accounted for 33% (21% and 12%)of total revenue.  These customers arelarge telecommunications operators located in the U.S. and Africa,respectively.  For the six months ended June 30,2009, one significant customer accounted for 24% of total revenue. Thiscustomer is a large telecommunications operator in the U.S. For the three andsix months ended June 30, 2008, two significant customers accounted for29% (18% and 11%) and 27% (15% and 12%), respectively, of total revenue.  These customers are large telecommunicationsoperators located in the U.S. and U.K., respectively.

 

As of June 30, 2009, one significant customer accounted forapproximately 25% of contract receivables. This customer is a large wireless company located in Africa.  AtDecember 31, 2008, one significant customer accounted for approximately45% of contract receivables.  Thiscustomer is a large telecommunications operator located in the U.S.

 

**NOTE 6 – LONG-TERM DEBT**

 

Long-term debt consistsof the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Senior  term loan with financial institution, interest at a fixed rate of 8.25%,  principal installments and interest payments are due monthly with final  maturity on February 22, 2010. The loan is secured by substantially all  of our assets.             |       | $                 | 1,333      |                  | $          | 2,333 |   |
| Long-term  unsecured subordinated notes payable, interest ranges from 11-14% with a  weighted average rate of 12.74% and 13.72% at June 30, 2009 and  December 31, 2008, respectively, accrued interest and principal are due  in full May 16, 2011. |       | 2,977             |       | 4,550                 |       |
| Total  debt                                                                                                                                                                                                                                                         |       | 4,310             |       | 6,883                 |       |
| Less  current portion                                                                                                                                                                                                                                               |       | (1,333            | )          | (2,000                | )          |
| Long-term  debt, excluding current portion                                                                                                                                                                                                                          |       | $                 | 2,977      |                  | $          | 4,883 |   |

 

OnFebruary 22, 2008, we replaced our existing senior term note and seniorrevolving facility with a new $4.0 million senior term loan, a $1.0 millionU.S. revolving credit facility (“U.S. Revolving Facility”) and a $5.0 millionU.K. revolving credit facility (“U.K. Revolving Facility”).  On December 18, 2008 we modified ourU.S. and U.K. Revolving Facilities. The U.S. Revolving Facility is now a $2.5million credit facility and the U.K. Revolving Facility is now a $3.5 millionfacility. All other terms and conditions remained the same. There have been noborrowings on either facility and therefore there are no outstanding balanceson either facility as of June 30, 2009.

 

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

 

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The remainingscheduled principal payments as of June 30, 2009 on our long-term debt areas follows (in thousands):

 
| **Year ending June 30,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2010                          |       | $          | 1,333      |   |
| 2011                          |       | 2,977      |       |
|                          |       | $          | 4,310      |   |

 

Our $2.5 million U.S. Revolving Facility bears interest at Prime Rateplus 0.5%.  Prime Rate was 3.25% as of June 30,2009.  Borrowings under the seniorrevolving facilities are limited to a percentage of our eligible accountsreceivable and cash.  The U.S. RevolvingFacility is secured by all assets of Evolving Systems, Inc. and is subjectto the same covenants as the senior term loan. All accrued interest on outstanding borrowings under the U.S. RevolvingFacility is paid monthly, with any outstanding balance due with a finalmaturity of February 22, 2011.  Asof June 30, 2009, we had $2.5 million in availability, but no borrowingoutstanding under this U.S. Revolving Facility.

 

Our $3.5 million U.K. Revolving Facility bears interest at Prime Rateplus 0.5%.  Prime Rate was 3.25% as of June 30,2009.  Borrowings under the U.K.Revolving Facility are limited to a percentage of our eligible accountsreceivable and cash.  The U.K. RevolvingFacility is secured by all assets of Evolving Systems Holdings Ltd. andEvolving Systems Ltd. and is subject to the same covenants as the Senior TermLoan.  All accrued interest onoutstanding borrowings under the U.K. Revolving Facility is paid monthly, withany outstanding balance due with a final maturity of February 22,2011.  As of June 30, 2009, we had$3.5 million in availability, but no borrowing outstanding under this U.K.Revolving Facility.

 

In connection with the replacement of our existing senior term note andsenior revolving facility with the new senior term loan and U.S. RevolvingFacility and the U.K. Revolving Facility, during the three months ended March 31,2008, we recorded a write-off of debt issuance costs associated with theretired senior debt of approximately $0.3 million.  Additionally, we capitalized debt issuancecosts related to our new senior debt of approximately $0.3 million.  These newly capitalized debt issuance costswill be amortized over the term of the new senior debt.

 

On April 20, 2009, we made an optional pre-payment of $1.0 millionto the holders of our subordinated notes.  On March 11,2009, we paid $2.0 million against our subordinated notes, including accruednon-current interest. Both payments were unscheduled and reduced balances thatotherwise would have been classified as long-term as of December 31, 2009.

 

On February 22, 2008, we paid $272,000 to retire $279,000 ofsubordinated debt and related accrued interest held by two of our subordinatednote holders.  The retirements includedprincipal of $217,000 and accrued interest of $62,000.  The $7,000 gain on extinguishment of thisdebt is reflected within our other income (expense) on the consolidatedstatements of operations.  On February 22,2008, we also paid $728,000 in accrued interest to the remaining subordinatednote holders.

 

The remaininglong-term unsecured subordinated notes payable of $3.0 million, at June 30,2009, accrued interest at 11% through December 31, 2007 and 14%thereafter.  Interest expense wasrecognized using an effective rate of 12.74% through June 30, 2009 and13.72% through December 31, 2008.

 

The unsecuredsubordinated notes are subordinate to the senior note and senior revolvingcredit facility.  The unsecuredsubordinated notes payable agreements subject us to certain affirmative andnegative covenants; however, certain covenants are not in effect until thesenior note and senior revolving credit facility are paid in full.  Outstanding amounts of the unsecuredsubordinated notes may be accelerated upon the occurrence of an uncured eventof default or if we achieve certain minimum cash thresholds.  Accrued interest on the unsecuredsubordinated notes payable is separately reflected on the balance sheet under “Otherlong-term obligations.”

 

We were in compliancewith all of our debt covenants as of June 30, 2009 and December 31,2008.

