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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-K**

 

| **x**                                                                                                                                                                                             | **Annual Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                        | ** **                                                                                                   |
| **For the fiscal year ended December 31, 2009**                                                                                                                                              |
| ** **                                                                                                                                                                                        | ** **                                                                                                   |
| ** **                                                                                                                                                                                        | **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**

** **

**EVOLVINGSYSTEMS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                    | ** ** | **84-1010843**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction of

incorporation or organization) |       | (I.R.S. Employer

Identification Number) |
| ** **                                                      | ** ** | ** **                               |
| **9777 Pyramid Court, Suite 100, Englewood,  Colorado**    | ** ** | **80112**                                |
| (Address of principal executive offices)                        |       | (Zip Code)                               |

** **

**(303) 802-1000**

(Registrant’s telephonenumber, including area code)

 

Securities registered under Section 12(b) ofthe Act:

 

| **Common  Stock, Par Value $0.001 Per Share** | ** ** | **The  Nasdaq Capital Market**         |
|-----------------------------------------------|------------|----------------------------------------|
| (Title of Class)                              |       | (Name of exchange on which registered) |

 

Securities registered under Section 12(g) ofthe Act: **None**

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.   Yes  ̈  No x

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act.   Yes  ̈  No x

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes x  No  ̈

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post suchfiles).   Yes o  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. x

 

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

 

| Large  accelerated filer  ̈ |   | Accelerated  filer  ̈    |
|--------------------------------------|--------|-----------------------------------|
|                                 |   |                              |
| Non-accelerated  filer  ̈   |   | Smaller  reporting company x |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).   Yes  ̈  No x

 

The aggregate market value of the Common Stock held by non-affiliatesof the registrant, based upon the last sale price of the Common Stock reportedon the Nasdaq Capital Market, was approximately $36.4 million as of June 30,2009.

 

The number of shares of Common Stock outstanding was 9,982,228 as of March 4,2010.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

The information required by Part III (Items 10, 11, 12, 13 and14) is incorporated by reference to portions of the registrant’sdefinitive proxy statement for the 2010 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission within 120 daysafter the close of the 2009 year.

 

 

 

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**EVOLVING SYSTEMS, INC.**

**Annual Report on Form 10-K**

**For the year ended December 31,2009**

**Table ofContents**

 
| ** ** | ** **                                                                                                          | **Page** |
|------------|---------------------------------------------------------------------------------------------------------------------|----------|
|       |                                                                                                                |     |
| ** ** | **PART I**                                                                                                     |     |
| Item 1     | Business                                                                                                            | 1        |
| Item 1A    | Risk Factors                                                                                                        | 7        |
| Item 1B    | Unresolved Staff Comments                                                                                           | 15       |
| Item 2     | Properties                                                                                                          | 15       |
| Item 3     | Legal Proceedings                                                                                                   | 15       |
| Item 4     | Reserved                                                                                                            | 15       |
| ** ** | ** **                                                                                                          |     |
| ** ** | **PART II**                                                                                                    |     |
| Item 5     | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities | 15       |
| Item 6     | Selected Financial Data                                                                                             | 16       |
| Item 7     | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         | 17       |
| Item 7A    | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 27       |
| Item 8     | Financial  Statements and Supplementary Data                                                                        | 28       |
|       | Report of  Independent Registered Public Accounting Firm                                                            | 28       |
|       | Consolidated Balance  Sheets                                                                                        | 29       |
|       | Consolidated  Statements of Operations                                                                              | 30       |
|       | Consolidated  Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)                    | 31       |
|       | Consolidated Statements of Cash Flows                                                                               | 32       |
|       | Notes to Consolidated Financial Statements                                                                          | 33       |
| Item 9     | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               | 49       |
| Item 9A    | Controls and  Procedures                                                                                            | 49       |
| Item 9B    | Other Information                                                                                                   | 50       |
| ** ** | ** **                                                                                                          |     |
| ** ** | **PART III**                                                                                                   |     |
| Item 10    | Directors,  Executive Officers and Corporate Governance                                                             | 50       |
| Item 11    | Executive  Compensation                                                                                             | 50       |
| Item 12    | Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters                     | 50       |
| Item 13    | Certain  Relationships and Related Transactions, and Director Independence                                          | 50       |
| Item 14    | Principal  Accounting Fees and Services                                                                             | 50       |
| ** ** | ** **                                                                                                          |     |
| ** ** | **PART IV**                                                                                                    |     |
| Item 15    | Exhibits,  Financial Statement Schedules                                                                            | 50       |
|       | Signatures                                                                                                          | 53       |

 

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**FORWARD-LOOKINGSTATEMENTS**

 

*Exceptfor the historical information contained in this document, this report containsforward-looking statements including estimates, projections, statementsrelating to our business plans, objectives and expected operating results andassumptions. These forward-looking statements generally are identified by thewords “believes,” “goals,” “projects,” “expects,” “anticipates,” “estimates,” “intends,”“strategy,” “plan” and similar expressions. Forward-looking statements arebased on current expectations and assumptions and are subject to risks anduncertainties which may cause our actual results to differ materially fromthose discussed here. Factors that could cause or contribute to suchdifferences include, but are not limited to those discussed in this section, inthe sections entitled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and “Risk Factors.” We undertake noobligation to update or revise publicly any forward-looking statements, whetheras a result of new information, future events or otherwise.*

 

**PART I**

 

**ITEM 1.    BUSINESS**

 

**INTRODUCTION**

 

Evolving Systems, Inc. is a leading provider of software solutionsand services to the wireless, wireline and cable markets. We maintainlong-standing relationships with many of the largest wireline, wireless andcable companies worldwide. Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, reliable software solutions for arange of Operations Support Systems (“OSS”). Included among our more than 70network operators is the largest wireline carrier, the second largest wirelesscarrier and the largest cable company in North America, as well as two of theworld’s largest wireless carriers headquartered outside of North America. Weoffer software products and solutions in four core areas:

 

·                  service activation solutionsused to activate complex bundles of voice, video and data services fortraditional and next generation wireless, wireline and cable networks;

 

·                  SIM card activation solutionsdynamically allocate and assign resources to a wireless device when it is firstused;

 

·                  numbering solutions managecarriers’ resource inventory and resource assignment processes includingproducts that comply with government-mandated requirements regarding localnumber portability in North America; and

 

·                  mediation solutions supportdata collection for both service assurance and billing applications.

 

Our products support traditional and next generation networktechnologies, convergent service offerings, and advanced wireless and otherbroadband networks.

 

We report the operations of our business as two operating segmentsbased on revenue type:  license fees andservices revenue and customer support revenue. We also report revenue based on three of the core areas described above.Because our SIM card activation solution is an early stage product, we reportit within activation and numbering solutions. We further report geographicinformation based upon revenue and long-lived assets in the United States, UnitedKingdom and all other foreign countries as a group.   Further information regarding our operatingsegments and geographical information is contained in Note 11 to ourConsolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

 

**COMPANYBACKGROUND**

 

Founded in 1985,we initially focused on providing custom software development and professionalservices to telecommunications companies in the United States. In 1996,concurrent with the passage of the Telecommunications Act of 1996 (“the TelecomAct”), we made a strategic decision to add software products to our establishedprofessional services offerings. The outcome of that decision was the creationof a comprehensive product portfolio, of which we are best known in NorthAmerica, for our Local Number Portability and Number Management solutions.

 

In 2003 and 2004,we significantly expanded our portfolio of products as a result of threeacquisitions that we made over the periods of November 2003 through November 2004.  The first acquisition was CMS Communications, Inc.(“CMS”) in November 2003, where we acquired a network mediation andservice assurance solution.  In October 2004,we acquired Telecom Software Enterprises, LLC (“TSE”) adding Local NumberPortability (“LNP”) and Wireless Number Portability (“WNP”) number ordering andprovisioning monitoring and testing products. Finally, in November 2004, we acquired Tertio Telecoms Ltd. (“EvolvingSystems U.K.”), a supplier of OSS software solutions for service activation andmediation to communication carriers throughout Europe, the Middle East, Africaand Asia. With this acquisition we expanded our markets beyond North Americaand added a service activation solution, *TertioTM,*and abilling mediation solution, *EvidentTM*, toour product portfolio. The consequence of these acquisitions is a significantlyexpanded product and service capability to address a larger portion of ourcustomers’ OSS application needs with a balanced mix of products and productenhancements, as well as services.

 

Since theacquisition of Evolving Systems U.K., with our growing product portfolio andgeographic reach, we enhanced our sales

 

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model to include bothdirect and indirect channels.  We formednew relationships with network equipment providers and system integrators toextend our reach to new geographical regions as well as help us further penetrateour existing territories.   Recently, wehave added more regional partners to help with both local selling anddeployments in emerging markets.

 

**RECENTDEVELOPMENTS**

 

·                  As part of our announced strategy, we continue toinvest in expanding our sales and support capabilities to support our growth inthe emerging markets.  In 2009 we weresuccessful in expanding our customer base, notably in Africa, Asia and CentralAmerica.

 

·                  We continued to make advances in the development,deployment and selling of our new product Dynamic SIM AllocationTM (“DSA”).  In addition in 2009, we announced a newpartnership with a leading SIM card manufacturer for the sales, support anddistribution of DSA.

 

·                  During 2009, we paid $6.2 million to retire oursubordinated notes, including accrued interest. These payments were made fromcash on hand and $1.5 million in borrowings on our U.K. revolving creditfacility. The subordinated debt payments were unscheduled and reduced balancesclassified as long-term as of December 31, 2008.

