**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **x**      | ** ** | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**                                                                                                                     |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                       |
| ** ** | ** ** | **For the quarterly period ended March 31,  2008**                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                       |
| ** ** | ** ** | **OR**                                                                                                                                                                                                                     |
| ** ** | ** ** | ** **                                                                                                                                                                                                                 |
| **o**      | ** ** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**                                                                                                                    |
|       |       |                                                                                                                                                                                                                       |
| ** ** | ** ** | **For the  transition period  from               to               ** |

 

**Commission File Number: 0-24081**

 

**EVOLVING SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**(303) 802-1000**

(Registrant’s telephone number, including area code)

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer, or a smaller reportingcompany.  See definition of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

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 May 1,2008 there were 19,373,507 shares outstanding of Registrant’s Common Stock (parvalue $0.001 per share).

 

 

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**EVOLVING SYSTEMS, INC.**

**Quarterly Report on Form 10-Q**

**March 31, 2008**

**Table of Contents**

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

 

2

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**PART I— FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                       | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                                       |       |                     |       |                        |       |
| Current assets:                                                                                                                                                                                                  |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                       |       | $                        | 6,737      |                        | $          | 7,271 |   |
| Contract  receivables, net of allowance of $36 and $66 at March 31, 2008 and  December 31, 2007, respectively                                                                                          |       | 6,448                    |       | 10,959                      |       |
| Unbilled  work-in-progress                                                                                                                                                                                       |       | 1,555                    |       | 922                         |       |
| Deferred income  taxes                                                                                                                                                                                           |       | 4                        |       | 4                           |       |
| Prepaid and  other current assets                                                                                                                                                                                |       | 1,625                    |       | 1,331                       |       |
| Total current  assets                                                                                                                                                                                            |       | 16,369                   |       | 20,487                      |       |
| Property and  equipment, net                                                                                                                                                                                     |       | 1,678                    |       | 1,677                       |       |
| Amortizable intangible  assets, net                                                                                                                                                                              |       | 4,301                    |       | 4,687                       |       |
| Goodwill                                                                                                                                                                                                         |       | 26,395                   |       | 26,417                      |       |
| Long-term  restricted cash                                                                                                                                                                                       |       | 100                      |       | 100                         |       |
| Other long-term  assets                                                                                                                                                                                          |       | 346                      |       | 359                         |       |
| Total assets                                                                                                                                                                                                     |       | $                        | 49,189     |                        | $          | 53,727 |   |
|                                                                                                                                                                                                             |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                    |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                                                                            |       |                     |       |                        |       |
| Current portion  of capital lease obligations                                                                                                                                                                    |       | $                        | 21         |                        | $          | 20 |   |
| Current portion  of long-term debt                                                                                                                                                                               |       | 2,000                    |       | 2,500                       |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                        |       | 5,723                    |       | 5,903                       |       |
| Deferred income  taxes                                                                                                                                                                                           |       | 26                       |       | 34                          |       |
| Unearned revenue                                                                                                                                                                                                 |       | 9,766                    |       | 10,635                      |       |
| Total current  liabilities                                                                                                                                                                                       |       | 17,536                   |       | 19,092                      |       |
| Long-term  liabilities:                                                                                                                                                                                          |       |                     |       |                        |       |
| Capital lease  obligations, net of current portion                                                                                                                                                               |       | 74                       |       | 79                          |       |
| Other long-term  obligations                                                                                                                                                                                     |       | 872                      |       | 1,477                       |       |
| Long-term debt,  net of current portion                                                                                                                                                                          |       | 6,383                    |       | 8,686                       |       |
| Deferred foreign  income taxes                                                                                                                                                                                   |       | 811                      |       | 878                         |       |
| Total  liabilities                                                                                                                                                                                               |       | 25,676                   |       | 30,212                      |       |
|                                                                                                                                                                                                             |       |                     |       |                        |       |
| Commitments and  contingencies (Note 10)                                                                                                                                                                         |       |                     |       |                        |       |
|                                                                                                                                                                                                             |       |                     |       |                        |       |
| Series B  convertible redeemable preferred stock                                                                                                                                                            |       | —                   |       | 5,587                       |       |
|                                                                                                                                                                                                             |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                      |       |                     |       |                        |       |
| Preferred stock,  $0.001 par value; 2,000,000 shares authorized; 0 and 478,750 shares of  Series B issued and outstanding as of March 31, 2008 and  December 31, 2007, respectively (shown above) |       | —                   |       | —                      |       |
| Common stock,  $0.001 par value; 40,000,000 shares authorized; 19,361,920 and 17,914,770  shares issued and outstanding as of March 31, 2008 and December 31,  2007, respectively                      |       | 19                       |       | 18                          |       |
| Additional  paid-in capital                                                                                                                                                                                      |       | 81,147                   |       | 75,317                      |       |
| Accumulated  other comprehensive income                                                                                                                                                                          |       | 2,142                    |       | 2,144                       |       |
| Accumulated  deficit                                                                                                                                                                                             |       | (59,795                  | )          | (59,551                     | )          |
| Total  stockholders’ equity                                                                                                                                                                                 |       | 23,513                   |       | 17,928                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                 |       | $                        | 49,189     |                        | $          | 53,727 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| License fees and  services                                                   |       | $                                                | 4,832      |   | $ | 3,991 |   |
| Customer support                                                             |       | 4,295                                            |       | 4,470 |   |
| Total revenue                                                                |       | 9,127                                            |       | 8,461 |   |
|                                                                         |       |                                             |       |   |   |
| **COSTS  OF REVENUE AND OPERATING EXPENSES**                                 |       |                                             |       |   |   |
| Costs of license  fees and services, excluding depreciation and amortization |       | 2,224                                            |       | 1,924 |   |
| Costs of  customer support, excluding depreciation and amortization          |       | 1,493                                            |       | 1,493 |   |
| Sales and  marketing                                                         |       | 2,187                                            |       | 2,040 |   |
| General and  administrative                                                  |       | 1,425                                            |       | 1,550 |   |
| Product  development                                                         |       | 1,068                                            |       | 549 |   |
| Depreciation                                                                 |       | 230                                              |       | 288 |   |
| Amortization                                                                 |       | 380                                              |       | 388 |   |
| Restructuring  and other expense (recovery)                                  |       | —                                           |       | (1 | ) |
| Total costs of  revenue and operating expenses                               |       | 9,007                                            |       | 8,231 |   |
|                                                                         |       |                                             |       |   |   |
| Income from  operations                                                      |       | 120                                              |       | 230 |   |
|                                                                         |       |                                             |       |   |   |
| Other income  (expense):                                                     |       |                                             |       |   |   |
| Interest income                                                              |       | 78                                               |       | 64 |   |
| Interest expense                                                             |       | (336                                             | )          | (464 | ) |
| Gain (loss) on  extinguishment of debt                                       |       | (290                                             | )          | 42 |   |
| Foreign currency  exchange gain (loss)                                       |       | 110                                              |       | (58 | ) |
| Other expense,  net                                                          |       | (438                                             | )          | (416 | ) |
|                                                                         |       |                                             |       |   |   |
| Loss before  income taxes                                                    |       | (318                                             | )          | (186 | ) |
|                                                                         |       |                                             |       |   |   |
| Income tax  expense (benefit)                                                |       | (74                                              | )          | 140 |   |
|                                                                         |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (244       | ) | $ | (326 | ) |
|                                                                         |       |                                             |       |   |   |
| Basic and diluted  loss per common share                                     |       | $                                                | (0.01      | ) | $ | (0.02 | ) |
|                                                                         |       |                                             |       |   |   |
| Weighted average  basic and diluted shares outstanding                       |       | 19,362                                           |       | 19,153 |   |