 

**NOTE 7 —INCOME TAXES**

 

Werecorded net income tax expense of $53,000 and $113,000 for the three monthsended June 30, 2009 and 2008, respectively.  The net expense during the three months endedJune 30, 2009 consisted of income tax expense of $38,000 and a deferredtax expense of $15,000. The net expense during the three months ended June 30,2008 consisted of income tax expense of $175,000 and a deferred tax benefit of$62,000, related to our U.K.-based operations.

 

Werecorded net income tax expense of $58,000 and $39,000 for the six months endedJune 30, 2009 and 2008, respectively.

 

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The net expense duringthe six months ended June 30, 2009 consisted of income tax expense of$94,000 and a deferred tax benefit of $36,000. The net expense during the sixmonths ended June 30, 2008 consisted of income tax expense of $180,000 anda deferred tax benefit of $141,000, related to our U.K.-based operations.

 

Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe amortization of these identifiable intangibles is not deductible for incometax purposes, we established a long-term deferred tax liability of $4.6 millionat the acquisition date for the expected difference between what would beexpensed for financial reporting purposes and what would be deductible forincome tax purposes. As of June 30, 2009 and December 31, 2008, thiscomponent of the deferred tax liability was $0.6 million and $0.7 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

As of June 30, 2009and December 31, 2008 we continued to maintain a full valuation allowanceon the domestic net deferred tax asset as we have determined it is more likelythan not that we will not realize our domestic deferred tax assets.  Such assets primarily consist of certain netoperating loss carryforwards.  Weassessed the realizability of our domestic deferred tax assets using allavailable evidence.  In particular, weconsidered both historical results and projections of profitability for thereasonably foreseeable future periods. We are required to reassess our conclusions regarding the realization ofour deferred tax assets at each financial reporting date. A future evaluationcould result in a conclusion that all or a portion of the valuation allowanceis no longer necessary which could have a material impact on our results ofoperations and financial position.

 

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

 

On January 1,2007, we recorded a FIN 48 transition adjustment consisting of a $0.4 milliondecrease in our deferred tax assets related to Research and Development TaxCredits that was offset by a corresponding decrease in our valuation allowancebecause we determined that it was not more likely than not that our deferredtax assets would be realized.  As of June 30,2009 and December 31, 2008, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes in our unrecognized tax positions over the next twelvemonths.

 

We conductbusiness globally and, as a result, Evolving Systems, Inc. or one or moreof our subsidiaries file income tax returns in the U.S. federal jurisdictionand various state and foreign jurisdictions. In the normal course of business, we are subject to examination bytaxing authorities throughout the world, namely the United Kingdom, Germany andIndia.  With few exceptions, we are nolonger subject to U.S. federal, state and local, or non-U.S. income taxexaminations for years before 2005.

 

**NOTE 8 —STOCKHOLDERS’ EQUITY**

 

OnFebruary 25, 2008, holders of 461,758 shares of Series B PreferredStock with a carrying value of $5.4 million, or approximately 96% of theoutstanding preferred stock, converted their shares of preferred stock into692,637 shares of our common stock in accordance with the conversion provisionsof the Series B Preferred Stock.  OnMarch 19, 2008, a holder of 16,992 shares of Series B Preferred Stockwith a carrying value of $0.2 million, which represented the remainder of theoutstanding preferred stock, converted his shares of preferred stock into25,488 shares of our common stock in accordance with the conversion provisionsof the Series B Preferred Stock.  As we previously included the Series BConvertible Preferred Stock as a participating security for basic EPS purposes,these conversions did not change our basic or diluted EPS calculations.

 

OnMarch 4, 2009 our Board of Directors adopted a stockholder rights planthat is designed to strengthen the ability of the Board of Directors to protectEvolving Systems’ stockholders.  The plan was not adopted in response toany unsolicited offer or takeover attempt. Under the plan, each commonstockholder of the Company at the close of business on March 16, 2009received a dividend of one right for each share of the Company’s common stockheld of record on that date.  Each right will entitle the holder topurchase from the Company, in certain circumstances, two one-hundredths of ashare of newly-created Series C junior participating preferred stock ofthe Company for an initial purchase price of $8.00 per share. The rightsdistribution will not be taxable to stockholders and the distribution of rightsunder the plan will not interfere with the Company’s business plans or bedilutive to or affect the Company’s reported per share results.

 

**NOTE 9 —SEGMENT INFORMATION**

 

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” we define operating segments as components of anenterprise for which separate financial information is reviewed regularly bythe chief

 

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operating decision-makinggroup to evaluate performance and to make operating decisions. We haveidentified our Chief Executive Officer and Chief Financial Officer as our chiefoperating decision-makers (CODM). These chief operating decision makers reviewrevenues by segment and review overall results of operations.

 

Wecurrently operate our business as two operating segments based on revenuetype:  license fees and services revenueand customer support revenue (as shown on the consolidated statements ofoperations).  License fees and services(L&S) revenue represents the fees received from the license of softwareproducts and those services directly related to the delivery of the licensedproducts, such as fees for custom development and integration services.  Customer support (CS) revenue includes annualsupport fees, recurring maintenance fees, fees for maintenance upgrades andwarranty services.  Warranty servicesthat are similar to software maintenance services are typically bundled with alicense sale. Total assets by segment have not been disclosed as theinformation is not available to the chief operating decision-making group.

 

Segmentinformation is as follows (in thousands):

 
| ** **                                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Revenue**                                                                 | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** |   |   |   |
| License  fees and services                                                  |       | $                                    | 5,359      |                               | $          | 5,342 |   | $ | 10,104 |   | $ | 10,174 |   |
| Customer  support                                                           |       | 4,270                                |       | 4,303                              |       | 8,368 |   | 8,598 |   |
| Total  revenue                                                              |       | 9,629                                |       | 9,645                              |       | 18,472 |   | 18,772 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| **Revenue less costs of revenue, excluding depreciation and  amortization** |       |                                 |       |                               |       |   |   |   |   |
| License  fees and services                                                  |       | 3,294                                |       | 3,440                              |       | 6,362 |   | 6,048 |   |
| Customer  support                                                           |       | 2,869                                |       | 2,671                              |       | 5,534 |   | 5,473 |   |
|                                                                        |       | 6,163                                |       | 6,111                              |       | 11,896 |   | 11,521 |   |
| **Unallocated Costs**                                                       |       |                                 |       |                               |       |   |   |   |   |
| Other  operating expenses                                                   |       | 4,027                                |       | 4,380                              |       | 8,042 |   | 9,060 |   |
| Depreciation  and amortization                                              |       | 341                                  |       | 631                                |       | 668 |   | 1,241 |   |
| Interest  income                                                            |       | (18                                  | )          | (39                                | )          | (23 | ) | (117 | ) |
| Interest  expense                                                           |       | 161                                  |       | 283                                |       | 418 |   | 619 |   |
| Loss  on extinguishment of debt                                             |       | —                               |       | —                             |       | — |   | 290 |   |
| Foreign  currency exchange loss (gain)                                      |       | 497                                  |       | (32                                | )          | 662 |   | (142 | ) |
| **Income before income taxes**                                              |       | $                                    | 1,155      |                               | $          | 888 |   | $ | 2,129 |   | $ | 570 |   |