 

·                  Our Board of Directors approved a one-for-two reversesplit of our common stock, as previously authorized and approved by ourstockholders at the June 9, 2009 annual meeting, which took effect at11:59 p.m. (Eastern time) on July 20, 2009 (the “Effective Time”).Our common stock began trading on a post-split basis on July 21, 2009. Asa result of the reverse stock split, every two shares of our common stock wascombined into one share of common stock. The reverse stock split affected allof our common stock outstanding immediately prior to the Effective Time of thereverse stock split as well as the number of shares of common stock availablefor issuance under our equity incentive plans. In addition, the reverse stocksplit reduced the number of shares of common stock issuable upon the exerciseof stock options. Our common stock outstanding at June 30, 2009 wasapproximately 19.6 million shares. Adjusting for the reverse stock split,the common stock outstanding at June 30, 2009 was reduced to approximately9.8 million shares. The number of authorized shares of common stockremains at 40.0 million. The reverse split did not affect the par value of ourcommon stock which remains at $0.001. As a result of the reverse stock split,the stated capital on our balance sheet attributable to our common stock wasreduced in proportion to the size of the reverse stock split. Common stock andadditional paid-in capital balances, all share amounts, stock option amountsand per share/option prices appearing in this Annual Report on Form 10-Kreflect the reverse stock split for all periods presented.

 

**INDUSTRYDYNAMICS**

 

The rapidintroduction of new technologies such as wireless and broadband services hascreated a growing market for telecommunications solutions worldwide.  This emergence of new technologies intelecommunications networks and end-user devices, consumer electronics, andpersonal computers, has created an industry that is in the midst of significantchange. Carriers not only compete with companies from other industries, such asmedia and entertainment, but also with companies providing applications andservices over the Internet.  In such acompetitive market, companies are increasingly bundling voice, messaging, dataaccess, and music and video services in order to increase market share.  This bundling of services is just one facetof what is called convergence.  In orderto facilitate convergence, as well as reduce costs, carriers are implementing avariety of network transformation programs that include: the migration topacket-switching transmission networks based on the Internet protocol (oftencalled all-Internet Protocol (“IP”) networks); the migration to new service creationand delivery platforms that enable the provision of multimedia services overIP-based networks; and the introduction of one or more broadband accessnetworks over existing wired infrastructure, new fiber deployments, cableaccess networks, and evolved wireless broadband networks including GlobalSystem for Mobile Communication (“GSM”)/EDGE, 3G/WCDMA/HSPA, and WiMAX. Alongwith the continued development of new technologies, carriers are facingincreasing levels of competition due to the varying demand in connection types,subscribers and service usage, as well pricing declines due to regulatory andcompetitive pressures.  Given the currenteconomic climate many carriers are either aggressively pursuing cost reductionprograms, increased sales efficiency, and/or are focusing on growth fromvalue-added services (“VAS”).  Thiscomplex and rapidly changing landscape is further affected by the continuedconsolidation of carriers and their suppliers.

 

**OPERATIONSSUPPORT SYSTEMS (“OSS”)**

 

OSS encompasses abroad array of software and systems that perform critical functions fortelecommunications carriers, such as service fulfillment, service assurance,and billing.  Service fulfillmentencompasses ordering, provisioning and activation.  Ordering systems collect customerinformation, retrieve current service information, capture and validate newservice requests, verify the availability of selected services and transmitcompleted orders to one or more provisioning OSS.  Inventory systems maintain both physical and logicalviews of all the telecommunications assets required to turn up a service.  Carriers use provisioning and activationsystems to turn up network service and turn services off and on for customers,as well as change or add services. Service assurance systems allow carriers to perform the testing,monitoring and reporting necessary to maintain appropriate network availabilityand feed operational data to other business systems. Service assurance systemsalso allow carriers to track and report on service conditions or outages inorder to dispatch their large work force for necessary repairs. Carriers usebilling systems to collate, manage and report usage information for partner and

 

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customer billing. OSSsystems typically operate in a 24x7 environment to support the real-timecommunication networks that facilitate the carriers’ service offerings.

 

Traditionally, ascarriers have added new services, such as wireless or Internet-based services,they have either developed their own in-house OSS applications or added new OSSapplications from product vendors. These additional OSS systems can bedifficult to integrate into the carriers’ operations, as they often utilizeheterogeneous elements, making interoperability among the systems difficult.These OSS are further constrained by the many incremental changes that havebeen made in order to accommodate new computing and network technologies andnew value-added services, such as call waiting, call forwarding and voice mail,broadband data and video.  In addition,carriers have had to adapt their OSS to comply with government or regulatorymandates that in some cases change how systems and processes are required towork.  Because of these challenges,carriers have difficulty replacing existing OSS due to the large investment andvast amounts of historical data contained in these systems. As a result,carriers continue to make incremental modifications to these OSS, in some casesfurther increasing their complexity and making it more difficult for theapplications to be replaced.  However, atrend over the past decade has been the replacement of a portion of the carrier’slegacy OSS environment with OSS software packages designed to meet growingcomplex processes in the areas of service fulfillment, service assurance andbilling.

 

**PRODUCTPORTFOLIO**

 

# ***DynamicSIM Allocation***

# *** ***

In 2007, weannounced our *Dynamic SIM Allocation* (“DSA”)solution that offers carriers a new way to provision wireless services bydynamically activating and assigning resources to the wireless device when itis first used. The wireless Subscriber Identity Module (“SIM”) card is centralto the provision of wireless access and services for GSM/EDGE and 3G/WCDMAnetworks and is specified as part of the next generation LTE technologies.These networks represent the most common type of wireless technology used todayby wireless operators world-wide. Typically, SIM cards are either pre-provisioned before they aredistributed to the retail environment or are provisioned at the point-of-sale.Pre-provisioning SIM cards means that resources are allocated well in advanceof the SIM card becoming available for sale, leading to poor utilization ofnumbers, increased network costs, and a poor user experience. Provisioning SIMcards at the point-of-sale overcomes many of these issues but at a high cost,as retail and back-office infrastructure needs to be in place and consequentlydistribution is constrained. Our DSA solution offers carriers the userexperience and resource efficiency benefits of provisioning at thepoint-of-sale without demanding the retail and back-office infrastructureusually required. The solution offers a number of benefits including:

 

·                  Improve efficiency and utilization: Carriers canexperience a high wastage of SIM cards that are never activated for arevenue-generating subscriber. Our solution reduces the cost of this wastage byremoving the need for SIM cards to be pre-provisioned in network databases.

 

·                  Ensure availability: Carriers can find it difficult toeffectively and reliably manage the utilization, ordering and distribution ofSIM cards, especially when multiple SIM card variants and profiles are needed.The solution helps carriers to make sure new SIM cards and numbers are alwaysavailable to meet demand.

 

·                  Easier to personalize: Prepaid subscribers havetraditionally been unable to choose their mobile phone number easily and from awide range of available numbers. With this solution, prepaid subscribers canchoose their number using just their mobile phone, and carriers can monetizetheir valuable stock of vanity or golden numbers.

 

·                  Improved user experience: Carriers can have variouscustomer care processes, like those for mobile number portability, or replacinglost or stolen SIM cards, that are inefficient and have high operational costs.The solution helps carriers provide more customer self-care for an improveduser experience and lower costs.

 

# ***ServiceActivation***

# *** ***

Our serviceactivation solution, *Tertio*, isemployed by carriers to activate a new subscriber or to add a new service to anexisting subscriber.  Our Tertio productprovides a flexible operating environment and can be used by carriers to managetheir voice, data, and content service needs for both their traditional andbroadband IP networks.  Our solution isdeployed as the service activation engine for over 70 networks around the worldincluding two of the world’s largest wireless carriers.

 

Tertio is an integratedsolution comprised of the following components:

 

·                  Tertio Service Composer — a modeling tool that simplifies the creationof new services;

 

·                  Tertio Content Connector — a tool used for activation ofnext-generation services;

 

·                  Tertio Activation Designer — a tool that is designed to speed networkfeature activation;

 

·                  Tertio Service Activation — the platform that provides scalability andperformance, flexibility and a graphical interface;

 

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·                  Tertio Service Verification — a module that allows carriers to verifythat the services implemented in the network match those that were in theoriginal service order.  By providingthis capability, carriers can continually check the accuracy of theirorder/activation processes; and

 

·                  Tertio Process Management — a module that allows carriers to managelong running transactions.  Long runningtransactions can often occur when a carrier is implementing a convergedactivation solution that encompasses the activation of both a wireless andfixed line (or IP) component.

 

Our Tertiosolution addresses the entire service lifecycle, enabling service providers tobetter plan, manage and execute the introduction of new services. Tertio allowscarriers to introduce new network technologies and eases the burden ofintegration with existing devices and systems.

 

***Numbering Solutions***

 

Evolving Systems’Numbering Solutions product line includes our Local Number Portability (“LNP”)and Wireless Number Portability (“WNP”) products as well as our *NumeriTrack®* number management solution*.*

 

***LNPand WNP***

 

Our NumberPortability software solution enables carriers to comply with U.S. and Canadianregulations for implementing LNP and WNP. Number porting allows customers the ability to retain, or “port”, theirphone numbers when changing from one service provider to another. Our LNPsoftware, which includes the functionality to support ordering, provisioning,reporting, testing and exchanging information between carriers, is widely usedby wireline, wireless and cable service providers in North America. Over time,we have expanded our number portability product features and developed othernumber portability related OSS software products for the wireline, wireless andcable markets.  Our full LNP and WNPproduct line is comprised of the following suite of products:

 

·                  *OrderPath®* order entry;

 

·                  *NumberManager®* network provisioning;

 

·                  *LNP DataServerTM* data warehousing;

 

·                  *VeriPortTM* NPAC testing; and

 

·                  *VerifyTM* product suite for monitoring carriers’application communications for optimum service assurance.