 

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

 

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**EVOLVINGSYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME (LOSS)**

**(inthousands, except share data)**

**(unaudited)**

 
| ** **                                                        | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**       | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**      | ** ** | **Deficit**            | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2007**                            |       | 17,914,770            |       | $           | 18         |              | $          | 75,317          |       | $                      | 2,144      |       | $          | (59,551 | ) | $ | 17,928 |   |
| Common stock  issued pursuant to the Employee Stock Purchase Plan |       | 10,900                |       | —      |       | 16                |       | —          |       | —                 |       | 16         |       |
| Stock-based  compensation expense                                 |       | —                |       | —      |       | 228               |       | —          |       | —                 |       | 228        |       |
| Preferred stock  conversion                                       |       | 1,436,250             |       | 1           |       | 5,586             |       | —          |       | —                 |       | 5,587      |       |
| Comprehensive  loss:                                              |       |                  |       |        |       |              |       |            |       |                   |       |       |       |
| Net loss                                                          |       | —                |       | —      |       | —            |       | —          |       | (244                   | )          |       |       |
| Foreign currency  translation adjustment                          |       | —                |       | —      |       | —            |       | (2              | )          | —                 |       |       |       |
| Comprehensive  loss                                               |       |                  |       |        |       |              |       |            |       |                   |       | (246       | )          |
| **Balance  at March 31, 2008**                               |       | 19,361,920            |       | $           | 19         |              | $          | 81,147          |       | $                      | 2,142      |       | $          | (59,795 | ) | $ | 23,513 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **CASH FLOWS  FROM OPERATING ACTIVITIES:**                                       |       |                                             |       |   |   |
| Net loss                                                                         |       | $                                                | (244       | ) | $ | (326 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation                                                                     |       | 230                                              |       | 288 |   |
| Amortization of  intangible assets                                               |       | 380                                              |       | 388 |   |
| Amortization of  debt issuance costs                                             |       | 41                                               |       | 64 |   |
| Equity  compensation                                                             |       | 228                                              |       | 249 |   |
| Gain on disposal  of property and equipment                                      |       | —                                           |       | (1 | ) |
| (Gain) loss on  extinguishment of debt                                           |       | 290                                              |       | (42 | ) |
| Foreign currency  transaction (gains) losses, net                                |       | (110                                             | )          | 58 |   |
| Benefit from  foreign deferred income taxes                                      |       | (74                                              | )          | (9 | ) |
| Change in  operating assets and liabilities:                                     |       |                                             |       |   |   |
| Contract  receivables                                                            |       | 4,653                                            |       | 1,479 |   |
| Unbilled  work-in-progress                                                       |       | (634                                             | )          | 576 |   |
| Prepaid and  other current assets                                                |       | (330                                             | )          | 161 |   |
| Accounts payable  and accrued liabilities                                        |       | (253                                             | )          | 344 |   |
| Unearned revenue                                                                 |       | (871                                             | )          | 366 |   |
| Other                                                                            |       | (603                                             | )          | 161 |   |
| Net cash  provided by operating activities                                       |       | 2,703                                            |       | 3,756 |   |
|                                                                             |       |                                             |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                       |       |                                             |       |   |   |
| Purchases of  property and equipment                                             |       | (314                                             | )          | (233 | ) |
| Proceeds from  sale of property and equipment                                    |       | —                                           |       | 1 |   |
| Earnout payments  from business combinations                                     |       | —                                           |       | (24 | ) |
| Net cash used in  investing activities                                           |       | (314                                             | )          | (256 | ) |
|                                                                             |       |                                             |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                       |       |                                             |       |   |   |
| Capital lease  payments                                                          |       | (4                                               | )          | (9 | ) |
| Principal  payments on long-term debt                                            |       | (6,798                                           | )          | (642 | ) |
| Proceeds from  issuance of long-term debt                                        |       | 4,000                                            |       | — |   |
| Payments for  debt issuance costs                                                |       | (129                                             | )          | — |   |
| Proceeds from  issuance of common stock                                          |       | 16                                               |       | 17 |   |
| Net cash used in  financing activities                                           |       | (2,915                                           | )          | (634 | ) |
|                                                                             |       |                                             |       |   |   |
| Effect of foreign  exchange rate changes on cash                                 |       | (8                                               | )          | 23 |   |
|                                                                             |       |                                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                            |       | (534                                             | )          | 2,889 |   |
| Cash and cash  equivalents at beginning of period                                |       | 7,271                                            |       | 5,076 |   |
| Cash and cash  equivalents at end of period                                      |       | $                                                | 6,737      |   | $ | 7,965 |   |
|                                                                             |       |                                             |       |   |   |
| Supplemental  disclosure of other cash and non-cash transactions:                |       |                                             |       |   |   |
| Interest paid                                                                    |       | $                                                | 928        |   | $ | 244 |   |
| Income taxes  paid                                                               |       | $                                                | 75         |   | $ | 2 |   |
| Conversion of  preferred stock into common stock                                 |       | $                                                | 5,587      |   | $ | 5,152 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

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

 

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

 

**Use of Estimates –**The preparation of financial statements in conformity with accountingprinciples generally accepted in the U.S. requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities, at the date of the financialstatements, as well as the reported amounts of revenue and expenses during thereporting period. We made estimates with respect to revenue recognition forestimated hours to complete projects accounted for using the percentage ofcompletion method, allowance for doubtful accounts, income tax valuationallowance, fair values of long-lived assets, valuation of intangible assets andgoodwill, useful lives for property, equipment and intangible assets, businesscombinations, capitalization of internal software development costs and fairvalue of stock-based compensation amounts. Actual results could differ from these estimates.

 

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

 

**Principles of 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.

 

**Goodwill –**Goodwill is the excess of acquisition costof an acquired entity over the fair value of the identifiable net assetsacquired.  Goodwill is not amortized, buttested for impairment annually or whenever indicators of impairment exist.These indicators may include a significant change in the business climate,legal factors, operating performance indicators, competition, sale ordisposition of a significant portion of the business or other factors. Forpurposes of the goodwill evaluation, we compare the fair value of each of ourreporting units to its respective carrying amount. If the carrying value of areporting unit were to exceed its fair value, we would then compare the fairvalue of the reporting unit’s goodwill to its carrying amount, and any excessof the carrying amount over the fair value would be charged to operations as animpairment loss.

 

**Intangible Assets –**Amortizable intangible assetsconsist primarily of purchased software and licenses, customer contracts andrelationships, trademark and tradenames, and business partnerships acquired inconjunction with our purchases of CMS Communications, Inc. (“CMS”),Telecom Software Enterprises, LLC (“TSE”) and Tertio Telecoms Ltd. (“EvolvingSystems U.K.”).  These finite life assetsare amortized using the straight-line method over their estimated lives.

 

We assess the impairment of identifiable intangibles if events orchanges in circumstances indicate that the carrying value of the asset may notbe recoverable. Factors that we consider significant which could trigger animpairment analysis include the following:

 

·      Significant under-performancerelative to historical or projected future operating results;

 

7

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·      Significant changes in themanner of use of the acquired assets or the strategy of the overall business;

 

·      Significant negative industryor economic trends; and/or

 

·      Significant decline in ourstock price for a sustained period.