 

***Geographic Regions***

 

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

 
| ** **      | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------|------------|--------------------------------------|------------|
| ** **      | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **      | ** ** | **L&S**                          | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**     |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| United  States  |       | $                                    | 664        |   | $ | 2,336 |   | $ | 3,000 |   | $ | 822 |   | $ | 2,439 |   | $ | 3,261 |   |
| United  Kingdom |       | 638                                  |       | 525 |   | 1,163 |   | 1,194 |   | 635 |   | 1,829 |   |
| Other           |       | 4,057                                |       | 1,409 |   | 5,466 |   | 3,326 |   | 1,229 |   | 4,555 |   |
| Total  revenues |       | $                                    | 5,359      |   | $ | 4,270 |   | $ | 9,629 |   | $ | 5,342 |   | $ | 4,303 |   | $ | 9,645 |   |

 

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| ** **      | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------|------------|------------------------------------|------------|
| ** **      | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| ** **      | ** ** | **L&S**                        | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| United  States  |       | $                                  | 1,347      |   | $ | 4,907 |   | $ | 6,254 |   | $ | 1,221 |   | $ | 4,909 |   | $ | 6,130 |   |
| United  Kingdom |       | 1,325                              |       | 1,019 |   | 2,344 |   | 2,387 |   | 1,317 |   | 3,704 |   |
| Other           |       | 7,432                              |       | 2,442 |   | 9,874 |   | 6,566 |   | 2,372 |   | 8,938 |   |
| Total  revenues |       | $                                  | 10,104     |   | $ | 8,368 |   | $ | 18,472 |   | $ | 10,174 |   | $ | 8,598 |   | $ | 18,772 |   |

 

Financialinformation relating to product groupings was as follows (in thousands):

** **
| ** **           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **           | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Revenue**          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Activation           |       | $                                    | 5,674      |                               | $          | 5,325 |   | $ | 10,516 |   | $ | 10,017 |   |
| Numbering  solutions |       | 3,383                                |       | 3,492                              |       | 6,771 |   | 6,424 |   |
| Mediation            |       | 572                                  |       | 828                                |       | 1,185 |   | 2,331 |   |
| Total  revenues      |       | $                                    | 9,629      |                               | $          | 9,645 |   | $ | 18,472 |   | $ | 18,772 |   |

 

**NOTE10 — COMMITMENTS AND CONTINGENCIES**

 

**(a)****                                 ****Other Commitments**

 

Aspermitted under Delaware law, we have agreements with officers and directorsunder which we agree to indemnify them for certain events or occurrences whilethe officer or director is, or was, serving at our request in this capacity.The term of the indemnification period is indefinite. There is no limit on theamount of future payments we could be required to make under theseindemnification agreements; however, we maintain Director and Officer insurancepolicies, as well as an Employment Practices Liability Insurance Policy, thatmay enable us to recover a portion of any amounts paid. As a result of ourinsurance policy coverage, we believe the estimated fair value of theseindemnification agreements is minimal. Accordingly, there were no liabilitiesrecorded for these agreements as of June 30, 2009 or December 31,2008.

 

Weenter into standard indemnification terms with customers and suppliers,  in the ordinary course of business for thirdparty claims arising under our contracts. In addition, as we may subcontractthe development of deliverables under customer contracts, we could be requiredto indemnify customers for work performed by subcontractors. Depending upon thenature of the indemnification, the potential amount of future payments we couldbe required to make under these indemnification agreements may be unlimited. Wemay be able to recover damages from a subcontractor or other supplier if theindemnification results from the subcontractor’s or supplier’s failure toperform. To the extent we are unable to recover damages from a subcontractor orother supplier, we could be required to reimburse the indemnified party for thefull amount. We have never incurred costs to defend lawsuits or settle claimsrelating to an indemnification. As a result, we believe the estimated fairvalue of these agreements is minimal. Accordingly, there were no liabilitiesrecorded for these agreements as of June 30, 2009 or December 31,2008.

 

Ourstandard license agreements contain product warranties that the software willbe free of material defects and will operate in accordance with the statedrequirements for a limited period of time. The product warranty provisions require us to cure any defects throughany reasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, there were no liabilitiesrecorded for these product warranty provisions as of June 30, 2009 or December 31,2008.

 

Oursoftware arrangements generally include a product indemnification provisionwhereby we will indemnify and defend a customer in actions brought against thecustomer for claims that our products infringe upon a copyright, trade secret,or valid patent. We have not historically incurred any significant costsrelated to product indemnification claims. Accordingly, there were noliabilities recorded for these indemnification provisions as of June 30,2009 or December 31, 2008.

 

Inrelation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreedto indemnify certain parties from any losses, actions, claims, damages orliabilities (or actions in respect thereof) resulting from any claim raised bya third party.  We do not believe that therewill be any claims related to these indemnifications. Accordingly, there wereno liabilities recorded for these agreements as of June 30, 2009 or December 31,2008.

 

**(b)****                                 ****Litigation**

 

During the fourthquarter of 2006, a previous vendor filed a complaint in the Superior Court ofNew Jersey against us asserting we breached certain provisions of a licenseagreement. On April 10, 2009, we settled our litigation with this previousvendor and the matter pending in the United States District Court of New Jerseywas dismissed with prejudice.