 

***Number Management***

 

We developed our *NumeriTrack* solution in response to the FederalCommunications Commission (“FCC”) mandated number conservation and numberpooling regulations for both wireline and wireless carriers. These regulations,implemented in 2003, resulted from the FCC’s concern that the U.S. was runningout of 10-digit telephone numbers. As a result, the FCC designed regulations toextend the life of the 10-digit numbering plan well into the 21st century bychanging the way phone numbers are allocated to carriers and specifying rules regardingthe assignment and classification of those numbers.  The regulations also require regularutilization reporting by carriers and articulation of circumstances under whichpreviously underutilized telephone numbers must be returned to the “pool” to bereallocated to other carriers. Our *NumeriTrack*solution, which has been licensed to seven carriers, facilitates compliancewith the FCC mandates for both wireline and wireless carriers (and cablecarriers providing telephony services). Our solution provides inventory management of phone numbers and otherassets such as SIM cards and supports inventory assignments and integrationwith carriers’ existing back-office systems. The *NumeriTrack*solution also contains features for the inventory of, and assignment logic for,numbers associated with IP addresses and is used by a large carrier in the U.S.for deployment of a Voice over Internet Protocol (“VoIP”) service offering. Asis the case with our LNP and WNP solutions, the implementation of our *NumeriTrack* solution has far-reaching implications forintegration with carriers’ existing OSS environments and businessprocesses.  Beginning in 2006, weenhanced our *NumeriTrack* application toaddress markets outside of North America.

 

Our investments inour International *NumeriTrack* solution allow us tosell and deploy this solution in markets outside of North America with aversion of the product that we call International *NumeriTrack*.  The resource management and assignmentcapabilities of International *NumeriTrack*enables carriers around the globe to acquire and track phone numbers and otherlogical and physical assets for their products on both traditional and nextgeneration wireline and wireless networks. The solution will efficiently manage those assets through the lifecycleof the service, allowing carriers to spend less in acquiring new resources suchas IP addresses, phone numbers and SIM cards for various products and regions.

 

***Mediation***

 

Our mediationportfolio consists of network data mediation products and billingmediation.  Our billing mediation productis *Evident*. Our network mediation products are Traffic Data Management System (“TDMS”)and *Mediation CentralTM*.

 

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# ***Billing Mediation***

# *** ***

Billing mediationis the process of collecting network usage data and verifying that usage datais accurate, and is a required pre-condition for generating accurate bills fora carrier’s customers. Billing mediation’s importance lies in its ability toprovide a systematic point of reliability and assurance between networkconsumption and the billing system input. Our Evident product supportsconvergent voice, data, and content services. Evident software enables theaccurate management of data, allowing reconciliation of data inputs andoutputs.  In addition, it providessupport for compliance with relevant regulatory, accounting and data integrityrequirements.  This product also providesservice usage data for business intelligence, revenue assurance, andnext-generation billing solutions. Our Evident solution can be used bywireline, broadband and wireless carriers and provides carrier-grade support interms of reliability, performance, and scalability.

 

As carriers bringnew services to market they often need a new mediation process to support thosenew services.  Our Evident solution hasbeen designed with the flexibility to support new service concepts and designs.

 

# ***Network Assurance and Data Collection Solutions***

# *** ***

A common challengefor telecommunications carriers is to create an integration layer betweennetwork element (“NE”) devices and the OSS applications that provision, monitorand control these devices. Deploying new devices needed for extending serviceofferings into the network can therefore be difficult, time consuming andexpensive. Our mediation solutions provide a common framework for simplifyingthe collection and distribution of critical network data.  Our network mediation product, MediationCentral, supports a broad array of technologies that carriers typically deployin their network.  Mediation Centralprovides support for wireline, broadband, transport and wireless networks. OurMediation Central product supports both centralized and distributedconfigurations allowing, for example, carriers to deploy a single solution forall their data collection and distribution needs.  Our TDMS product is a legacy product thathelps traditional wireline carriers collect usage data from their circuitswitch networks.

 

**PROFESSIONALAND INTEGRATION SERVICES**

 

Our Professionaland Integration Services team provides expert consulting services and advicefor the design, customization, integration and deployment of our ServiceActivation, Numbering Solutions, and Mediation product portfolios.  TheProfessional and Integration Services team works closely with the ProductEngineering and Development teams to ensure our customers are up to date withour latest product developments.  Theseservices cover all aspects of the project lifecycle including systemarchitecture and design, component design, development and customization,system integration and testing, deployment and production support, program andproject level management, domain and product expertise.  Our teams workclosely with customers and integration partners and have established close,long-term relationships with operators in the Americas, Europe, the MiddleEast, Africa and Asia Pacific regions.

 

**RESEARCHAND DEVELOPMENT**

 

We expend amountson research and development (“R&D”), particularly for new products and/orfor enhancements of existing products. R&D is expensed as incurred.  For the years ended December 31, 2009,2008 and 2007, we expensed $3.5 million, $3.6 million and $2.4 million,respectively, in R&D costs.  Themajority of all new R&D investments in 2009 have gone into enhancing ourcore service activation solutions and numbering solutions products as well asthe further development of our DSA solution.

 

We focus ourproduct development efforts on identifying specific industry and customerbusiness needs as well as market requirements and then developing solutionsthat leverage our existing product capabilities.  Based upon the identified customer businessneeds, our research and development efforts comprise a combination of designand development of new products or features to enhance our existing products,and design and development of new product functionality as identified in ourproduct “roadmaps.”  We build investmentplans for our principal product areas and we make other investments in toolsand product extensions to accelerate the development, implementation andintegration process for customer solutions.

 

**SALES ANDMARKETING**

 

Our sales force isprimarily a field-based organization structured to focus on specificgeographical territories: North America, Europe, Middle East and Africa, Russiaand the Commonwealth of Independent States, Asia Pacific, and Central and LatinAmerica. Our sales activities cover both direct sales to the end user customersas well as sales through partners such as Gemalto, Oberthur, IBM, Siemens, andAlcatel who will often include our products as part of a wider solutionoffering which they have architected. We plan to continue to work with these orother partners in the future as well as looking to develop new potential routesto market for our products.

 

The primaryobjective of our marketing organization is to identify markets for our productsand to establish an awareness of our offerings in those markets through acombination of direct marketing, web marketing, and through our participationin shows, conferences, and industry bodies. The marketing organization alsocreates electronic and print based sales collateral to support theseactivities, as well as maintaining a permanent presence on the web.

 

Evolving Systemsoffers a complex product set which lends itself to a high degree of on-siteconsultative selling with the prospect

 

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as part of the salesprocess. Our sales efforts also cover a large amount of interaction withexisting customers where we work to develop incremental revenue streams onexisting platforms as well as the introduction of new value propositions. Thesales team is responsible for the generation of proactive proposals toprospects as well as the management and delivery of responses to competitive tenders.This complex, highly involved approach creates a long sales cycle requiring usto invest a considerable amount of time toward uncertain results.

 

**COMPETITION**

 

The market fortelecommunications OSS products is intensely competitive and is subject to rapidtechnological change, changing industry standards, regulatory developments andconsolidation. We face increasing demand for improved product performance,reduced prices and rapid integration capabilities, and pricing pressures. Ourexisting and potential competitors include many large domestic andinternational companies that often have substantially greater financial,technological, marketing, distribution and other resources, larger installedcustomer bases and longer-standing relationships with telecommunicationscustomers than we do. The market for telecommunications OSS software andservices is extremely large. And, we currently hold only a small portion oftotal market share.  Our increased focuson numbering solutions and activation solutions has resulted in our achieving ameasurable and reasonable market share in those two areas.

 

Our principalcompetitors in service activation are Comptel Corporation, Oracle Corporation,Synchronoss Technologies, Inc., and Huawei.  Our principal competitors in the numberingsolutions market include Telcordia Technologies, Inc., Neustar, Inc.and Syniverse Technologies. In mediation, we compete with many differentcompanies including Intec Telecom Systems PLC, Amdocs and Comptel. We believewe have an early advantage with our DSA solution but are aware of potentialcompetition for some elements of our solution’s value proposition fromcompanies such as Giesecke & Devrient GmbH, Hewlett-Packard Companyand Comptel.

 

We believe thatour ability to compete successfully depends on a wide range of factors.  We deliver value by offering qualitysolutions at a competitive price that are tailored specifically to thecustomer. Once a customer has implemented one of our products, we often receivesubsequent orders for enhancements and change requests to addfunctionality.  This follow-on business,and the fact that it is a complex and expensive process to replace our softwareonce installed and integrated into the carrier’s networks, provides anattractive revenue opportunity for us. Furthermore, many of our customer relationships span five years ormore with some extending beyond ten years. We believe these long-term relationships give us a competitive advantageand can be a barrier to entry for our competitors.

 

**SIGNIFICANTCUSTOMERS**

 

In 2009,approximately 19% of our consolidated revenue came from one customer in thetelecommunications industry.  Thiscustomer is located in the U.S.  The lossof this customer would have a material adverse effect on our business as awhole. In 2008, approximately 34% of our consolidated revenue came from twounrelated customers in the telecommunications industry. Of these customers, oneis located in the U.S. and the other in the U.K. The loss of either of thesecustomers would have a material adverse effect on our business as a whole.

 

**INTELLECTUALPROPERTY**

 

We rely on acombination of patents, copyright, trademark and trade secret laws, as well asconfidentiality agreements and licensing arrangements, to establish and protectour proprietary rights. We presently have U.S. and Canadian patents on elementsof our principal LNP OSS products, *NumberManager* and *OrderPath***and have apatent pending in the U.S. and other countries on elements of our**DSA**product.

 

**BACKLOG**

 

We define backlogas firm non-cancelable sales orders that are anticipated to be delivered andrecognized in revenue over the next twelve months. As of December 31, 2009and 2008, our backlog was approximately $20.8 and $20.6 million,respectively.  Our backlog at December 31,2009 was comprised of license fees and services of $8.5 million and customersupport of $12.3 million compared to license fees and services of $8.8 millionand customer support of $11.8 million at December 31, 2008.

 

**EMPLOYEES**

 

As of December 31,2009, we employed 244 people including 55 in the United States, 76 in theUnited Kingdom and 113 in Bangalore, India. Of our worldwide staff, 86% are involved in product delivery,development, support and professional services, 6% in sales and marketing, and8% in general administration.