 

If, as a result of the existence of one or more of the above indicatorsof impairment, we determine that the carrying value of intangibles and/orlong-lived assets may not be recoverable, we compare the estimated undiscountedcash flows expected to result from the use of the asset and its eventualdisposition to the asset’s carrying amount. If an amortizable intangible orlong-lived asset is not deemed to be recoverable, we will recognize animpairment loss representing the excess of the asset’s carrying value over itsestimated fair value.

 

**Revenue Recognition –**We recognize revenuefrom two primary sources: license fees and services, and customer support, inaccordance with Statement of Position (“SOP”) 97-2, “Software RevenueRecognition,” as amended and interpreted by SOP 98-9, “Modification of SOP97-2, 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 infinancial statements.  In addition to thecriteria described below, we generally recognize revenue when an agreement issigned, the fee is fixed or determinable and collectibility is reasonablyassured.

 

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

 

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

 

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

 

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

 

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

 

**Stock-based Compensation –**We account for stock-based compensation under Statement of Financial AccountingStandards No. 123(Revised), “Share-Based Payment” (“SFAS 123R”).  This statement replaced SFAS No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”) and superseded APB Opinion No. 25,“Accounting for Stock Issued to Employees.” Under SFAS 123R, we apply a fair-value-based measurement method toaccount for share-based payment transactions with employees and directors andrecord compensation cost for all stock awards granted after January 1,2006 and awards modified, repurchased, or cancelled after that date. Inaddition, we record compensation costs associated with the vesting of unvestedoptions outstanding at January 1, 2006 using the guidance under SFAS123.  Stock-based compensation is anon-cash expense because we settle these obligations by issuing shares of ourcommon stock instead of settling such obligations with cash payments.  We recognized compensation cost for optionson a straight-line basis over the vesting period using an estimated forfeiturerate.   Effective January 1, 2006,stock option grants and employee stock purchase plan purchases were accountedfor under SFAS 123R.  We used theBlack-Scholes model to estimate the fair value of each option grant on the dateof grant.  This model requires the use ofestimates for expected term of the options and expected volatility of the priceof our common stock.

 

8

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**RecentAccounting Pronouncements –**In December 2007, the SECissued Staff Accounting Bulletin 110, *Share-Based Payment*(“SAB 110”), which amends Staff Accounting Bulleting 107 (“SAB 107”), *Share-Based Payment*, to permit public companies, undercertain circumstances, to use the simplified method of SAB 107 for employeeoption grants after December 31, 2007. Use of the simplified method after December 31, 2007 is permittedonly for companies whose historical data about their employees’ exercisebehavior does not provide a reasonable basis for estimating the expected termof the options.  We currently use thesimplified method to estimate expected term for employee option grants asadequate historical experience is not available to provide a reasonableestimate.  SAB 110 is effective foremployee options granted after December 31, 2007.  We adopted SAB 110 effective January 1,2008 and will continue to apply the simplified method until adequate historicalexperience is readily available to provide a reasonable estimate of theexpected term for employee option grants.

 

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

 

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

 

**NOTE 2 –GOODWILL AND INTANGIBLE ASSETS**

 

We recorded goodwill as a result of three acquisitions which occurredover the period from November 2003 to November 2004. We acquired CMSin November 2003, TSE in October 2004 and Evolving Systems U.K. in November 2004.

 

Changes in the carrying amount of goodwill byreporting unit were as follows (in thousands):

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|---------------------------|------------|-----------|------------|
| ** **                                             | ** ** | **U.S.**                           | ** ** | **U.K.**                  | ** ** | **U.S.**  | ** ** | **U.K.** | ** ** | **Goodwill** | ** ** |
| Balance as of  December 31, 2007                  |       | $                                  | —     |                      | $          | 9,118     |       | $ | 6,033 |   | $ | 11,266 |   | $ | 26,417 |   |
| Effects of  changes in foreign currency exchange rates |       | —                             |       | (10                       | )          | —    |       | (12 | ) | (22 | ) |
| Balance as of  March 31, 2008                     |       | $                                  | —     |                      | $          | 9,108     |       | $ | 6,033 |   | $ | 11,254 |   | $ | 26,395 |   |

 

Our annual goodwill impairment test wasconducted as of July 31, 2007, and we determined that goodwill was notimpaired as of the test date.  From July 31,2007 through March 31, 2008, no events have occurred that we believe mayhave impaired goodwill.

 

We amortized identifiable intangible assets ona straight-line basis over estimated lives ranging from one to seven years andinclude the cumulative effects of foreign currency exchange rates.  As of March 31, 2008 and December 31,2007, identifiable intangibles were as follows (in thousands):

 
| ** **                 | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** | ** **                | ** ** |
|----------------------------|------------|------------------------------|------------|---------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **(1)  Gross  Amount**       | ** ** | **Accumulated  Amortization**   | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Weighted-  Average  Amortization  Period** | ** ** |
| Purchased  software        |       | $                            | 2,070      |                            | $          | 814                       |       | $ | 1,256 |   | $ | 2,072 |   | $ | 700 |   | $ | 1,372 |   | 4.7 yrs |   |
| Purchased  licenses        |       | 227                          |       | 170                             |       | 57                        |       | 227 |   | 146 |   | 81 |   | 2.3 yrs |   |
| Trademarks and  tradenames |       | 894                          |       | 224                             |       | 670                       |       | 896 |   | 192 |   | 704 |   | 7.0 yrs |   |
| Business  partnerships     |       | 146                          |       | 51                              |       | 95                        |       | 146 |   | 44 |   | 102 |   | 5.0 yrs |   |
| Customer  relationships    |       | 3,705                        |       | 1,482                           |       | 2,223                     |       | 3,707 |   | 1,279 |   | 2,428 |   | 5.6 yrs |   |
|                       |       | $                            | 7,042      |                            | $          | 2,741                     |       | $ | 4,301 |   | $ | 7,048 |   | $ | 2,361 |   | $ | 4,687 |   | 5.4 yrs |   |

 

----

      (1)  Changes in intangible values as of March 31,2008 compared to December 31, 2007 are the direct result of changes inforeign currency exchange rates for the periods then ended.

 

9

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Amortization expense of identifiable intangible assets was $0.4 millionfor each of the three months ended March 31, 2008 and 2007.  As Evolving Systems U.K. uses the GreatBritish pound as its functional currency, the amount of future amortizationactually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related toidentifiable intangibles based on our carrying amount as of March 31, 2008was as follows (in thousands):

 
| **Twelve months ending March 31,** | ** ** | ** ** | ** **  |
|--------------------------------------------------------|------------|------------|-------------|
| 2009                                                   |       | $          |  1,277 |   |
| 2010                                                   |       | 911        |        |
| 2011                                                   |       | 887        |        |
| 2012                                                   |       | 598        |        |
| 2013                                                   |       | 502        |        |
| Thereafter                                             |       | 126        |        |
|                                                   |       | $          |  4,301 |   |

 

**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, including common stock issuable underparticipating securities, such as the Series B Convertible RedeemablePreferred Stock (“Series B Preferred Stock”). We compute diluted EPS usingthe weighted average number of shares outstanding, including participatingsecurities, plus all potentially dilutive common stock equivalents. Commonstock equivalents consist of stock options. The following is the reconciliationof the denominator of the basic and diluted EPS computations (in thousands):

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Weighted average  common shares outstanding            |       | 18,866                                           |       | 16,695 |   |
| Participating  securities                              |       | 496                                              |       | 2,458 |   |
| Basic and  diluted weighted average shares outstanding |       | 19,362                                           |       | 19,153 |   |

 

Weightedaverage options to purchase 1.8 million and 0.7 million shares of common stockwere excluded from the dilutive stock calculation for the three months ended March 31,2008 and 2007, respectively, as their effect would have been anti-dilutive as aresult of the net loss for the period. Weighted average options to purchase 2.7 million and 3.4 million sharesof common stock were excluded from the dilutive stock calculation for the threemonths ended March 31, 2008 and 2007, respectively, because their exerciseprices were greater than the average fair value of our common stock for theperiod.