 

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

 

**NOTE11 — RELATED PARTY TRANSACTIONS**

 

During 2008, weentered into a consulting agreement with Stephen K. Gartside, Jr., ourprevious President and CEO and current Chairman of the Board.  Under the agreement, we paid Mr. Gartsidean annual fee of $20,000 for consulting services provided to us during 2008. Wehad current obligations in the consolidated balance sheets, under theagreement, of $0 and $5,000 as of June 30, 2009 and December 31,2008, respectively.    We recorded $5,000and $10,000 of general and administrative expense in the consolidatedstatements of operations, related to this agreement, for the three and sixmonths ended June 30, 2008. This contract terminated December 31,2008.

 

**NOTE12 — SUBSEQUENT EVENTS**

 

On July 1,2009, we announced that our Board of Directors approved a one-for-two reversesplit of our common stock, as previously authorized and approved by ourstockholders at the June 9, 2009 annual meeting, which took effect at11:59 p.m. (Eastern time) on July 20, 2009 (the “Effective Time”).Our common stock began trading on a post-split basis on July 21, 2009. Asa result of the reverse stock split, every two shares of the Company’s commonstock was combined into one share of common stock. The reverse stock splitaffects all the Company’s common stock outstanding immediately prior to theEffective Time of the reverse stock split as well as the number of shares ofcommon stock available for issuance under the Company’s equity incentive plans.In addition, the reverse stock split reduced the number of shares of commonstock issuable upon the exercise of stock options. The Company’s common stockoutstanding at June 30, 2009 was approximately 19.6 million shares.Adjusting for the reverse stock split, the common stock outstanding at June 30,2009 was reduced to approximately 9.8 million shares. The number of authorizedshares of common stock remained at 40.0 million.  The reverse split did not affect the parvalue of our common stock and will remain at $0.001. As a result of the reversestock split, the stated capital on our balance sheet attributable to our commonstock was reduced in proportion to the size of the reverse stock split. Commonstock and additional paid-in capital balances, all share amounts, stock optionamounts and per share/option prices appearing in this Quarterly Report on Form 10-Qreflect the reverse stock split for all periods presented.

 

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

 

**SPECIAL NOTE ABOUT FORWARD-LOOKINGSTATEMENTS**

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements thathave been made pursuant to the provisions of the Private Securities LitigationReform Act of 1995.  Theseforward-looking statements are based on current expectations, estimates, andprojections about Evolving Systems’ industry, management’s beliefs, and certainassumptions made by management. Forward-looking statements include our expectations regarding product,services, and maintenance revenue, annual savings associated with theorganizational changes effected in prior years, and short- and long-term cashneeds.  In some cases, words such as “anticipates”,“expects”, “intends”, “plans”, “believes”, “estimates”, variations of thesewords, and similar expressions are intended to identify forward-lookingstatements.  The statements are not guaranteesof future performance and are subject to certain risks, uncertainties, andassumptions that are difficult to predict; therefore, actual results may differmaterially from those expressed or forecasted in any forward-lookingstatements.  Risks and uncertainties ofour business include those set forth in our Annual Report on Form 10-K forthe year ended December 31, 2008 under “Item 1A. Risk Factors” as well asadditional risks described in this Form 10-Q.  Unless required by law, we undertake no obligationto update publicly any forward-looking statements, whether as a result of newinformation, future events, or otherwise. However, readers should carefully review the risk factors set forth inother reports or documents we file from time to time with the Securities andExchange Commission, particularly the Quarterly Reports on Form 10-Q andany Current Reports on Form 8-K.*

 

**OVERVIEW**

 

We area worldwide provider of software solutions and services to telecommunicationscarriers, with 70 network operators in 45 countries.  Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, highly reliable software solutions fora range of Operations Support Systems (“OSS”). Our activation solution is a leading packaged solution for serviceactivation in the wireless industry.

 

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

 

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**RECENTDEVELOPMENTS**

 

Beginning in thefourth quarter of 2008, the U.S. Dollar strengthened against many othercurrencies, including the British Pound Sterling and the Euro. As a result, theportion of the Company’s revenue which is denominated in foreign currencies,when converted to U.S. Dollars, is reduced. At the same time, with more than 50% of the Company’s operating expensesoriginating overseas, the strengthening dollar conversely lowers expensesoutside of the U.S. The net effect of our foreign currency translations for thethree months ended June 30, 2009 was a $0.8 million decrease in revenueand a $1.1 million decrease in operating expenses versus the three months endedJune 30, 2008.  The net effect ofour foreign currency translations for the six months ended June 30, 2009was a $1.8 million decrease in revenue and a $2.6 million decrease in operatingexpenses versus the six months ended June 30, 2008.

 

During the firsthalf of the year, we retired $3.0 million of our subordinated notes, includingaccrued non-current interest. This debt payment was unscheduled and reducedbalances classified as long-term as of December 31, 2008.

 

We reported netincome of $1.1 million and $2.1 million for the three and six months ended June 30,2009, respectively. This is the fifth consecutive quarter in which we havereported net income.  Our twelve monthbacklog increased to $19.3 million, including $9.6 million in license andservices and $9.7 million in customer support.

 

**RESULTSOF OPERATIONS**

 

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

 
| ** **                                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| **REVENUE**                                                                  |       |                                 |       |                               |       |   |   |   |   |
| License  fees and services                                                   |       | 56                                   | %          | 55                                 | %          | 55 | % | 54 | % |
| Customer  support                                                            |       | 44                                   | %          | 45                                 | %          | 45 | % | 46 | % |
| Total  revenue                                                               |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                 |       |                               |       |   |   |   |   |
| Costs  of license fees and services, excluding depreciation and amortization |       | 21                                   | %          | 20                                 | %          | 20 | % | 22 | % |
| Costs  of customer support, excluding depreciation and amortization          |       | 15                                   | %          | 17                                 | %          | 15 | % | 17 | % |
| Sales  and marketing                                                         |       | 20                                   | %          | 23                                 | %          | 21 | % | 23 | % |
| General  and administrative                                                  |       | 14                                   | %          | 13                                 | %          | 15 | % | 14 | % |
| Product  development                                                         |       | 7                                    | %          | 10                                 | %          | 8 | % | 11 | % |
| Depreciation                                                                 |       | 2                                    | %          | 2                                  | %          | 2 | % | 3 | % |
| Amortization                                                                 |       | 2                                    | %          | 4                                  | %          | 2 | % | 4 | % |
| Total  costs of revenue and operating expenses                               |       | 81                                   | %          | 89                                 | %          | 83 | % | 94 | % |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Income  from operations                                                      |       | 19                                   | %          | 11                                 | %          | 17 | % | 6 | % |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Interest  income                                                             |       | 0                                    | %          | 1                                  | %          | 0 | % | 1 | % |
| Interest  expense                                                            |       | (2                                   | )%         | (3                                 | )%         | (2 | )% | (3 | )% |
| Loss  on extinguishment of debt                                              |       | —                               |       | —                             |       | — |   | (2 | )% |
| Foreign  currency exchange gain (loss)                                       |       | (5                                   | )%         | 0                                  | %          | (4 | )% | 1 | % |
| Other  income, net                                                           |       | (7                                   | )%         | (2                                 | )%         | (6 | )% | (3 | )% |
|                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Income  before income taxes                                                  |       | 12                                   | %          | 9                                  | %          | 11 | % | 3 | % |
| Income  tax expense                                                          |       | 1                                    | %          | 1                                  | %          | 0 | % | 0 | % |
| Net  income                                                                  |       | 11                                   | %          | 8                                  | %          | 11 | % | 3 | % |