 

**ACCELERATED FILER STATUS**

 

Companies consideredaccelerated or large accelerated filers under Securities Exchange Act Rule 12b-2,are required to comply with the internal control reporting and disclosurerequirements of Section 404 of the Sarbanes-Oxley Act of 2002. Anaccelerated or large accelerated filer is defined as a company that meets thefollowing conditions:

 

·                  Has a common equity public float of $75 million ormore as of the last business day of its most recently completed second fiscalquarter;

 

·                  Has been subject to the reporting requirements of Section 13(a) or15(d) of the Exchange Act for a period of at least 12 

 

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calendar months;

 

·                  Previously filed at least one annual report pursuantto Section 13(a) or 15(d) of the Exchange Act; and

 

·                  Is not eligible to use smaller public companydisclosure standards for its annual and quarterly reports.

 

As of the last businessday of our most recently completed second fiscal quarter, June 30, 2009,our common equity public float was less than $75 million.  Therefore, we are not an accelerated or largeaccelerated filer, as defined in Securities Exchange Act Rule 12b-2.  Under current SEC rules, we are required inthis Annual Report on Form 10-K to provide a report by managementassessing the effectiveness of our internal control over financial reporting asof December 31, 2009 and will be required to provide an auditor’s reporton internal control over financial reporting in our Annual Report on Form 10-Kfor the year ended December 31, 2010.

 

**AVAILABLEINFORMATION**

 

You can find outmore information about us at our Internet website located at www.evolving.com*.* The information on our website is not incorporated intothis Annual Report on Form 10-K. Our Annual Reports on Form 10-K,our Quarterly Reports on Form 10-Q, and our Current Reports on Form 8-Kand any amendments to those reports are available free of charge on ourInternet website as soon as reasonably practicable after we electronically filesuch material with the SEC. Additionally, these reports are available at theSEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549or on the SEC’s website at www.sec.gov. Information on the operation of the Public Reference Room can beobtained by calling the SEC at 1-800-SEC-0330.

 

**ITEM1A.    RISK FACTORS**

 

**Risks Related to Our Business**

 

***Because our quarterly and annual operating results aredifficult to predict and may fluctuate, the market price for our stock may bevolatile.***

 

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

 

·                  the size of new contracts and when we are able torecognize the related revenue;

·                  our rate of progress under our contracts;

·                  foreign exchange fluctuations;

·                  budgeting cycles of our customers;

·                  changes in the terms and rates related to the renewalof support agreements;

·                  the mix of products and services sold;

·                  the timing of third-party contractors’ delivery ofsoftware and hardware;

·                  level and timing of expenses for product developmentand sales, general and administrative expenses;

·                  changes in our strategy;

·                  general economic conditions.

 

Personnel costs are asignificant component of our budgeted expense levels and, therefore, ourexpenses are, to a degree, variable based upon our expectations regardingfuture revenue. As discussed above, our revenue is difficult to forecast andour sales cycle and the size and timing of significant contracts varysubstantially among customers. Accordingly, we may be unable to adjust spendingin a timely manner to compensate for any unexpected shortfall in revenue. Anysignificant shortfall from anticipated levels of demand for our products andservices could adversely affect our business, financial condition, results ofoperations and cash flows.

 

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

 

***Ourresults of operations could be negatively impacted if we are unable to manageour liquidity.***

 

Our cash forecastindicates that we will have sufficient liquidity to cover anticipated operatingcosts as well as debt service payments for at least the next twelve months, butthis could be negatively impacted to the extent we are unable to invoice andcollect from our customers in a timely manner, or an unexpected adverse event,or combination of events occurs. Therefore, if the timing of cash generatedfrom operations is insufficient to satisfy our liquidity requirements, we mayrequire access to additional funds to support our business objectives through acredit facility or possibly the issuance of additional equity. Additionalfinancing may not be available at all or, if available, may not be obtainableon terms that are favorable to us and not dilutive.

 

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***Our revolving linesof credit call for the acceleration of payments if certain covenants arebreached or cash balance thresholds are achieved.***

 

Our revolvingcredit facility contains certain affirmative and negative covenants that, ifbreached, could result in any outstanding amounts becoming immediately due andpayable. The covenants include our agreement to do the following:

 

·                  maintain a specified ratio of debt to EBITDA, minimumEBITDA for the trailing twelve months, minimum liquidity, and ratio of fixedcharges to EBITDA;

·                  comply with applicable laws and licensingrequirements;

·                  file and pay all applicable taxes as they becomedue; and

·                  operate in the ordinary course of business.

 

The covenants also include ouragreement not to do any of the following (except as specifically authorized):

 

·                  liquidate, dissolve or wind-up operations;

·      cause or permit a change in control;

·                  pay any dividends or make prepayments on anyindebtedness;

·                  acquire, merge or consolidate with any otherbusinesses or entities or make investments in third parties;

·                  sell or transfer a substantial portion of ourassets;

·                  incur additional indebtedness or permit any lienson our assets;

·                  make loans or enter into letters for credit orguarantees;

·                  enter into affiliate transactions;

·                  make negative pledges;

·                  change our methods of accounting and recordkeeping away from generally accepted accounting principles;

·                  change the nature of our business materially;

·                  make capital expenditures beyond establishedthresholds; or

·                  take certain other operational actions.

 

The covenants maylimit our flexibility in planning for, or reacting to changes in, our business.Failure to comply with the covenants, if not waived, could result in theacceleration of the debt. If we are required to pay the debt on an acceleratedbasis, it would have a significant adverse impact on our liquidity andfinancial condition and could cause us to incur additional indebtedness.

 

***If we are unable to properly supervise our softwaredevelopment subsidiary in India, or if political or other uncertaintiesinterfere,******we may be unable to satisfactorilyperform our customer contracts and our business could be materially harmed.***

 

In February 2004, weformed Evolving Systems India, a wholly owned subsidiary of Evolving Systems, Inc.  In the past we experienced a high level ofturnover with our Indian development staff as a result of strong competitionfor technology-based personnel in India, and we may experience high turnoveragain in the future. In addition, salary levels in India are steadilyincreasing, reducing the competitive advantages associated with offshore labor.If we are unable to effectively manage the Evolving Systems India developmentstaff and/or we continue to experience high levels of staff turnover, we mayfail to provide quality software in a timely fashion, which could negativelyaffect our ability to satisfy our customer contracts. Furthermore, politicalchanges and uncertainties in India could negatively impact the business climatethere.  As a result, we may be unable tosatisfactorily perform our customer contracts and our business, financialcondition and results of operations could be materially harmed.

 

***Weoperate a global business that exposes us to additional currency, economic,regulatory and tax risks.***

 

A significant part of ourrevenue comes from international sales. Our international operations are subject to the risk factors inherent inthe conduct of international business, including:

 

·                   fluctuations in currency exchange rates;

·                   compliance with U.S. Foreign Corrupt Practices acts and localanti-bribery laws and regulations;

·                   unexpected changes in regulatory requirements;

·                   tariffs and other barriers;

·                   political and economic instability;

·                   limited intellectual property protection;

·                   difficulties in staffing and managing foreign operations; and

·                   potentially adverse tax consequences in connection with repatriatingfunds.

 

The U.S. Dollarhas recently strengthened against foreign currencies and approximately half ofour revenue is transacted in non-Dollar denominated currencies (e.g. BritishPound Sterling and Euro).  As a result,when the dollar strengthens, the Company’s revenue, when converted to U.S.dollars, is reduced.  At the same time,with more than 50% of the Company’s operating expenses originating overseas,the strengthening dollar conversely lowers expenses outside of the U.S.Although this has provided some defenseagainst currency fluctuations for our bottom line results, we may not be ableto maintain this ratio of revenue to expense in the future.  In addition, we may not be able to sustain orincrease our international revenue or repatriate cash without incurringsubstantial risks

 

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involving floatingcurrency exchange rates and income tax expenses.  Any of the foregoing factors may have amaterial adverse impact on our international operations and, therefore, ourbusiness, financial condition and results of operations.

 

***Changes or challenges to the regulations ofthe communication industry could hurt the market for our products and services.***

 

The market for ourtraditional North American OSS products was created and has primarily beendriven by the adoption of regulations under the Telecom Act requiring NorthAmerican carriers to implement number portability as a condition to beingpermitted to provide long distance services. Therefore, any changes to theseregulations, or the adoption of new regulations by federal or state regulatoryauthorities under the Telecom Act, or any legal challenges to the Telecom Act,could hurt the market for our products and services.  In addition, customers may require, or we mayfind it necessary or advisable, to modify our products or services to addressactual or anticipated changes in regulations affecting our customers. Thiscould also materially harm our business, financial condition, results ofoperations, and cash flows.  We are alsosubject to numerous regulatory requirements of foreign jurisdictions.  Any compliance failures or changes in suchregulations could, likewise, materially harm our business, financial condition,results of operations and cash flows.

 

***Consolidationin the communications industry may impact our financial performance.***

 

The communicationsindustry has experienced and continues to experience significant consolidation,both in the United States and internationally.    These consolidations have caused us to losecustomers and may result in fewer potential customers requiring OSS solutionsin the future.  In addition, combiningcompanies may re-evaluate their OSS solutions and their capital expendituresand may choose a competitive OSS solution used by one of the combiningcompanies.  As our customers becomelarger, they generally have stronger purchasing power, which can result inreduced prices for our products, lower margins on our products and longer salescycles.  Because of the uncertaintyresulting from these consolidations and the variations in our quarterlyoperating results, it is extremely difficult for us to forecast our quarterlyand annual revenue and we have discontinued providing revenue guidance.  All of these factors can have a negativeimpact on our financial performance, particularly in any fiscal quarter.  This negative impact, in turn, could resultin noncompliance with certain financial covenants governing our revolvingcredit facility.  If we were unsuccessfulin amending the agreements or obtaining a waiver from our senior lender infuture reporting periods, these violations could result in such credit facilitybecoming immediately due and payable.  Wemay not be successful in amending the agreements or obtaining a waiver of anycovenant violation.

 

***We depend on a limited number ofsignificant customers for a substantial portion of our revenue, and the loss ofone or more of these customers could adversely affect our business.***

 

In the past, andcurrently, we earn a significant portion of our revenue from a small number ofcustomers in the communications industry. This has been mitigated somewhat bythe expansion of our customer base in recent years, but, as noted above,consolidation in the industry continues. The loss of any significant customer,delays in delivery or acceptance of any of our products by a customer, delaysin the performance of services for a customer, or delays in collection ofcustomer receivables could harm our business and operating results.