 

**NOTE 4 –SHARE-BASED COMPENSATION**

 

We adopted SFAS 123R effective January 1, 2006 usingthe modified prospective method.  Werecognized $0.2 million of compensation expense in the consolidated statementsof operations for each of the three months ended March 31, 2008 and 2007,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  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Cost of license  fee and services, excluding depreciation and amortization |       | $                                                | 17         |   | $ | 22 |   |
| Cost of customer  support, excluding depreciation and amortization         |       | 2                                                |       | (2 | ) |
| Sales and  marketing                                                       |       | 42                                               |       | 39 |   |
| General and  administrative                                                |       | 146                                              |       | 183 |   |
| Product  development                                                       |       | 21                                               |       | 7 |   |
|                                                                       |       | $                                                | 228        |   | $ | 249 |   |

 

Thenegative amount in the table above for the three months ended March 31,2007 resulted from the true-up of estimated forfeitures to actual forfeitures.

 

**StockOption Plan**

 

In January 1996, our stockholders approved an Amended and RestatedStock Option Plan (the “Option Plan”). Under the Option Plan, as amended, 8,350,000 shares were reserved forissuance.  Options issued under theOption Plan were at the discretion of the Board 

 

10

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of Directors, including the vesting provisions of each stock optiongranted. Options were granted with an exercise price equal to the closing priceof our common stock on the date of grant, generally vest over four years andexpire no more than ten years from the date of grant. The Option Planterminated on January 18, 2006; options granted before that date were notaffected by the plan termination.  At March 31,2008, 3,865,253 options remained outstanding under the Option Plan.

 

In March 2007, upon the hiring of our Vice President of World WideSales and Marketing, in accordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv), the board of directors approved an inducementaward under a stand-alone equity incentive plan.  We granted 100,000 non-qualified options topurchase shares of our common stock at an exercise price equal to the closingprice of our common stock on the date of grant. The options vest over four years and expire ten years from the date ofgrant.

 

In June 2007, our stockholders approved the 2007 Stock IncentivePlan (the “2007 Stock Plan”).  A maximumof 2,000,000 shares may be issued under the 2007 Stock Plan.  Awards permitted under the 2007 Stock Planinclude:  Stock Options, StockAppreciation Rights, Restricted Stock, Restricted Stock Units, PerformanceAwards and Other Stock-Based Awards. Awards issued under the 2007 Stock Plan are at the discretion of theBoard of Directors.  As applicable,awards are granted with an exercise price equal to the closing price of ourcommon stock on the date of grant, generally vest over four years and expire nomore than ten years from the date of grant.

 

In December 2007, under the 2007 Stock Plan, we awarded a total of137,500 shares of restricted stock to members of our board of directors andsenior management.  The fair market valuefor share-based compensation expensing is equal to the closing price of ourcommon stock on the date of grant.  Therestrictions on the stock award are released over four years for awards grantedto employees and over one year for awards granted to members of the board of directors.

 

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

 
| ** **               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Expected term  (years)   |       | 6.2                                              |       | 6.1 |   |
| Risk-free  interest rate |       | 2.7                                              | %          | 4.5 | % |
| Expected volatility      |       | 101.9                                            | %          | 108.0 | % |
| Expected  dividend yield |       | 0                                                | %          | 0 | % |

 

11

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The following is a summary of stock option activity under the plan forthe three months ended March 31, 2008:

 
| ** **                                     | ** ** | **Number of  Shares  (in  thousands)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Options  outstanding at December 31, 2007 |       | 4,534                                       |       | $                                       | 3.02       |                                                          |       |                                                 |       |   |
| Options granted                                |       | 80                                          |       | $                                       | 2.06       |                                                          |       |                                                 |       |   |
| Less options  forfeited                        |       | (3                                          | )          | $                                       | 2.32       |                                                          |       |                                                 |       |   |
| Less options  expired                          |       | (42                                         | )          | $                                       | 5.35       |                                                          |       |                                                 |       |   |
| Less options  exercised                        |       | —                                      |       | $                                       | —     |                                                          |       |                                                 |       |   |
| Options  outstanding at March 31, 2008    |       | 4,569                                       |       | $                                       | 2.98       |                                                          | 5.86       |                                                 | $          | 725 |   |
|                                           |       |                                        |       |                                    |       |                                                          |       |                                                 |       |
| Options  exercisable at March 31, 2008    |       | 3,529                                       |       | $                                       | 3.22       |                                                          | 4.98       |                                                 | $          | 704 |   |

 

The weighted-average grant-date fair value of stock options grantedduring the three months ended March 31, 2008 and 2007 was $1.67 and $1.45,respectively.

 

As of March 31, 2008, there was approximately $1.9 million of totalunrecognized compensation costs related to unvested stock options.  These costs are expected to be recognizedover a weighted average period of 1.4 years.

 

The total intrinsic value of stock option exercises for each of thethree months ended March 31, 2008 and 2007 was $0.  The total fair value of stock options vestedduring the three months ended March 31, 2008 and 2007 was $0.3 million and$0.2 million, respectively.

 

The deferred income tax benefits from stock option expense related toEvolving Systems U.K. totaled approximately $15,000 and $11,000 for the threemonths ended March 31, 2008 and 2007, respectively.

 

Cash received from stock option exercises for each of the three monthsended March 31, 2008 and 2007 was $0.

 

**Employee Stock Purchase Plan**

 

Under the Employee Stock Purchase Plan (“ESPP”), we are authorized toissue up to 1,100,000 shares of our common stock to full-time employees, nearlyall of whom are eligible to participate. Under the terms of the ESPP, employeesmay elect to have up to 15% of their gross compensation withheld throughpayroll deduction to purchase our common stock, capped at $25,000 annually. Thepurchase price of the stock is 85% of the lower of the market price at thebeginning or end of each three-month participation period. As of March 31,2008, there were 292,000 shares available for purchase.  For each of the three months ended March 31,2008 and 2007, we recorded compensation expense of $6,000, associated withgrants under the ESPP which includes the fair value of the look-back feature ofeach grant as well as the 15% discount on the purchase price.  This expense fluctuates each period basedupon employee participation.

 

The fair value of each purchase made under our ESPP is estimated on thedate of purchase using the Black-Scholes model. The Black-Scholes model uses four assumptions to calculate the fairvalue of each purchase.  The expectedterm of each purchase is based upon the three-month participation period ofeach offering.  The risk-free interestrate is based upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of 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:

 
| ** **              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Expected term (years)   |       | 0.25                                             |       | 0.25 |   |
| Risk-free interest rate |       | 1.3                                              | %          | 5.1 | % |
| Expected volatility     |       | 70.4                                             | %          | 70.0 | % |
| Expected dividend yield |       | 0                                                | %          | 0 | % |

 

Cash received from employee stock plan purchases for the three monthsended March 31, 2008 and 2007 was $16,000 and $17,000, respectively.

 

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**NOTE 5 – CONCENTRATION OF CREDIT RISK**

 

For the three months ended March 31, 2008, twosignificant customers (defined as contributing at least 10%) accounted for 30%(18% and 12%) of total revenue.  These customers are large telecommunicationsoperators located in the U.S. and U.K., respectively.  For the three months ended March 31,2007, two significant customers accounted for 34% (22% and 12%) of totalrevenue.  These customers are large telecommunicationsoperators located in the U.S. and U.K., respectively.