 

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***Revenue***

 

Revenueis comprised of license fees/services and customer support.  License fees and services revenue representthe fees we receive from the licensing of our software products and thoseservices directly related to the delivery of the licensed product as well asintegration and consulting services. Customer support revenue includes annual support, recurringmaintenance, maintenance upgrades and warranty services.  Warranty services consist of maintenanceservices and are typically bundled with a license sale and the related revenue,based on Vendor-Specific Objective Evidence (VSOE). Such revenues are deferredand recognized ratably over the warranty period.  The followingtable presents our revenue by product group (in thousands):

 
| ** **           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **           | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Revenue**          |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Activation           |       | $                                    | 5,674      |                               | $          | 5,325 |   | $ | 10,516 |   | $ | 10,017 |   |
| Numbering  solutions |       | 3,383                                |       | 3,492                              |       | 6,771 |   | 6,424 |   |
| Mediation            |       | 572                                  |       | 828                                |       | 1,185 |   | 2,331 |   |
| Total  revenues      |       | $                                    | 9,629      |                               | $          | 9,645 |   | $ | 18,472 |   | $ | 18,772 |   |

 

Revenuefor each of the three months ended June 30, 2009 and 2008 was $9.6million. For the three months ended June 30, 2009, increased revenue fromour new *Dynamic SIM Allocation**TM*(“DSA”) and international *NumeriTrack®*products was offset by the strengthened U.S. Dollar.

 

Revenuefor the six months ended June 30, 2009 and 2008 was $18.5 million and$18.8 million, respectively. The decrease of $0.3 million is primarily due tothe strengthened U.S. Dollar partially offset by increased revenue from our newDSA and international *NumeriTrack*products.

 

***License Fees and Services***

 

License fees and services revenue was $5.3 million for the three monthsended June 30, 2009 and 2008. Changes within license fees and services revenue included an increase of$0.3 million in revenue from our activation products, a decrease of $0.1million in revenue from our numbering solutions products and a decrease of $0.2million from our mediation products.  Theincrease in our activation and numbering solutions product revenue is theresult of increased sales of DSA and international *NumeriTrack*offsetby the strengthened U.S. Dollar. The decrease in mediation product revenue isdue to lower sales from our existing mediation account base.

 

License fees and services revenue decreased 1%, or $0.1 million, to$10.1 million for the six months ended June 30, 2009 from $10.2 millionfor the six months ended June 30, 2008. This decrease in license fees and services revenue was composed of anincrease of $0.8 million in revenue from our activation products, an increaseof $0.2 million in revenue from our numbering solutions products and a decreaseof $1.1 million in revenue from our mediation products.  The increase in our activation productrevenue is the result of increased DSA and international *NumeriTrack*sales, partially offset by the strengthened U.S. Dollar. The decrease in ourmediation product revenue is the result of lower sales from our existingmediation account base.

 

***Customer Support***

 

Customer support revenue was $4.3 million for the three months ended June 30,2009 and 2008.  The slight decrease incustomer support revenue resulted from a decrease in mediation customer supportrevenue.  The decrease in customersupport revenue is primarily the result of the strengthened U.S. dollar andpricing pressures from customers.

 

Customer support revenue decreased $0.2 million, or 3%, to $8.4 millionfor the six months ended June 30, 2009 from $8.6 million for the sixmonths ended June 30, 2008.  Thedecrease in customer support revenue resulted primarily from a decrease of $0.3million in activation customer support revenue, partially offset by a $0.1million increase in numbering solutions customer support revenue.  The decrease in customer support revenue isprimarily the result of the strengthened U.S. dollar and pricing pressures fromcustomers.

 

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

 

Costsof revenue, excluding depreciation and amortization, consist primarily ofpersonnel costs and other direct costs associated with these personnel,facilities costs, costs of third-party software and partner commissions.  Costs of revenue, excluding depreciation andamortization, were $3.5 million for the three months ended June 30, 2009and 2008, respectively. Costs of revenue, excluding depreciation andamortization, were $6.6 million and $7.3 million for the six months ended June 30,2009 and 2008, respectively.

 

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***Costsof License Fees and Services, Excluding Depreciation and Amortization***

 

Costs of license fees and services, excludingdepreciation and amortization, increased $0.2 million, or 9%, to $2.1 millionfor the three months ended June 30, 2009 from $1.9 million for the threemonths ended June 30, 2008. The increase in costs is the result of higherpartner commissions in emerging markets related to increased sales of DSA,partially offset by the effects of the strengthened U.S. Dollar. As apercentage of license fees and services revenue, costs of license fees andservices, excluding depreciation and amortization, increased to 39% for thethree months ended June 30, 2009 from 36% for the three months ended June 30,2008.  The increase in costs as apercentage of revenue is primarily due to the increase in partner commissionsoffset by the strengthened U.S. Dollar.

 

Costs of license fees and services, excludingdepreciation and amortization, decreased $0.4 million, or 9%, to $3.7 millionfor the six months ended June 30, 2009 from $4.1 million for the sixmonths ended June 30, 2008.  Thedecrease in costs is primarily the result of the effects of the strengtheningU.S. Dollar. As a percentage of license fees and services revenue, costs oflicense fees and services, excluding depreciation and amortization, decreasedto 37% for the six months ended June 30, 2009 from 41% for the six monthsended June 30, 2008.  The decrease incosts as a percentage of revenue is primarily due to the strengthened U.S.Dollar.