 

***Our products are complex and have a lengthy implementationprocess; unanticipated difficulties or delays in the customer acceptanceprocess could result in higher costs and delayed payments.***

 

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

 

The majority of ourexisting contracts provide for acceptance testing by the customer, which can bea lengthy process. Unanticipated difficulties or delays in the customeracceptance process could result in higher costs, delayed payments, and deferralof revenue recognition. In addition, if our software contains defects or weotherwise fail to satisfy acceptance criteria within prescribed times, thecustomer may be entitled to cancel its contract and receive a refund of all ora portion of amounts paid or other amounts as damages, which could exceedrelated contract revenue and which could result in a future charge to earnings.Any failure or delay in achieving final acceptance of our software and servicescould harm our business, financial condition, results of operations and cashflows.

 

***Sales of our products typically require significant reviewand internal approval processes by our customers over an extended period oftime.  Interruptions in such process dueto economic downturns, consolidations or otherwise could result in the loss ofour sale or deferral of revenue into later periods and adversely affect ourfinancial performance.***

 

Large communicationssolutions used for enterprise-wide, mission-critical purposes, involvesignificant capital expenditures and lengthy implementation plans. Prospectivecustomers typically commit significant resources to the technical evaluation ofour products and services and require us to spend substantial time, effort andmoney providing education regarding our solutions. This evaluation processoften results in an extensive and lengthy sales cycle, typically rangingbetween three and twelve months, making it difficult for us to forecast thetiming and magnitude of our contracts. For example, customers’ budgetaryconstraints and internal 

 

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acceptance reviews maycause potential customers to delay or forego a purchase. The delay or failureto complete one or more large contracts could materially harm our business,financial condition, results of operations and cash flows and cause ouroperating results to vary significantly from quarter to quarter and year toyear.

 

Mergers and acquisitionsof large communications companies, as well as the formation of new alliances,have resulted in a constantly changing marketplace for our products andservices. Purchasing delays and pricing pressures associated with these changesare common. In addition, many of the companies in the communications industryhave kept capital expenditures at historically low levels in response tochanges in the communications marketplace; some companies have declaredbankruptcy, cancelled contracts, delayed payments to their suppliers or delayedadditional purchases.  The delay orfailure to complete one or more large contracts, or the loss of a significantcustomer, could materially harm our business, financial condition, results ofoperations, or cash flows, and cause our operating results to varysignificantly from quarter to quarter and year to year.

 

***Many of our products and services are soldon a fixed-price basis.  If we incurbudget overruns, our margins and results of operations may be materiallyharmed.***

 

Currently, a largeportion of our revenue is from contracts that are on a fixed-price basis. Weanticipate that customers will continue to request we provide software andintegration services as a total solution on a fixed-price basis. Thesecontracts specify certain obligations and deliverables we must meet regardlessof the actual costs we incur. Projects done on a fixed-price basis are subjectto budget overruns. On occasion, we have experienced budget overruns, resultingin lower than anticipated margins. We may incur similar budget overruns in thefuture, including overruns that result in losses on these contracts. If we incurbudget overruns, our margins may be harmed, thereby affecting our overallprofitability.

 

***Percentage-of-completionaccounting used for most of our projects can result in overstated orunderstated profits or losses.***

 

The revenue for most ofour contracts is accounted for on the percentage-of-completion method ofaccounting.  This method of accountingrequires us to calculate revenue and profits to be recognized in each reportingperiod for each project based on our predictions of future outcomes, includingour estimates of the total cost to complete the project, project schedule andcompletion date, the percentage of the project that is completed and theamounts of any probable unapproved change orders.  Our failure to accurately estimate theseoften subjective factors could result in reduced profits or losses for certaincontracts.

 

***The industry in which we compete is subjectto rapid technological change. If we fail to develop or introduce new, reliableand competitive products in a timely fashion, our business may suffer.***

 

The market for ourproducts and services is subject to rapid technological changes, evolvingindustry standards, changes in carrier requirements and preferences andfrequent new product introductions and enhancements. The introduction ofproducts that incorporate new technologies and the emergence of new industrystandards can make existing products obsolete and unmarketable. In addition, “internationalizing”products that we have developed for our U.S. customer carriers is a complex process.To compete successfully, we must continue to design, develop and sellenhancements to existing products and new products that provide higher levelsof performance and reliability in a timely manner, take advantage oftechnological advancements and changes in industry standards and respond to newcustomer requirements. As a result of the complexities inherent in softwaredevelopment, major new product enhancements and new products can require longdevelopment and testing periods before they are commercially released anddelays in planned delivery dates may occur. We may not be able to successfullyidentify new product opportunities or achieve market acceptance of new productsbrought to market. In addition, products developed by others may cause our productsto become obsolete or noncompetitive. If we fail to anticipate or respondadequately to changes in technology and customer preferences, or if ourproducts do not perform satisfactorily, or if we have delays in productdevelopment, we may lose customers and our sales may deteriorate.

 

***The market for our number portability andservice activation products is mature and we may not be able to successfullydevelop new products to remain competitive.***

 

The market for our numberportability products and our service activation product is mature and we maynot be able to successfully identify new product opportunities.  If we areunable to identify new product opportunities sales and profit growth would beadversely affected.

 

***The market for our new products is uncertain and we maynot be able to generate sufficient demand for those products to grow ourbusiness.***

 

The market for our newproducts, specifically International *NumeriTrack* andDSA, is uncertain and we are still in the early stages of developing customerdemand for these products.  Our current strategy is heavily reliant onachieving increased sales of these products and if we are unable to achievemarket acceptance of these products our sales and profit growth would beadversely affected.

 

***The communications industry is highly competitive and if ourproducts do not satisfy customer demand for performance or price, our customerscould purchase products and services from our competitors.***

 

Our primary markets areintensely competitive and we face continuous demand for improved productperformance, new product features and reduced prices, as well as intensepressure to accelerate the release of new products and product enhancements. 

 

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Our existing andpotential competitors include many large domestic and international companies,including some competitors that have substantially greater financial,manufacturing, technological, marketing, distribution and other resources,larger installed customer bases and longer-standing relationships withcustomers than we do. Our principal competitors in the numbering solutionsmarket include Telcordia Technologies, Inc., Syniverse Technologies andNeuStar, Inc. Our principal competitors in activation are Oracle (as aresult of its acquisition of Metasolv), Comptel, Intec and SynchronossTechnologies. In mediation, we compete with many different companies with nosingle dominant competitor. Customers also may offer competitive products orservices in the future since customers who have purchased solutions from us arenot precluded from competing with us. Many telecommunications companies havelarge internal development organizations, which develop software solutions andprovide services similar to the products and services we provide. We alsoexpect competition may increase in the future from application serviceproviders, existing competitors and from other companies that may enter ourexisting or future markets with solutions which may be less costly, providehigher performance or additional features or be introduced earlier than oursolutions.

 

We believe thatour ability to compete successfully depends on numerous factors, including thequality and price competitiveness of our products and services compared tothose of our competitors, the emergence of new industry standards and technicalinnovations and our ability to respond to those changes. Some of these factorsare within our control, and others are not. A variety of potential actions byour competitors, including a reduction of product prices or increasedpromotion, announcement or accelerated introduction of new or enhancedproducts, or cooperative relationships among competitors and their strategicpartners, could negatively impact the sales of our products and we may have toreduce the prices we charge for our products. Revenue and operating margins may consequently decline. We may not beable to compete successfully with existing or new competitors or to properlyidentify and address the demands of new markets. This is particularly true innew markets where standards are not yet established. Our failure to adapt toemerging market demands, respond to regulatory and technological changes orcompete successfully with existing and new competitors would materially harmour business, financial condition, results of operations and cash flows.

 

***Our business depends largely on our ability to attract andretain talented employees.***

 

Our ability to managefuture expansion, if any, effectively will require us to attract, train,motivate and manage new employees successfully, to integrate new management andemployees into our overall operations and to continue to improve ouroperations, financial and management systems. We may not be able to retainpersonnel or to hire additional personnel on a timely basis, if at all. Becauseof the complexity of our software solutions, a significant time lag existsbetween the hiring date of technical and sales personnel and the time when theybecome fully productive. We have at times experienced high employee turnoverand difficulty in recruiting and retaining technical personnel. Our failure toretain personnel or to hire qualified personnel on a timely basis couldadversely affect our business by impacting our ability to develop new products,to complete our projects and secure new contracts.

 

***Our products are complex and may have errors that are notdetected until deployment, and litigation related to warranty and productliability claims could be expensive and could negatively affect our reputationand profitability.***

 

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

 

***Our measures to protect our proprietary technology and otherintellectual property rights may not be adequate and if we fail to protectthose rights, our business would be harmed.***

 

Our success and abilityto compete are dependent to a significant degree on our proprietary technology.We rely on a combination of patent, copyright, trademark and trade secret laws,as well as confidentiality agreements and licensing arrangements, to establishand protect our proprietary rights. We have patents pending in U.S. and othercountries on elements of our DSA product and we have U.S. and Canadian patentson elements of our LNP products, ***NumberManager®***and ***OrderPath®***, and U.S. patents onelements of some of our other products. In addition, we have registered orfiled for registration of certain of our trademarks. Our patent portfolio isrelatively small and given the cost of obtaining patent protections, we maychoose not to patent certain inventions that turn out to be important. There isalso the possibility that a third party may copy or otherwise obtain and useour products or technology without authorization or may develop similartechnology independently through reverse engineering or other means. Inaddition, the laws of some foreign countries may not adequately protect ourproprietary rights. Our means of protecting our proprietary rights in the U.S.or abroad may not be adequate or others may independently develop technologiesthat are similar or superior to our technology, duplicate our technology ordesign around any of our patents. If our intellectual property protectionproves inadequate, we may lose our competitive advantage and our futurefinancial results may suffer.