 

As of March 31,2008, three significant customers accounted for approximately 44% (18%, 16% and10%) of contract receivables.  Thesecustomers are large telecommunications operators located in Chile, the U.S.and the U.K, respectively.  At December 31,2007, one significant customer accounted for approximately 42% of contractreceivables.  This customer is a largetelecommunications operator located in the U.S.

 

**NOTE 6 – LONG-TERM DEBT**

 

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

 
| ** **                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Senior term loan  with financial institution, interest at a fixed rate of 8.25%, principal  installments and interest payments are due monthly with final maturity on  February 22, 2010. The loan is secured by substantially all of our  assets.                                                                                                                                 |       | $                  | 3,833      |                  | $          | — |   |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |               |       |                  |       |   |   |
| Senior note  payable to financial institution, interest at the one-month London InterBank  Offered Rate (“LIBOR”) plus a margin of 5.25% at December 31, 2007;  however, the LIBOR rate cannot be less than 3.75%, interest rate was 10.25%  at December 31, 2007. In February 2008, this note payable was  replaced by our new $4.0 million senior term loan. |       | —             |       | 4,419                 |       |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |               |       |                  |       |
| $4.5 million  senior revolving credit facility payable to financial institution, interest  at one-month LIBOR plus 4.0%; however, the LIBOR rate cannot be less than  3.75%; interest rate was 9.00% at December 31, 2007. In  February 2008, this revolver was replaced with our $6.0 million senior  revolving credit facilities.                                           |       | —             |       | 2,000                 |       |
|                                                                                                                                                                                                                                                                                                                                                                                    |       |               |       |                  |       |
| Long-term unsecured  subordinated notes payable, interest ranges from 11-14% with a weighted  average rate of 12.60% and 12.82% at March 31, 2008 and  December 31, 2007, respectively, accrued interest and principal are due  in full May 16, 2011.                                                                                                                    |       | 4,550              |       | 4,767                 |       |
| Total debt                                                                                                                                                                                                                                                                                                                                                                              |       | 8,383              |       | 11,186                |       |
| Less current  portion                                                                                                                                                                                                                                                                                                                                                                   |       | (2,000             | )          | (2,500                | )          |
| Long-term debt,  excluding current portion                                                                                                                                                                                                                                                                                                                                              |       | $                  | 6,383      |                  | $          | 8,686 |   |

 

On February 22, 2008, we replaced our existingsenior term note and senior revolving facility with a new $4.0 million seniorterm loan, a $1.0 million U.S. revolving credit facility (“U.S. RevolvingFacility”) and a $5.0 million U.K. revolving credit facility (“U.K. RevolvingFacility”).

 

We used proceeds from the $4.0 million seniorterm loan to pay down our existing senior term note balance of approximately$3.8 million.  The $4.0 million seniorterm loan bears interest at a fixed rate of 8.25% and is payable in 24 equalmonthly installments 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 March 31, 2008 on our senior term loanare as follows (in thousands):

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2008                                        |       | $          | 1,500      |   |
| 2009                                        |       | 2,000      |       |
| 2010                                        |       | 333        |       |
|                                        |       | $          | 3,833      |   |

 

Additionally, we obtained a new $1.0 million U.S.Revolving Facility that bears interest at Prime Rate plus 0.5%.  Prime Rate was 5.25% as of March 31,2008.  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 March 31, 2008, we had $1.0 million in availability, but no borrowing outstandingunder this U.S. Revolving Facility.

 

We also entered into a $5.0 million U.K. RevolvingFacility that bears interest at Prime Rate plus 0.5%.  Prime Rate was 5.25% as of March 31,2008.  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 and EvolvingSystems Limited and is subject to the same covenants as the Senior TermLoan.  All accrued interest onoutstanding borrowings under the Senior Revolving Facility is paid monthly,with any outstanding balance due with a final maturity of February 22,2011.  As of March 31, 2008, we had$3.8 million in availability, but no borrowing outstanding under this U.K.Revolving Facility,

 

In connection with the replacement of our existingsenior term note and senior revolving facility with the new senior term loanand U.S. Revolving Facility and the U.K. Revolving Facility, we recorded awrite-off of debt issuance costs associated with the retired senior debt ofapproximately $0.3 million. Additionally, we capitalized debt issuance costs related to our newsenior debt of approximately $0.3 million. These newly capitalized debt issuance costs will be amortized over theterm of the new senior debt.

 

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

 

Wewere in compliance with all of our debt covenants as of March 31, 2008.

 

**NOTE 7 –INCOME TAXES**

 

Werecorded net income tax benefit of $0.1 million for the three months ended March 31,2008.  The net benefit during the threemonths ended March 31, 2008 consisted of a deferred tax benefit of $0.1million, related to our U.K.-based operations.

 

Werecorded net income tax expense of $0.1 million for the three months ended March 31,2007.  The net expense during the threemonths ended March 31, 2007 consisted of current income tax expense ofapproximately $0.2 million and a deferred tax benefit of $0.1 million both ofwhich were related to our U.K.-based operations.

 

EffectiveApril 2007, our Indian subsidiary was subject to a 10% minimum alternativetax.  This tax did not have a materialimpact on our results for the three months ended March 31, 2008, and we donot expect this tax to have a material impact on future results.

 

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 March 31, 2008 and December 31, 2007, thiscomponent of the deferred tax liability was $1.1 million and $1.2 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

As of March 31, 2008and December 31, 2007 we continued to maintain a full valuation allowanceon the domestic net deferred tax asset as we have determined it is more likelythan not that we will not realize our domestic deferred tax assets.  Such assets primarily consist of certain netoperating loss carryforwards.  Weassessed the realizability of our domestic deferred tax assets using allavailable evidence.  In particular, weconsidered both historical results and projections of profitability for thereasonably foreseeable future periods. We are required to reassess our conclusions regarding the realization ofour deferred tax assets at each 

 

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financial reporting date.A future evaluation could result in a conclusion that all or a portion of thevaluation allowance is no longer necessary which could have a material impacton our results of operations and financial position.

 

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

 

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

 

We conduct businessglobally and, as a result, Evolving Systems, Inc. or one or more of oursubsidiaries file income tax returns in the U.S. federal jurisdiction andvarious 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 2003.

 

**NOTE 8 –STOCKHOLDERS’ EQUITY**

 

On February 25, 2008, holders of 461,758 sharesof Series B Preferred Stock with a carrying value of $5.4 million, orapproximately 96% of the outstanding preferred stock, converted their shares ofpreferred stock into 1,385,274 shares of our common stock in accordance withthe conversion provisions of the Series B Preferred Stock.  On March 19, 2008, a holder of 16,992shares of Series B Preferred Stock with a carrying value of $0.2 million,which represented the remainder of the outstanding preferred stock, convertedhis shares of preferred stock into 50,976 shares of our common stock inaccordance with the conversion provisions of the Series B PreferredStock.  As we previously included the Series B Convertible Preferred Stockas a participating security for basic EPS purposes, these conversions did not changeour basic or diluted EPS calculations.