 

***Costsof Customer Support, Excluding Depreciation and Amortization***

 

Costs of customer support, excluding depreciation andamortization, decreased $0.2 million, or 14%, to $1.4 million for thethree months ended June 30, 2009 from $1.6 million for the threemonths ended June 30, 2008.  As apercentage of customer support revenue, costs of customer support revenue,excluding depreciation and amortization, decreased to 33% for the three monthsended June 30, 2009 from 38% for the three months ended June 30,2008.  These decreases are primarily theresult of the strengthened U.S. Dollar.

 

Costs of customer support, excluding depreciation andamortization, decreased $0.3 million, or 9%, to $2.8 million for the six monthsended June 30, 2009 from $3.1 million for the six months ended June 30,2008.  As a percentage of customersupport revenue, costs of customer support revenue, excluding depreciation andamortization, decreased to 34% for the six months ended June 30, 2009 from36% for the six months ended June 30, 2008. These decreases are primarilythe result of the strengthened U.S. Dollar.

 

***Salesand Marketing***

 

Sales and marketingexpenses primarily consist of compensation costs, including incentivecompensation and commissions, travel expenses, advertising, marketing andfacilities expenses. Sales and marketing expenses decreased $0.3 million, or11%, to $1.9 million for the three months ended June 30, 2009 from $2.2million for the three months ended June 30, 2008.  As a percentage of total revenue, sales andmarketing expenses decreased to 20% for the three months ended June 30,2009 from 23% for the three months ended June 30, 2008. The decrease inthe expense and percentage of revenue is primarily due to the effects of thestrengthening U.S. Dollar, partially offset by higher commissions related toincreased sales of DSA.

 

Sales and marketing expenses decreased $0.6 million,or 13%, to $3.8 million for the six months ended June 30, 2009 from $4.4million for the six months ended June 30, 2008.  As a percentage of total revenue, sales andmarketing expenses decreased to 21% for the six months ended June 30, 2009from 23% for the six months ended June 30, 2008. The decrease in theexpense and percentage of revenue is primarily due to the effects of thestrengthening U.S. Dollar, partially offset by higher commissions related toincreased sales of DSA.

 

***Generaland Administrative***

 

General and administrative expenses consist principallyof employee related costs and professional fees for the following departments:facilities, finance, legal, human resources, and certain executivemanagement.  General and administrativeexpenses increased $0.2 million, or 13%, to $1.4 million from $1.2million for the three months ended June 30, 2009 and 2008,respectively.  As a percentage of totalrevenue, general and administrative expenses for the three months ended June 30,2009 and 2008, increased to 14% from 13%, respectively.  These increases were primarily due toincreased professional fees.

 

General and administrative expenses increased $0.1million, or 6%, to $2.8 million from $2.7 million for the six months endedJune 30, 2009 and 2008, respectively. As a percentage of total revenue, general and administrative expensesfor the six months ended June 30, 2009 and 2008, increased to 15% from14%, respectively.  These increases wereprimarily due to increased professional fees.

 

***ProductDevelopment***

 

Product developmentexpenses consist primarily of employee related costs and subcontractorexpenses.  Product development expensesdecreased $0.3 million, or 28%, to $0.7 million from $1.0 million for the threemonths ended June 30, 2009 and 2008,

 

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respectively.  As a percentage of revenue, productdevelopment expenses for the three months ended June 30, 2009 and 2008,decreased to 7% from 10%, respectively. These decreases are the result of decreased hours spent oninternationalizing our *NumeriTrack*product,as well as the development of our DSA product as these products have beenreleased to our customers.

 

Product development expenses decreased $0.6 million,or 32%, to $1.4 million from $2.0 million for the six months ended June 30,2009 and 2008, respectively.  As apercentage of revenue, product development expenses for the six months ended June 30,2009 and 2008, decreased to 8% from 11%, respectively.  These decreases are the result of decreasedhours spent on internationalizing our *NumeriTrack*product,as well as on the development of DSA, as these products have been released toour customers.

 

***Amortization***

 

Amortization expenseconsists of amortization of identifiable intangible assets acquired through ouracquisitions of Evolving Systems U.K., TSE and CMS.  Amortization expense decreased 52% to $0.2million for the three months ended June 30, 2009 from $0.4 million for thethree months ended June 30, 2008. As a percentage of revenue, amortizationexpense for the three months ended June 30, 2009 and 2008, decreased to 2%from 4%, respectively. The decrease in amortization expense is due to all CMS,and some TSE intangible assets being fully amortized during 2008 and theeffects of the strengthened U.S. Dollar.

 

Amortization expensedecreased 53% to $0.4 million for the six months ended June 30, 2009 from$0.8 million for the six months ended June 30, 2008. As a percentage ofrevenue, amortization expense for the six months ended June 30, 2009 and2008, decreased to 2% from 4%, respectively. The decrease in amortizationexpense is due to all CMS, and some TSE intangible assets being fully amortizedduring 2008 and the effects of the strengthened U.S. Dollar.

 

***Depreciation***

 

Depreciationexpense consists of depreciation of long-lived property and equipment.  Depreciation expense decreased 37% to $0.2million for the three months ended June 30, 2009 from $0.3 million for thethree months ended June 30, 2008. As a percentage of total revenue,depreciation expense for the three months ended June 30, 2009 and 2008,decreased to 2% from 3%, respectively. The decrease is a result of certainassets becoming fully depreciated and the effects of the strengthened U.S.Dollar.

 

Depreciationexpense decreased 34% to $0.3 million for the six months ended June 30,2009 from $0.5 million for the six months ended June 30, 2008. As apercentage of total revenue, depreciation expense for the six months ended June 30,2009 and 2008, decreased to 2% from 3%, respectively. The decrease is a resultof certain assets becoming fully depreciated and the effects of thestrengthened U.S. Dollar.

 

***InterestExpense***

 

Interest expense includesinterest expense on our long-term debt and capital lease obligations as well asamortization of debt issuance costs. Interest expense was $0.2 million and $0.3 million for the three monthsended June 30, 2009 and 2008, respectively. The decrease of $0.1 millionis due to lower debt balances as we continue to pay down our subordinated debtand the continued payments on our senior term loan.