 

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***In the event that we are infringing upon the proprietaryrights of others or violating licenses, we may become subject to infringementclaims that may prevent us from selling certain products and we may incursignificant expenses in resolving these claims.***

 

It is also possible thatour business activities may infringe upon the proprietary rights of others, orthat other parties may assert infringement claims against us. Those claims mayinvolve patent holding companies or other adverse patent owners who have norelevant product revenue or their own, and against whom our own patents mayprovide little or no deterrence. If we become liable to any third party forinfringing its intellectual property rights, we could be required to paysubstantial damage awards and to develop non-infringing technology, obtainlicenses, or to cease selling the applications that contain the infringingintellectual property. Litigation is subject to inherent uncertainties, and anyoutcome unfavorable to us could materially harm our business. Furthermore, wecould incur substantial costs in defending against any intellectual propertylitigation, and these costs could increase significantly if any dispute were togo to trial. Our defense of any litigation, regardless of the merits of thecomplaint, likely would be time-consuming, costly, and a distraction to ourmanagement personnel. Adverse publicity related to any intellectual propertylitigation also could harm the sale of our products and damage our competitiveposition.

 

Certain softwaredeveloped or used by Evolving Systems, as well as certain software acquired inour acquisitions of CMS, TSE or Evolving Systems U.K., may include or so called“open source” software that is made available under an open source softwarelicense.

 

·                  Such open source software may be madeavailable under licenses, certain of which may impose obligations on us in theevent we were to distribute derivative works based on the open sourcesoftware.  Certain licenses imposeobligations that could require us to make source code for a derivative workavailable to the public or license the derivative work under a particular typeof open source software license, rather than the license terms we customarilyuse to protect our software.

·                  There is little or no legal precedent forinterpreting the terms of certain of these open source licenses, including theterms addressing the extent to which software incorporating open sourcesoftware may be considered a derivative work subject to these licenses.  We believe we have complied with ourobligations under the various applicable open source licenses.  However, if the owner of any open sourcesoftware were to successfully establish that we had not complied with the termsof an open source license for a particular product that includes such opensource software, we may be forced to release the source code for thatderivative work to the public or cease distribution of that work.

 

***Disruptions from terrorist activities or military actionsmay have an adverse effect on our business.***

 

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

 

***Weface risks associated with doing business through local partners.***

 

In some countries,because of local customs and regulations or for language reasons, we dobusiness with our customers through local partners who resell our products andservices, with or without value-added services. This can cause delays in closing contracts because of the increasedcomplexity of having another party involved in negotiations.  In addition, where the local partner providesadditional software, hardware and/or services to the end-user customer, ourproducts and services may only be a small portion of the total solution.  As a result, payments made to us, as well asconditions surrounding acceptance, may be impacted by things that are out ofour control.  There may also be delays ingetting payments made by the end-user customer through the reseller.  We recently experienced delays in collectingfrom one of our resellers and this situation may arise again in the future,negatively impacting our cash flows.

 

***Weface special risks associated with doing business in highly corruptenvironments.***

 

Our internationalbusiness operations include projects in developing countries and countries tornby conflict.  To the extent we operateoutside the U.S., we are subject to the Foreign Corrupt Practices Act (“FCPA”),which generally prohibits U.S. companies and their intermediaries from payingor offering anything of value to foreign government officials for the purposeof obtaining or keeping business, or otherwise receiving discretionaryfavorable treatment of any kind.  We mayalso be subject to local anti-bribery laws and regulations. In particular, wemay be held liable for actions taken by our local partners and agents, eventhough such parties are not always subject to our control.  Any determination that we have violated theFCPA (whether directly or through acts of others, intentionally or throughinadvertence) or other anti-bribery legislation could result in sanctions thatcould have a material adverse effect on our business.  While we have procedures and controls inplace to monitor compliance, situations outside of our control may arise thatcould potentially put us in violation of the FCPA or other anti-briberylegislation inadvertently and thus negatively impact our business.

 

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***The trading price of our stock has beensubject to wide fluctuations and may continue to experience volatility in thefuture.***

 

The trading price of ourcommon stock has been subject to wide fluctuations in response to quarterlyvariations in operating results, announcements of technological innovations ornew products by us or our competitors, merger and acquisition activity, changesin financial estimates by securities analysts, the operating and stock priceperformance of other companies that investors may deem comparable to us,general stock market and economic considerations and other events or factors.This may continue in the future.

 

In addition, thestock market has experienced volatility that has particularly affected themarket prices of stock of many technology companies and often has beenunrelated to the operating performance of these companies. These broad marketfluctuations may negatively impact the trading price of our common stock. As aresult of the foregoing factors, our common stock may not trade at or higherthan its current price.

 

***Sales of large blocks of our stock may result in thereduction in the market price of our stock and make it more difficult to raisefunds in the future.***

 

If our stockholders sellsubstantial amounts of our common stock in the public market, the market priceof our common stock could fall. The perception among investors that such saleswill occur could also produce this effect. To the extent we have one or morestockholders who own a large percentage of our stock and those stockholderschose to liquidate their holdings, it may have a dramatic impact on the marketprice of our stock. These factors also could make it more difficult to raisefunds through future offerings of common stock.

 

***We are subject to certain rules andregulations of federal, state and financial market exchange entities, thecompliance with which requires substantial amounts of management time andcompany resources.  Any materialweaknesses in our financial reporting or internal controls could adverselyaffect our business and the price of our common stock.***

 

Because our common stockis publicly traded, we are subject to certain rules and regulations offederal, state and financial market exchange entities charged with theprotection of investors and the oversight of companies whose securities arepublicly traded.  These entities,including the Public Company Accounting Oversight Board, the SEC and NASDAQ,have issued requirements and regulations and are currently developingadditional regulations and requirements in response to laws enacted byCongress, most notably the Sarbanes-Oxley Act of 2002.  Our compliance with certain of these rules,such as Section 404 of the Sarbanes-Oxley Act, is likely to require thecommitment of significant managerial resources. In addition, establishment ofeffective internal controls is further complicated because we are now a globalcompany with multiple locations and IT systems.

 

We continue to review ourmaterial internal control systems, processes and procedures for compliance withthe requirements of Section 404. Such a review may result in the identification of material weaknesses inour internal controls.  Disclosures ofmaterial weaknesses in our SEC reports could cause investors to lose confidencein our financial reporting and may negatively affect the price of our stock.  Moreover, effective internal controls arenecessary to produce reliable financial reports and to prevent fraud.  If we have material weaknesses in ourinternal control over financial reporting it may negatively impact ourbusiness, results of operations and reputation.

 

***We have never paid dividends and do notanticipate paying cash dividends on our common stock in the foreseeable future.***

 

We have never paid cashdividends on our common stock. We currently intend to retain all futureearnings, if any, for use in the operation of our business. In addition, unlesswe are specifically authorized, our revolving credit facility prohibits us fromdeclaring dividends to our common stockholders, . Accordingly, we do notanticipate paying cash dividends on our common stock in the foreseeable future.

 

***Certain provisions of our charterdocuments, employment arrangements, Delaware law and agreements with our mostsignificant stockholder may discourage, delay or prevent an acquisition of us,even if an acquisition would be beneficial to our stockholders, and may preventattempts by our stockholders to replace or remove our current management.***

 

Provisions of our amendedand restated certificate of incorporation and bylaws, as well as provisions ofDelaware law, could make it more difficult for a third party to acquire us,even if doing so would benefit our stockholders.  In addition, these provisions may frustrateor prevent any attempts by our stockholders to replace or remove our currentmanagement by making it more difficult for stockholders to replace members ofour board of directors.  Because ourboard of directors is responsible for appointing the members of our managementteam, these provisions could in turn affect any attempt by our stockholders toreplace current members of our management team. These provisions include the following:

 

·                  our board of directors is authorized toissue up to 2,000,000 shares of preferred stock and to determine the price,rights, preferences and privileges of those shares without any further vote oraction by our stockholders;

 

·                  our board of directors has adopted astockholder rights agreement or “poison pill” designed to protect stockholdersagainst unsolicited attempts to acquire the Company;

 

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·                  we have a staggered board with eachmember of the Board of Directors serving for three years; in any given year,only a portion of our Board of Directors have terms that expire;

 

·                  our stockholders cannot take action bywritten consent; and

 

·                  we have advance notice requirements fornominations for election to the Board of Directors or for proposing mattersthat can be acted upon at stockholder meetings.

 

In addition, we aresubject to the anti-takeover provisions of Section 203 of Delaware GeneralCorporation Law, which prohibit us from engaging in a “business combination”with an “interested stockholder” for a period of three years after thedate of the transaction in which the person became an interested stockholder,unless the business combination is approved in the prescribed manner. Theapplication of Section 203 and certain provisions of our restatedcertificate of incorporation, including a classified board of directors, mayhave the effect of delaying or preventing changes in control of our management,which could adversely affect the market price of our common stock bydiscouraging or preventing takeover attempts that might result in the payment ofa premium price to our stockholders. Notwithstanding the foregoing, the threeyear moratorium imposed on business combinations by Section 203 will notapply to the Singer Group because, prior to the date on which the Singer Groupbecame an interested stockholder, our board of directors approved thetransaction which resulted in the Singer Group becoming an interestedstockholder.  However, in connection withits purchase of the Company’s common stock resulting in the Singer Groupbecoming beneficial owners of more than 15% of the Company’s stock, KarenSinger, as Trustee of the Singer Children’s Management Trust, entered into astandstill agreement agreeing not to pursue, for 18 months, certain activitiesthe purpose or effect of which may be to change or influence the control of theCompany.  The standstill agreementexpired on September 30, 2009.

 

On December 10,2009, the Board of Directors approved an amendment to the stockholder rightsplan.  The amendment increases, from 22.5% to 25.0%, the percentage of ourcommon stock that a person or group of affiliated or associated persons maybeneficially own without triggering the exercisability of the stockholderrights plan.  All other provisions of the stockholder rights plan remainunchanged.