 

**NOTE 9 –SEGMENT INFORMATION**

 

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

 

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

 

15

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Segmentinformation is as follows (in thousands):

 
| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **Revenue**                                                                |       |                                             |       |   |   |
| License fees and  services                                                 |       | $                                                | 4,832      |   | $ | 3,991 |   |
| Customer support                                                           |       | 4,295                                            |       | 4,470 |   |
|                                                                       |       | 9,127                                            |       | 8,461 |   |
|                                                                       |       |                                             |       |   |   |
| **Revenue  less cost of revenue, excluding depreciation and amortization** |       |                                             |       |   |   |
| License fees and  services                                                 |       | 2,608                                            |       | 2,067 |   |
| Customer support                                                           |       | 2,802                                            |       | 2,977 |   |
|                                                                       |       | 5,410                                            |       | 5,044 |   |
|                                                                       |       |                                             |       |   |   |
| **Unallocated  costs**                                                     |       |                                             |       |   |   |
| Other operating  expenses                                                  |       | 4,680                                            |       | 4,139 |   |
| Depreciation and  amortization                                             |       | 610                                              |       | 676 |   |
| Restructuring  and other                                                   |       | —                                           |       | (1 | ) |
| Interest income                                                            |       | (78                                              | )          | (64 | ) |
| Interest expense                                                           |       | 336                                              |       | 464 |   |
| (Gain) loss on  debt extinguishment                                        |       | 290                                              |       | (42 | ) |
| Foreign currency  exchange (gain) loss                                     |       | (110                                             | )          | 58 |   |
| **Loss  before income taxes**                                              |       | $                                                | (318       | ) | $ | (186 | ) |

 

***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 March 31,** | ** ** |
|----------------|------------|------------------------------------------------------|------------|
| ** **     | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Revenue**    | ** ** | **L&S**                                          | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| United States  |       | $                                                    | 399        |   | $ | 2,470 |   | $ | 2,869 |   | $ | 611 |   | $ | 2,635 |   | $ | 3,246 |   |
| United Kingdom |       | 1,193                                                |       | 682 |   | 1,875 |   | 1,174 |   | 744 |   | 1,918 |   |
| Other          |       | 3,240                                                |       | 1,143 |   | 4,383 |   | 2,206 |   | 1,091 |   | 3,297 |   |
| Total Revenue  |       | $                                                    | 4,832      |   | $ | 4,295 |   | $ | 9,127 |   | $ | 3,991 |   | $ | 4,470 |   | $ | 8,461 |   |

 
| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| **Long-lived  assets, net**   |       |               |       |                  |       |
| United States                 |       | $                  | 7,706      |                  | $          | 7,814 |   |
| United Kingdom                |       | 24,597             |       | 25,883                |       |
| Other                         |       | 71                 |       | 84                    |       |
| Total long-lived  assets, net |       | $                  | 32,374     |                  | $          | 32,781 |   |

 

16

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

 
| ** **           | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------|------------|--------------------------------------------------|------------|
| **Revenue**          | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Activation           |       | $                                                | 4,692      |   | $ | 4,574 |   |
| Numbering  solutions |       | 2,933                                            |       | 2,801 |   |
| Mediation            |       | 1,502                                            |       | 1,086 |   |
|                 |       | $                                                | 9,127      |   | $ | 8,461 |   |

 

**NOTE10 – COMMITMENTS AND CONTINGENCIES**

 

**(a)****           OtherCommitments**

 

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 March 31, 2008 or December 31,2007.

 

Weenter into standard indemnification terms with customers and suppliers, asdiscussed below, in the ordinary course of business.  As we may subcontract the development ofdeliverables under customer contracts, we could be required to indemnifycustomers for work performed by subcontractors. Depending upon the nature ofthe customer 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 if the indemnification tocustomers results from the subcontractor’s failure to perform. To the extent weare unable to recover damages from a subcontractor, we could be required toreimburse the indemnified party for the full amount. We have never incurredcosts to defend lawsuits or settle claims relating to indemnification arisingout of subcontractors’ failure to perform. As a result, we believe theestimated fair value of these agreements is minimal. Accordingly, there were noliabilities recorded for these agreements as of March 31, 2008 or December 31,2007.

 

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

 

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

 

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

 

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

 

During the fourth quarter of 2006, a previous vendor filed a complaintin the Superior Court of New Jersey against us asserting we breached certainprovisions of a license agreement.  Whilethe outcome of this matter is uncertain, we believe we have paid all fees dueunder our license agreement and we are vigorously defending this claim.

 

We are involved in various other legal matters arising in the normalcourse of business.  Losses, includingestimated costs to defend, were recorded for these matters to the extent theywere probable of loss and the amount of loss could be reasonably estimated.

 

**NOTE 11 –RELATED PARTY TRANSACTIONS**

 

Effective January1, 2008, we entered into a consulting agreement with Stephen K. Gartside, Jr.,our previous President and CEO and current Chairman of the Board.  Under the agreement, we will pay Mr. Gartsidean annual fee of $20,000 for consulting services provided to us.  We had current obligations in theconsolidated balance sheets, under the agreement, of $5,000 and $0 as of March31, 2008 and December 31, 2007, respectively. We recorded $5,000 and $0 of general and administrative expense in theconsolidated statements of operations, related to this agreement, for the threemonths ended March 31, 2008 and 2007, respectively. 

 

17

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION 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 notguarantees of future performance and are subject to certain risks,uncertainties, and assumptions that are difficult to predict; therefore, actualresults may differ materially from those expressed or forecasted in anyforward-looking statements.  Risks anduncertainties of our business include those set forth in our Annual Report on Form 10-Kfor the year ended December 31, 2007 under “Item 1A. Risk Factors” as wellas additional risks described in this Form 10-Q.  Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events, or otherwise.  However, readers should carefully review therisk factors set forth in other reports or documents we file from time to timewith the Securities and Exchange Commission, particularly the Quarterly Reportson Form 10-Q and any Current Reports on Form 8-K.*

 

**OVERVIEW**

 

We area worldwide provider of software solutionsand services to telecommunications carriers, with 70 network operators in 45countries.  Our customers rely on us todevelop, deploy, enhance, maintain and integrate complex, highly reliablesoftware solutions for a range of Operations Support Systems (“OSS”).  Our activation solution is a leading packagedsolution for service activation in the wireless industry.

 

We recognize revenue in accordance with the prescribedaccounting standards for software revenue recognition under generally acceptedaccounting principles.  Our license feesand services revenues fluctuate from period to period as a result of the timingof revenue recognition on existing projects.

 

18

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**RESULTSOF OPERATIONS**

 

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

 
| ** **                                                                   | ** ** | **Three Months  Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **REVENUE**                                                                  |       |                                             |       |   |   |
| License fees and  services                                                   |       | 53                                               | %          | 47 | % |
| Customer support                                                             |       | 47                                               | %          | 53 | % |
| Total revenue                                                                |       | 100                                              | %          | 100 | % |
|                                                                         |       |                                             |       |   |   |
| **COSTS  OF REVENUE AND OPERATING EXPENSES**                                 |       |                                             |       |   |   |
| Costs of license  fees and services, excluding depreciation and amortization |       | 24                                               | %          | 23 | % |
| Costs of  customer support, excluding depreciation and amortization          |       | 16                                               | %          | 18 | % |
| Sales and  marketing                                                         |       | 24                                               | %          | 24 | % |
| General and  administrative                                                  |       | 16                                               | %          | 18 | % |
| Product  development                                                         |       | 12                                               | %          | 7 | % |
| Depreciation                                                                 |       | 3                                                | %          | 3 | % |
| Amortization                                                                 |       | 4                                                | %          | 4 | % |
| Total costs of  revenue and operating expenses                               |       | 99                                               | %          | 97 | % |
|                                                                         |       |                                             |       |   |   |
| Income from  operations                                                      |       | 1                                                | %          | 3 | % |
|                                                                         |       |                                             |       |   |   |
| Interest income                                                              |       | 1                                                | %          | 1 | % |
| Interest expense                                                             |       | (4                                               | )%         | (6 | )% |
| Gain (loss) on  debt extinguishment                                          |       | (3                                               | )%         | 1 | % |
| Foreign currency  exchange gain (loss)                                       |       | 1                                                | %          | (1 | )% |
| Other expense,  net                                                          |       | (5                                               | )%         | (5 | )% |
|                                                                         |       |                                             |       |   |   |
| Loss before  income taxes                                                    |       | (4                                               | )%         | (2 | )% |
|                                                                         |       |                                             |       |   |   |
| Income tax  expense (benefit)                                                |       | (1                                               | )%         | 2 | % |
|                                                                         |       |                                             |       |   |   |
| Net loss                                                                     |       | (3                                               | )%         | (4 | )% |