 

Interest expense was $0.4million and $0.6 million for the six months ended June 30, 2009 and 2008,respectively. The decrease of $0.2 million is due to lower debt balances as wecontinue to pay down our subordinated debt and the continued payments on oursenior term loan.

 

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

 

In February 2008,we wrote-off the remaining debt issuance costs of $297,000 related to oursenior term not payable that was replaced during the three months ended March 31,2008.  This loss related to the debtissuance cost write-off was partially offset by a $7,000 gain resulting from uspaying $272,000 to retire $279,000 of subordinated debt and related accruedinterest held by two of our subordinated note holders.  The retirements included principal of$217,000 and accrued interest of $62,000.

 

***ForeignCurrency Exchange Gain (Loss)***

 

Foreign currency transaction gains (losses) resultedfrom transactions denominated in a currency other than the functional currencyof the respective subsidiary and were $(497,000) and $32,000 for the threemonths ended June 30, 2009 and 2008, respectively, and $(662,000) and$142,000 for the six months ended June 30, 2009 and 2008,respectively.  The gains (losses) weregenerated primarily through the re-measurement of certain non-functionalcurrency denominated financial assets and liabilities of our Evolving SystemsU.K. subsidiary.

 

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***IncomeTaxes***

 

We recorded net incometax expense of $53,000 and $113,000 for the three months ended June 30,2009 and 2008, respectively.  The netexpense during the three months ended June 30, 2009 consisted of currentincome tax expense of $38,000, and deferred tax expense of $15,000. The currenttax expense primarily related to non-recoverable foreign withholding tax andestimated Alternative Minimum Tax (“AMT”) due in the U.S. The deferred taxexpense was related to us recording a valuation allowance related to our Indiandeferred tax asset, partially offset by the benefit related to the intangibleassets related to our U.K.-based operations. The net expense during the threemonths ended June 30, 2008 consisted of current income tax expense of$175,000 and deferred tax benefit of $62,000. Our effective tax rate of 5% forthe three months ended June 30, 2009 was down from an effective rate of13% for the three months ended June 30, 2008.  This reduction in our effective tax raterelates principally to an increased benefit from research and development taxcredits for our U.K.-based operations and increased income in the U.S., whichdue to its net operating losses, pays taxes at a lower effective rate.

 

We recorded net incometax expense of $58,000 and $39,000 for the six months ended June 30, 2009and 2008, respectively.  The net expenseduring the six months ended June 30, 2009 consisted of current income taxexpense of $94,000, partially offset by a deferred tax benefit of $36,000. Thecurrent tax expense primarily related to non-recoverable foreign withholdingtax and estimated AMT due in the U.S. The deferred tax expense was related tous recording an allowance related to our Indian deferred tax asset, partiallyoffset by the benefit related to the intangible assets related to ourU.K.-based operations. The net expense during the six months ended June 30,2008 consisted of current income tax expense of $180,000, partially offset by adeferred tax benefit of $141,000, both of which were primarily related to ourU.K.-based operations.  Our effective taxrate of 3% for the six months ended June 30, 2009 was down from 7% for thesix months ended June 30, 2008.  Thisreduction in our effective tax rate relates principally to an increased benefitfrom research and development tax credits for our U.K.-based operations andincreasing our income in the U.S., which due to its net operating losses, paystaxes at a lower effective rate.

 

In conjunction with theacquisition of Evolving Systems U.K., we recorded certain identifiableintangible assets.  Since theamortization of these identifiable intangibles is not deductible for income taxpurposes, we established a long-term deferred tax liability of $4.6 million atthe acquisition date for the expected difference between what would be expensedfor financial reporting purposes and what would be deductible for income taxpurposes. As of June 30, 2009 and December 31, 2008, this componentof the deferred tax liability was $0.6 million and $0.7 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

**FINANCIAL CONDITION**

 

Our working capitalposition increased $0.3 million to $2.1 million as of June 30, 2009 from a$1.8 million as of December 31, 2008.

 

**CONTRACTUAL OBLIGATIONS**

 

There have been nomaterial changes to the contractual obligations as disclosed in our 2008 AnnualReport on Form 10-K.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We have historicallyfinanced operations through cash flows from operations and equitytransactions.  At June 30, 2009, ourprincipal source of liquidity was $5.0 million in cash and cash equivalents,$9.0 million in contract receivables, net of allowance,  as well as $6.0 million available under ourrevolving credit facilities.

 

Net cash provided byoperating activities for the six months ended June 30, 2009 and 2008 was$1.6 million and $3.9 million, respectively. The primary contribution to the decrease in cash provided by operatingactivities for the six months ended June 30, 2009 was due primarily todecreased cash provided from contract receivables and additional payments ofaccounts payable and accrued liabilities and accrued interest paid on oursubordinated debt during the six months ended June 30, 2009.

 

Net cash used ininvesting activities during each of the six months ended June 30, 2009 and2008 was $0.3 and $0.4 million, respectively. The cash used for the six months ended June 30, 2009 and 2008 wasrelated to purchases of property and equipment.

 

Net cash used infinancing activities for the six months ended June 30, 2009 and 2008 was$2.6 million and $3.6 million, respectively. Financing activities in the six months ended June 30, 2009consisted primarily of principal payments on existing debt, of approximately$2.6 million.  Financing activities inthe six months ended June 30, 2008 consisted of principal payments onexisting debt, of approximately $7.3 million, partially offset by borrowingsrelated to our senior term loan, of approximately $3.7 million, net of issuancecosts.

 

We believe that ourcurrent cash and cash equivalents, together with anticipated cash flow fromoperations and availability under our revolving line of credit will besufficient to meet our working capital, capital expenditure and financingrequirements for at least the next twelve months. In making this assessment weconsidered the following:

 

·                  Our cash and cash equivalents balance at June 30, 2009 of$5.0 million;

 

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·                  The availability under our revolving credit facilities of $6.0 millionat June 30, 2009;

 

·                  Our demonstrated ability to generate positive cash flows fromoperations;

 

·                  Our backlog as of June 30, 2009 of approximately $19.3 million,including $9.6 million in license fees and services and $9.7 million incustomer support.