 

On December 11,2009, we received a letter from the Singer Trust informing us that as theresult of the appointment of John B. Spirtos to our Board of Directors and ourapproval of the amendment to the stockholder rights plan the Singer Trust willvote in favor of the reelection of Philip Neches and Richard Ramlall to ourBoard of Directors at our 2010 annual meeting of stockholders and the SingerTrust will not seek or otherwise support additional stockholder protections orreforms at the meeting.

 

Our executive officers have entered into management change in controlagreements with us. Each agreement generally provides for acceleration onvesting of options, 50% upon a change in control (as defined in suchagreements) if the executive remains employed with the new entity, or 100% inthe event such executive’s employment is terminated. The acceleration ofvesting of options upon a change in control may be viewed as an anti-takeovermeasure and may have the effect of discouraging a merger proposal, tender offeror other attempt to gain control of us.

 

Our Amended and RestatedStock Option Plan provides for acceleration of vesting under certaincircumstances. Upon certain changes in control of us, vesting on some optionsawarded to directors may be accelerated. In addition, the successor corporationmay assume outstanding stock awards or substitute equivalent stock awards. Ifthe successor corporation refuses to do so, such stock awards will become fullyvested and exercisable for a period of 15 days after notice from us but theoption will terminate if not exercised during that period. As noted above, theacceleration on vesting of options upon a change in control may be viewed as ananti-takeover measure.

 

***Generaleconomic factors, domestically and internationally, that impact thecommunications industry, could negatively affect our revenue and operatingresults.***

 

Unsettled financialmarkets, higher interest rates, inflation, levels of unemployment and othereconomic factors could adversely affect demand for our products and services asconsumers and businesses may postpone spending in response to these conditions,negative financial news and declines in income and asset values.  Challenging economic and market conditionsmay also result in:

 

·                  difficulty forecasting, budgeting andplanning due to limited visibility into the spending plans of current orprospective customers;

 

·                  pricing pressure that may adverselyaffect revenue and gross margin;

 

·                  lengthening sales cycles and slowingdeployments;

 

·                  increased competition for fewer projectsand sales opportunities;

 

·                  increased risk of charges relating towrite off of goodwill and other intangible assets;

 

·                  customer and reseller financialdifficulty and greater difficulty collecting accounts receivable.

 

We are unable to predicthow long the economic downturn will last and the magnitude of its effect on ourbusiness and results 

 

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of operations.  If these conditions continue, or furtherweaken, our business and results of operations could be materially adverselyaffected.

 

**General risk statement**

 

Based on all of theforegoing, we believe it is possible for future revenue, expenses and operatingresults to vary significantly from quarter to quarter and year to year. As aresult, quarter-to-quarter and year-to-year comparisons of operating resultsare not necessarily meaningful or indicative of future performance.Furthermore, we believe that it is possible that in any given quarter or fiscalyear our operating results could differ from the expectations of public marketanalysts or investors. In such event, or in the event that adverse conditionsprevail, or are perceived to prevail, with respect to our business orgenerally, the market price of our common stock would likely decline.

 

**ITEM1B.    UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2.     PROPERTIES**

 

We lease officespace at various locations which are shown below.

 
| **Location**                        | ** ** | **Square  Footage** | ** ** | **Lease  Expiration** | ** ** |
|-------------------------------------|------------|---------------------|------------|-----------------------|------------|
| Englewood,  Colorado (Headquarters) |       | 24,305              |       | 10/31/12              |       |
| Bradenton,  Florida                 |       | 150                 |       | 5/31/10               |       |
| Bath,  England                      |       | 5,100               |       | 9/26/10               |       |
| London,  England                    |       | 7,765               |       | 3/24/10               |       |
| Windsor,  England                   |       | 118                 |       | 12/31/10              |       |
| Bangalore,  India                   |       | 12,300              |       | 8/18/12               |       |
| Munich,  Germany                    |       | 732                 |       | Month-to-month        |       |
| Kuala  Lumpur, Malaysia             |       | 1,042               |       | 7/14/10               |       |

 

**ITEM 3.    LEGALPROCEEDINGS**

 

We are involved invarious legal matters arising in the normal course of business.  We do not believe that any such matters willhave a material impact on our results of operations and financial position.

 

**ITEM 4.    RESERVED**

 

**PART II**

 

**ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY,RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

Our common stockbegan trading publicly through the Nasdaq National Market under the symbol “EVOL”on May 12, 1998. Prior to that date, there was no public market for ourcommon stock. We transferred from the Nasdaq National Market to the NasdaqSmallCap Market (now known as the Nasdaq Capital Market) on August 28,2002. The closing price of our common stock as reported on the Nasdaq CapitalMarket as of March 4, 2010 was $6.97 pershare. The following table sets forth for the periods indicated the highand low closing sale quotations and may not be based on actual transactions forour common stock as reported on the Nasdaq Capital Market. The prices reporteddo not include retail mark-ups, markdowns or commissions.

 
| ** **     | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **     | ** ** | **High**                                  | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                                         | 2.88       |   | $ | 1.68 |   | $ | 5.24 |   | $ | 3.92 |   |
| Second Quarter |       | $                                         | 6.12       |   | $ | 2.36 |   | $ | 4.76 |   | $ | 3.92 |   |
| Third Quarter  |       | $                                         | 7.04       |   | $ | 4.48 |   | $ | 4.50 |   | $ | 3.00 |   |
| Fourth Quarter |       | $                                         | 7.49       |   | $ | 5.85 |   | $ | 3.06 |   | $ | 1.56 |   |

 

As of March 4,2010, there were approximately 33 holders of record of our common stock.

 

We have notdeclared or paid a cash dividend on our common stock. In addition, the terms ofour revolving credit facility 

 

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prohibits us fromdeclaring dividends to our common stockholders without bank approval. Wecurrently intend to retain future earnings, if any, to finance the growth anddevelopment of our business and, therefore, do not anticipate paying cashdividends in the foreseeable future.

 

The followinggraph compares the cumulative 5-year total return provided to shareholders onEvolving Systems, Inc.’s common stock relative to the cumulative totalreturns of the NASDAQ Composite index, the DJ Wilshire MicroCap Software index,and the RDG Software Composite index. An investment of $100 (with reinvestmentof all dividends) is assumed to have been made in our common stock and in eachindex on 12/31/2004 and its relative performance is tracked through 12/31/2009.

 

**COMPARISON OF 5 YEAR CUMULATIVETOTAL RETURN***

Among Evolving Systems, Inc., The NASDAQComposite Index,

The RDG Software Composite Index And The DJMicroCap Total Stock Market Software Index

 

 

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*$100 invested on 12/31/04 in stock or index, including reinvestment ofdividends.

Fiscal year ending December 31.

 

**ITEM 6.    SELECTEDFINANCIAL DATA**

 

The selectedfinancial data set forth below for each of the years in the five-year periodended December 31, 2009, has been derived from our consolidated financialstatements. The following selected financial data should be read in conjunctionwith “Item 7 - Management’s Discussion and Analysis of Financial Condition andResults of Operations”, the consolidated financial statements and the notesthereto and other financial information included elsewhere in this AnnualReport on Form 10-K.

 
| ** **                                                         | ** ** | **For the Years Ended December 31,**    | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                         | ** ** | **2009**                                     | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | **(in thousands, except per share amounts)** | ** ** |
|                                                               |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenue                                                            |       | $                                            | 38,196     |   | $ | 37,821 |   | $ | 35,953 |   | $ | 33,833 |   | $ | 39,452 |   |
| Costs of Revenue and Operating Expenses:                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Cost of revenue, excluding depreciation and                        |       |                                         |       |   |   |   |   |   |   |   |   |
| amortization                                                       |       | 13,185                                       |       | 13,919 |   | 14,260 |   | 13,036 |   | 16,070 |   |
| Sales and marketing                                                |       | 7,696                                        |       | 8,500 |   | 8,557 |   | 8,962 |   | 9,643 |   |
| General and administrative                                         |       | 5,737                                        |       | 5,676 |   | 5,862 |   | 5,138 |   | 6,818 |   |
| Product development                                                |       | 3,530                                        |       | 3,607 |   | 2,376 |   | 3,072 |   | 1,921 |   |
| Depreciation                                                       |       | 632                                          |       | 847 |   | 899 |   | 1,169 |   | 1,443 |   |
| Amortization                                                       |       | 732                                          |       | 1,363 |   | 1,565 |   | 2,511 |   | 5,215 |   |
| Impairment of goodwill and intangible assets (1)                   |       | —                                       |       | — |   | — |   | 16,516 |   | — |   |
| Restructuring and other expense                                    |       | —                                       |       | — |   | (4 | ) | (21 | ) | (49 | ) |
| Income (loss) from operations                                      |       | 6,684                                        |       | 3,909 |   | 2,438 |   | (16,550 | ) | (1,609 | ) |
| Interest and other, net                                            |       | (1,096                                       | )          | (420 | ) | (1,284 | ) | (1,837 | ) | (1,692 | ) |
| Income tax expense (benefit)                                       |       | 764                                          |       | 560 |   | 556 |   | (1,604 | ) | (396 | ) |
| Net income (loss)                                                  |       | $                                            | 4,824      |   | $ | 2,929 |   | $ | 598 |   | $ | (16,783 | ) | $ | (2,905 | ) |
|                                                               |       |                                         |       |   |   |   |   |   |   |   |   |
| Basic income (loss) per share                                      |       | $                                            | 0.49       |   | $ | 0.30 |   | $ | 0.06 |   | $ | (1.76 | ) | $ | (0.32 | ) |
| Diluted income (loss) per share                                    |       | $                                            | 0.48       |   | $ | 0.30 |   | $ | 0.06 |   | $ | (1.76 | ) | $ | (0.32 | ) |
| Weighted average basic shares outstanding                          |       | 9,816                                        |       | 9,695 |   | 9,599 |   | 9,550 |   | 9,348 |   |
| Weighted average diluted shares outstanding                        |       | 10,145                                       |       | 9,878 |   | 9,788 |   | 9,550 |   | 9,348 |   |
|                                                               |       |                                         |       |   |   |   |   |   |   |   |   |
| Working capital (6)                                                |       | $                                            | 4,774      |   | $ | 1,802 |   | $ | 1,395 |   | $ | 803 |   | $ | 447 |   |
| Total assets (2)                                                   |       | 45,837                                       |       | 45,411 |   | 53,727 |   | 51,338 |   | 67,398 |   |
| Long-term debt, net of current portion (7)                         |       | 1,500                                        |       | 4,883 |   | 8,686 |   | 11,370 |   | 14,373 |   |
| Series B convertible redeemable preferred stock  (4) (5) |       | —                                       |       | — |   | 5,587 |   | 11,281 |   | 11,281 |   |
| Stockholders’ equity (3)                                      |       | $                                            | 28,469     |   | $ | 19,942 |   | $ | 17,928 |   | $ | 10,158 |   | $ | 22,124 |   |

 

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(1)          In 2006, we recognized an impairment of$16.5 million on goodwill and amortizable intangible assets related to ourlicense fees and services operating segment.