 

***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 supportrevenue includes annual support, recurring maintenance, maintenance upgradesand warranty services.  Warranty servicesconsist of maintenance services and are typically bundled with a license saleand the related revenue, based on Vendor-Specific Objective Evidence (VSOE), isdeferred and recognized ratably over the warranty period.  The following table presents our revenue byproduct group (in thousands):

 
| ** **           | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------|------------|--------------------------------------------------|------------|
| ** **           | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Activation           |       | $                                                | 4,692      |   | $ | 4,574 |   |
| Numbering  solutions |       | 2,933                                            |       | 2,801 |   |
| Mediation            |       | 1,502                                            |       | 1,086 |   |
|                 |       | $                                                | 9,127      |   | $ | 8,461 |   |

 

19

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***License Fees and Services***

 

License fees and servicesrevenue increased 21%, or $0.8 million, to $4.8 million for the three monthsended March 31, 2008 from $4.0 million for the three months ended March 31,2007.  This increase in license fees andservices revenue was composed of an increase of $0.1 million in revenue fromour activation products, an increase of $0.2 million in revenue from ournumbering solutions and an increase of $0.5 million in revenue from ourmediation products.  This growth is due to our expansion into newinternational markets for both activation and numbering solutions and follow on sales from our existing mediationaccount base.

 

***Customer Support***

 

Customersupport revenue decreased $0.2 million, or 4%, to $4.3 million for the threemonths ended March 31, 2008 from $4.5 million for the three months ended March 31,2007.  The decrease in customer supportrevenue was the result of mediation customer support revenue decreasing $0.2million.  Customer support revenue fromactivation and numbering solutions remained constant for the three months endedMarch 31, 2008 compared to the three months ended March 31,2007.  The decrease in mediation customersupport revenue is the result of a decline in our network mediation supportaccount base.

 

***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, cost of third-party software and partner commissions.  Costs of revenue, excluding depreciation andamortization, were $3.7 million and $3.4 million for the three months ended March 31,2008 and 2007, respectively.  These costsare discussed further below.

 

***Costs of License Fees and Services, Excluding Depreciation andAmortization***

 

Costsof license fees and services, excluding depreciation and amortization,increased $0.3 million, or 16%, to $2.2 million for the three months ended March 31,2008 from $1.9 million for the three months ended March 31, 2007.  However, as a percentage of license fees andservices revenue, costs of license fees and services, excluding depreciation andamortization, decreased to 46% for the three months ended March 31, 2008from 48% for the three months ended March 31, 2007.  Although costs have increased to support theincreased revenues, they have decreased as a percentage of revenue due toincremental revenues growing at a faster rate than incremental costs.

 

***Costs of Customer Support, Excluding Depreciation and Amortization***

 

Costsof customer support, excluding depreciation and amortization, were $1.5 millionfor each of the three months ended March 31, 2008 and 2007.  As a percentage of customer support revenue,costs of customer support revenue, excluding depreciation and amortization,increased to 35% for the three months ended March 31, 2008 from 33% forthe three months ended March 31, 2007. Although the costs of customer support have remained constant for thethree months ended March 31, 2008 compared to the three months ended March 31,2007, they have increased as a percentage of customer support revenue.  This percentage increase is due to highersupport costs for our Local Number Portability (“LNP”) products as a result ofincreased porting volumes and supporting additional platforms.

 

***Salesand Marketing***

 

Salesand marketing expenses primarily consist of compensation costs, including bonusesand commissions, travel expenses, advertising, marketing and facilitiesexpenses.  Sales and marketing expensesincreased $0.2 million, or 7%, to $2.2 million for the three months ended March 31,2008 from $2.0 million for the three months ended March 31, 2007.  As a percentage of total revenue, sales andmarketing expenses remained constant at 24% for each the three months ended March 31,2008 and 2007.  The increase in theexpense base is the result of increased travel costs associated with ourexpansion into new international markets, as well as higher sales incentivecompensation related to our improved bookings and revenue.

 

***Generaland Administrative***

 

Generaland administrative expenses consist principally of employee related costs andprofessional fees for the following departments: facilities, finance, legal,human resources, and certain executive management.  General and administrative expenses decreased$0.1 million, or 8%, to $1.4 million from $1.5 million for the threemonths ended March 31, 2008 and 2007, respectively.  As a percentage of total revenue, general andadministrative expenses for the three months ended March 31, 2008 and2007, decreased to 16% from 18%, respectively. These decreases are a result of decreased professional fees.

 

***ProductDevelopment***

 

Productdevelopment expenses consist primarily of employee related costs andsubcontractor expenses.  Productdevelopment expenses increased $0.5 million, or 95%, to $1.0 million from $0.5million for the three months ended March 31, 2008 and 2007,respectively.  As a percentage ofrevenue, product development expenses for the three months ended March 31,2008 and 2007, increased to 12% from 7%, respectively.  These increases are the result of increasedinvestments made in our activation products, including, but not limited to, thedevelopment of *TertioTM Service Verification*, *TertioTM Service Activation* and *TertioTMProcess*

 

20

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*Management*.  We have also increased investment ininternationalizing our *NumeriTrack®*product,as well as investing in the development of our *Dynamic SIMAllocation*TM product.

 

***Amortization***

 

Amortizationexpense consists of amortization of identifiable intangible assets acquiredthrough our acquisitions of CMS, TSE and Evolving Systems U.K.  Amortization expense was $0.4 million foreach of the three months ended March 31, 2008 and 2007, respectively.

 

***InterestExpense***

 

Interest expense includes interest expense on ourlong-term debt and capital lease obligations as well as amortization of debtissuance costs.  Interest expensewas $336,000 and $464,000 for the three months ended March 31, 2008 and2007, respectively.  The decrease of$128,000 is due to lower debt balances and to lower interest rates on our newsenior debt.

 

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

 

                                               InFebruary 2008, we wrote-off the remaining debt issuance costs of $297,000related to our senior term not payable that was replaced during the threemonths ended March 31, 2008.  Thisloss related to the debt issuance cost write-off was partially offset by a$7,000 gain resulting from us paying $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.

 

In March 2007,we paid $77,000 to retire $119,000 of subordinated debt and related accruedinterest held by one of our subordinated note holders, resulting in a $42,000gain on debt extinguishment.  The retireddebt included principal of $103,000 and accrued interest of $16,000.

 

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

 

Foreign currency transaction gains (losses) resulted fromtransactions denominated in a currency other than the functional currency ofthe respective subsidiary and were $110,000 and $(58,000) for the threemonths ended March 31, 2008 and 2007, respectively.  The gains (losses) were generated primarilythrough the remeasurement of certain non-functional currency denominatedfinancial assets and liabilities of our Evolving Systems U.K. subsidiary.