 

We are exposed to foreign currency rate risks whichimpact the carrying amount of our foreign subsidiaries and our consolidatedequity, as well as our consolidated cash position due to translationadjustments.  For the six months ended June 30,2009, the effect of exchange rate changes resulted in a $0.4 million increaseto consolidated cash.  During the sixmonths ended June 30, 2008, the effect of exchange rate changes resultedin a $13,000 decrease in consolidated cash. We do not currently hedge our foreign currency exposure, but we monitorrate changes and may hedge our exposures if we see significant negative trendsin exchange rates.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

We have no off-balancesheet arrangements that have a material current effect or that are reasonablylikely to have a material future effect on our financial condition, changes infinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVE MARKETRISK DISCLOSURES**

 

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

 

***InterestRate Risks***

 

Ourcash balances are subject to interest rate fluctuations and as a result,interest income amounts may fluctuate from current levels.  We could be exposed to interest rate riskrelated to our senior revolving credit facilities entered into in February 2008.  These obligations are variable interest ratenotes based on Prime Rate.  Fluctuationsin Prime Rate affect our interest rates. As of June 30, 2009 and 2008,there was no balance due on our senior revolving credit facilities.

 

***ForeignCurrency Risk***

 

We areexposed to favorable and unfavorable fluctuations of the U.S. dollar (ourfunctional currency) against the currencies of our operating subsidiaries. Anyincrease (decrease) in the value of the U.S. dollar against any foreigncurrency that is the functional currency of one of our operating subsidiarieswill cause the parent company to experience unrealized foreign currencytranslation losses (gains) with respect to amounts already invested insuch foreign currencies.  In addition, weand our operating subsidiaries are exposed to foreign currency risk to theextent that we enter into transactions denominated in currencies other than ourrespective functional currencies, such as accounts receivable (includingintercompany amounts) that are denominated in a currency other than their ownfunctional currency. Changes in exchange rates with respect to these items willresult in unrealized (based upon period-end exchange rates) or realized foreigncurrency transaction gains and losses upon settlement of the transactions. Inaddition, we are exposed to foreign exchange rate fluctuations related to ouroperating subsidiaries’ monetary assets and liabilities and the financialresults of foreign subsidiaries and affiliates when their respective financialstatements are translated into U.S. dollars for inclusion in our consolidatedfinancial statements. Cumulative translation adjustments are recorded inaccumulated other comprehensive income (loss) as a separate component ofequity. As a result of foreign currency risk, we may experience economic lossand a negative impact on earnings and equity with respect to our holdingssolely as a result of foreign currency exchange rate fluctuations.

 

Therelationship between the British Pound Sterling, Indian rupee and the U.S.dollar, which is our functional currency, is shown below, per one U.S. dollar:

 
| ** **              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------|------------|-----------------------|------------|
| **Spot rates:**         | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| British  Pound Sterling |       | 0.60546           |       | 0.69096               |       |
| Indian  Rupee           |       | 48.3559           |       | 49.21259              |       |

 
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **Average rates:**      | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| British  Pound Sterling |       | 0.64756                              |       | 0.50717                            |       | 0.67168 |   | 0.50653 |   |
| Indian  Rupee           |       | 49.28691                             |       | 41.56813                           |       | 49.89934 |   | 40.65428 |   |

 

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At the present time, we do not hedge our foreign currencyexposure or use derivative financial instruments that are designed to reduceour long-term exposure to foreign currency exchange risk. To the extent that translation and transaction gain and losses becomesignificant, we will consider various options to reduce this risk.

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

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

 

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

 

Indesigning and evaluating our disclosure controls and procedures, managementrecognized that disclosure controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible disclosure controls and procedures. The design of anydisclosure controls and procedures also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.

 

Duringthe three months ended June 30, 2009, there were no changes in ourinternal controls over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) or in other factors that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II— OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

Duringthe fourth quarter of 2006, a previous vendor filed a complaint in the SuperiorCourt of New Jersey against us asserting we breached certain provisions of alicense agreement. On April 10, 2009, we settled our litigation with thisprevious vendor and the matter pending in the United States District Court ofNew Jersey, was dismissed with prejudice.

 

Weare involved in various other legal matters arising in the normal course ofbusiness.  Losses, including estimatedcosts to defend, were recorded for these matters to the extent they wereprobable of loss and the amount of loss could be reasonably estimated.

 

**ITEM1A.  RISK FACTORS**

 

This Quarterly Report on Form 10-Qshould be read in conjunction with the risk factors defined in our AnnualReport on Form 10-K for the year ended December 31, 2008 under “Item1A. Risk Factors.”

 

**ITEM2.  UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None

 

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

 

Weheld our Annual Meeting of Stockholders on June 9, 2009. According to thefinal vote tally received from the Company’s transfer agent, the results of thevoting on Proposals 1, 2 and 3, as described in the Company’s ProxyStatement, were as follows:

 

**Proposal #1:  Electionof Directors**

 

BruceW. Armstrong was re-elected to serve a three-year term until 2012.

For15,276,740

Withheld2,369,741

 

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GeorgeA. Hallenbeck was re-elected to serve a three-year term until 2012.

For15,272,267

Withheld2,374,214

 

DavidJ. Nicol was re-elected to serve a three-year term until 2012.

For15,295,708

Withheld2,350,773

 

**Proposal #2:  Approvalof the Amendment of our Restated Certificate of Incorporation to Effect aReverse Stock Split**

 

For13,209,931

Against4,408,778

Abstain27,769

 

**Proposal #3: Ratification of Independent Registered Public Accounting Firm**

 

GrantThornton LLP was ratified as the independent registered public accounting firmfor the year ending December 31, 2009.

 

For 17,397,906

Against177,490

Abstain71,084

 

**ITEM 5. OTHER INFORMATION**

 

None

 

**ITEM6.  EXHIBITS**

 

(a)          Exhibits

 

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

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

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

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

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Date: August 4,  2009 | /s/ BRIAN R. ERVINE                           |
|----------------------------|-----------------------------------------------|
|                       | Brian R. Ervine                               |
|                       | Executive Vice  President,                    |
|                       | Chief Financial and  Administrative Officer,  |
|                       | Treasurer and Assistant  Secretary            |
|                       | (Principal Financial  and Accounting Officer) |

 

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