 

***IncomeTaxes***

 

Werecorded income tax benefit of $0.1 million for the three months ended March 31,2008 and income tax expense of $0.1 million for the three months ended March 31,2007.  The net income tax benefit duringthe three months ended March 31, 2008 consisted of a deferred foreign taxbenefit of $0.1 million related to our UK-based operations.  The net income tax expense during the threemonths ended March 31, 2007 consisted of current foreign income taxexpense of $0.2 million and a deferred foreign tax benefit of $0.1 million bothof which are related to our UK-based operations.

 

Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe identifiable intangible amortization is not deductible for income tax purposes,we established a long-term deferred tax liability of $4.6 million at theacquisition date for the expected difference between what would be expensed forfinancial reporting purposes and what would be deductible for income taxpurposes. As of March 31, 2008 and December 31, 2007, this deferredtax liability was $1.1 million and $1.2 million, respectively.  This deferred tax liability is carried on thebooks of our United Kingdom subsidiary, and has no impact on our ability torecover our U.S.-based deferred tax assets. The aforementioned deferred tax liability will be recognized as areduction of deferred income tax expense as the identifiable intangibles areamortized.

 

**FINANCIALCONDITION**

 

 Our working capital position decreased $2.6million to a $1.2 million deficit as of March 31, 2008 from a $1.4 millionsurplus as of December 31, 2007. The decrease in our working capital position is primarily attributableto the $3.0 million in existing cash used to retire our $2.0 million revolvingcredit facility and to retire $1.0 million related to our subordinated notes,including interest.

 

**CONTRACTUALOBLIGATIONS**

 

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

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Wehave historically financed operations through cash flows from operations andequity transactions.  At March 31,2008, our principal source of liquidity was $6.7 million in cash and cashequivalents as well as $4.8 million available under our revolving

 

21

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credit facilities.  The following table summarizes our statementsof cash flows (in thousands):

 
| ** **                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|
| ** **                | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Cash provided  (used) by: |       |                                             |       |   |   |
| Operating activities      |       | $                                                | 2,703      |   | $ | 3,756 |   |
| Investing  activities     |       | (314                                             | )          | (256 | ) |
| Financing  activities     |       | (2,915                                           | )          | (634 | ) |
| Effect of  exchange rates |       | (8                                               | )          | 23 |   |
| Net cash  provided (used) |       | $                                                | (534       | ) | $ | 2,889 |   |

 

Net cash provided by operating activities for the threemonths ended March 31, 2008 and2007 was $2.7 million and $3.8 million, respectively.  Changes in operating assets and liabilities,which contributed to the majority of the decrease in cash provided by operatingactivities, reflected a net increase in cash from operating activities of $1.9million for the three months ended March 31, 2008 as compared to a net increase in cash of $3.1million for the three months ended March 31, 2007.  Thisfluctuation was primarily attributable to the $0.8 million interest payment madeon our subordinated notes during the three months ended March 31, 2008.

 

Netcash used by investing activities during each of the three months ended March 31,2008 and 2007 was $0.3 million.  The cashused for the three months ended March 31, 2008 related to purchases ofproperty and equipment of $0.3 million. The cash used for the three months ended March 31, 2007 relatedprimarily to purchases of property and equipment of $0.2 million.

 

Netcash used in financing activities for the three months ended March 31,2008 and 2007 was $2.9 million and $0.6 million, respectively.  Financing activities in the three monthsended March 31, 2008 consisted of principal payments on existing debt, ofapproximately $6.8 million, partially offset by borrowings related to our newsenior term loan, of approximately $3.9 million, net issuance costs.  During the three months ended March 31,2007, we paid $0.6 million and in principal payments on notes payable.

 

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

 

·                  Our cash andcash equivalents balance at March 31, 2008 of $6.7 million;

 

·                  The availabilityunder our revolving credit facilities of $4.8 million at March 31, 2008;

 

·                  Our demonstratedability to generate positive cash flows from operations;

 

·                  Our backlog asof March 31, 2008 of approximately $18.9 million, including $7.1 millionin license fees and services and $11.8 million in customer support;

 

·                  Our plannedcapital expenditures; and

 

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

 

Weare exposed to foreign currency rate risks which impact the carrying amount ofour foreign subsidiaries and our consolidated equity, as well as ourconsolidated cash position due to translation adjustments.  For the three months ended March 31,2008, the effect of exchange rate changesresulted in an $8,000 decrease to consolidated cash.  During the three months ended March 31,2007, the effect of exchange rate changesresulted in a $23,000 increase in consolidated cash.  We do not currently hedge our foreigncurrency exposure, but we monitor rate changes and may hedge our exposures ifwe see significant negative trends in exchange rates.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

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

 

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**ITEM3.  QUANTITATIVE AND QUALITATIVE MARKETRISK DISCLOSURES**

 

In the ordinary course of business, we are exposed to certain marketrisks, including changes in interest rates and foreign currency exchange rates.Uncertainties that are either non-financial or non-quantifiable such aspolitical, economic, tax, other regulatory, or credit risks are not included inthe following assessment of market risks.

 

***Interest Rate Risks***

 

Our cash balances are subject to interest rate fluctuations and as aresult, interest income amounts may fluctuate from current levels.  We are exposed to interest rate risk relatedto 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.

 

***ForeignCurrency Risk***

 

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

 

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

 
| **Spot rates:** | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------|------------|--------------------------|------------|-----------------------------|------------|
| Great British  Pound |       | 0.50148                  |       | 0.50092                     |       |
| Indian Rupee         |       | 39.88831                 |       | 39.43218                    |       |

 
| ** **          | ** ** | **Three months ended**   | ** ** |
|---------------------|------------|--------------------------|------------|
| **Average rates:**  | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** |
| Great British Pound |       | 0.50588                  |       | 0.51177 |   |
| Indian Rupee        |       | 39.77975                 |       | 44.109463 |   |

 

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

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

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

 

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

 

In designing andevaluating our disclosure controls and procedures, management recognized thatdisclosure controls and procedures, no matter how well conceived and operated,can provide only reasonable, not absolute, assurance that the objectives of thedisclosure controls and procedures are met.  Additionally, in designingdisclosure controls and procedures, our management necessarily was required toapply its judgment in evaluating the cost-benefit relationship of possibledisclosure controls and

 

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procedures. The design ofany disclosure 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.

 

                                                                        During the three months ended March 31,2008, there were no changes in our internal controls over financial reporting(as defined in Rule 13a-15(f) under the Exchange Act) or in otherfactors that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II— OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

During the fourth quarter of 2006, a previous vendor filed a complaintin the Superior Court of New Jersey against us asserting we breached certainprovisions of a license agreement.  Whilethe outcome of this matter is uncertain, we believe we have paid all fees dueunder our license agreement and we are vigorously defending this claim.

 

We are involved in various other legal matters arising in the normalcourse of business.  Losses, includingestimated costs to defend, were recorded for these matters to the extent theywere probable 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, 2007 under “Item1A. Risk Factors.”

 

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

 

None

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None

 

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

 

None

 

**ITEM 5. OTHER INFORMATION**

 

None

 

**ITEM6.  EXHIBITS**

 

(a)          Exhibits

 

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

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

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

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

 

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**SIGNATURE**

 

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

 
| Date: May 8,  2008 | /s/ BRIAN R.  ERVINE                          |
|-------------------------|-----------------------------------------------|
|                    | Brian R. Ervine                               |
|                    | Executive Vice  President,                    |
|                    | Chief Financial  and Administrative Officer,  |
|                    | Treasurer and  Assistant Secretary            |
|                    | (Principal  Financial and Accounting Officer) |

 

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