 

(2)          The decrease in total assets from 2005 to2006 is primarily due to impairment of intangible assets, amortization ofintangible assets, goodwill impairment, adjustments to goodwill related to theacquisitions of TSE and Evolving Systems U.K., foreign currency translationadjustments and use of cash to pay short-term obligations owed as a result of theacquisitions of TSE and Evolving Systems U.K.

 

(3)          The decrease in stockholders’ equity from2005 to 2006 is primarily a result of the impairment of goodwill and intangibleassets recorded during 2006.

 

(4)          The decrease in Series B convertibleredeemable preferred stock and the increase in stockholders’ equity from 2006to 2007 is primarily the result of holders of 487,916 shares of Series BPreferred Stock, with an aggregate carrying value of $5.7 million, convertingtheir shares of preferred stock into 1,463,748 shares of our common stock inaccordance with the conversion provisions of the Series B Preferred Stock,during 2007.

 

(5)          On February 25, 2008, holders of461,758 shares of Series B Preferred Stock with a carrying value of $5.4million, or approximately 96% of the outstanding preferred stock, convertedtheir shares of preferred stock into 692,637 shares of our common stock inaccordance with the conversion provisions of the Series B PreferredStock.  On March 19, 2008, a holderof 16,992 shares of Series B Preferred Stock with a carrying value of $0.2million, which represented the remainder of the outstanding preferred stock,converted his shares of preferred stock into 25,488 shares of our common stockin accordance with the conversion provisions of the Series B PreferredStock.  As we previously included the Series BConvertible Preferred Stock as a participating security for basic EPS purposes,these conversions did not change our basic or diluted EPS calculations.

 

(6)          During 2009 we reduced our senior termnote by $2.0 million which was classified as a current liability at December 31,2008.

 

(7)          During 2009, we paid $6.2 million to retire oursubordinated notes, including accrued interest. These payments were made fromcash on hand and $1.5 million in borrowings on our U.K. revolving creditfacility. The subordinated debt payments were unscheduled and reduced balancesclassified as long-term as of December 31, 2008.

 

**ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

*ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements that have been made pursuant tothe provisions of the Private Securities Litigation Reform Act of 1995. 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 ourexpectations regarding product, services, and*

 

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*customersupport revenue; our expectations associated with Evolving India and EvolvingSystems U.K., and short- and long-term cash needs. In some cases, words such as“anticipates”, “expects”, “intends”, “plans”, “believes”, “estimates”,variations of these words, and similar expressions are intended to identifyforward-looking statements. The following discussion should be read inconjunction with, and is qualified in its entirety by, the consolidatedfinancial statements and the notes thereto included elsewhere in this AnnualReport on Form 10-K. Our actual results could differ materially from thoseanticipated in these forward-looking statements as a result of certain factors,including those set forth in this section and in “Item 1A - Risk Factors.”*

 

**OVERVIEW**

 

Evolving Systems, Inc.is a leading provider of software solutions and services to the wireless,wireline and cable markets. We maintain long-standing relationships with manyof the largest wireline, wireless and cable companies worldwide. Our customersrely on us to develop, deploy, enhance, maintain and integrate complex,reliable software solutions for a range of Operations Support Systems (“OSS”).  Our activation solution is the leadingpackaged solution for activation in the wireless industry.

 

We recognize revenue inaccordance with the prescribed accounting standards for software revenuerecognition under generally accepted accounting principles. As a result, ourlicense fees and services revenue fluctuate from period to period as a resultof the timing of revenue recognition on existing projects.

 

**2009HIGHLIGHTS**

 

Consolidated revenueincreased, for the third consecutive year, to $38.2 million from $37.8 millionfor the years ended December 31, 2009 and 2008, respectively.  Thisgrowth is primarily the result of increased revenue from our DSA solution andInternational *NumeriTrack*.

 

We reported netincome of $4.8 million, $2.9 million and $0.6 million for the years ended December 31,2009, 2008 and 2007, respectively. This is the third consecutive year in whichwe have reported net income.  The endingbacklog of $20.8 million, represents our highest ending backlog for any yearfollowing our 2003 and 2004 acquisitions of Tertio, TSE and CMS.

 

Our Board ofDirectors approved a one-for-two reverse split of our common stock, aspreviously authorized and approved by our stockholders at the June 9, 2009annual meeting, which took effect at 11:59 p.m. (Eastern time) on July 20,2009 (the “Effective Time”). Our common stock began trading on a post-splitbasis on July 21, 2009. As a result of the reverse stock split, every twoshares of our common stock was combined into one share of common stock. Thereverse stock split affected all of our common stock outstanding immediatelyprior to the Effective Time of the reverse stock split as well as the number ofshares of common stock available for issuance under our equity incentive plans.In addition, the reverse stock split reduced the number of shares of commonstock issuable upon the exercise of stock options. Our common stock outstandingat June 30, 2009 was approximately 19.6 million shares. Adjusting forthe reverse stock split, the common stock outstanding at June 30, 2009 wasreduced to approximately 9.8 million shares. The number of authorizedshares of common stock remains at 40.0 million. The reverse split did notaffect the par value of our common stock which remains at $0.001. As a resultof the reverse stock split, the stated capital on our balance sheetattributable to our common stock was reduced in proportion to the size of thereverse stock split. Common stock and additional paid-in capital balances, allshare amounts, stock option amounts and per share/option prices appearing inthis Annual Report on Form 10-K reflect the reverse stock split for allperiods presented.

 

We also had several significant improvements to our balance sheetduring 2009.  Benefiting from ourimproved performance, working capital grew to $4.8 million at December 31,2009 from $1.8 million at December 31, 2008 despite $2.0 million inexisting cash used to reduce our senior term note and $6.2 million related toour subordinated notes, including accrued non-current interest. These paymentswere made from cash on hand and $1.5 million in borrowings on our U.K.revolving credit facility. The subordinated debt payments were unscheduled andreduced balances classified as long-term as of December 31, 2008.

 

We have operationsin foreign countries where the local currency is used to prepare the financialstatements which are translated into our reporting currency, U.S. Dollars.Changes in the exchange rates between these currencies and our reportingcurrency are partially responsible for some of the changes from period toperiod in our financial statement amounts. The majority of the changes in 2009and 2008 are a result of the U.S. Dollar strengthening on average versus theBritish Pound Sterling. The chart below summarizes what our revenue andexpenses would be on a constant currency basis. The constant currency basisassumes that the exchange rate was constant for the periods presented (inthousands).

 
| ** **                              | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2009 vs. 2008**                         | ** ** | **2008 vs. 2007** | ** ** |
| ** **                              | ** ** | **Increase/(Decrease)**                   | ** ** |
| Revenue                                 |       | $                                         | (1,984     | ) | $ | (323 | ) |
| Costs of revenue and operating expenses |       | (3,035                                    | )          | (1,534 | ) |
| Operating income                        |       | $                                         | 1,051      |   | $ | 1,211 |   |

 

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The net effect of our foreign currency translations for the year ended December 31,2009 was a $2.0 million decrease in revenue and a $3.0 million decrease inoperating expenses versus the year ended December 31, 2008. The net effectof our foreign currency translations for the year ended December 31, 2008was a $0.3 million decrease in revenue and a $1.5 million decrease in operatingexpenses versus the year ended December 31, 2007.

 

**RESULTSOF OPERATIONS**

 

The following tablepresents our consolidated statements of operations in comparative format.

 
| ** **                                                                   | ** ** | **For the Years Ended December 31,** | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                                  | ** ** | **2008**                                  | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| **Revenue:**                                                                 | ** ** | ** **                                |       |                                      |       |   |   |   |   |   |   |   |   |
| License fees and services                                                    |       | $                                         | 21,561     |                                      | $          | 20,324 |   | $ | 1,237 |   | $ | 20,324 |   | $ | 17,895 |   | $ | 2,429 |   |
| Customer support                                                             |       | 16,635                                    |       | 17,497                                    |       | (862 | ) | 17,497 |   | 18,058 |   | (561 | ) |
| Total revenue                                                                |       | 38,196                                    |       | 37,821                                    |       | 375 |   | 37,821 |   | 35,953 |   | 1,868 |   |
|                                                                         |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| **Costs of  revenue and operating expenses:**                                |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Costs of license fees and services, excluding  depreciation and amortization |       | 7,642                                     |       | 7,816                                     |       | (174 | ) | 7,816 |   | 8,023 |   | (207 | ) |
| Costs of customer support, excluding depreciation  and amortization          |       | 5,543                                     |       | 6,103                                     |       | (560 | ) | 6,103 |   | 6,237 |   | (134 | ) |
| Sales and marketing                                                          |       | 7,696                                     |       | 8,500                                     |       | (804 | ) | 8,500 |   | 8,557 |   | (57 | ) |
| General and administrative                                                   |       | 5,737                                     |       | 5,676                                     |       | 61 |   | 5,676 |   | 5,862 |   | (186 | ) |
| Product development                                                          |       | 3,530                                     |       | 3,607                                     |       | (77 | ) | 3,607 |   | 2,376 |   | 1,231 |   |
| Depreciation                                                                 |       | 632                                       |       | 847                                       |       | (215 | ) | 847 |   | 899 |   | (52 | ) |
| Amortization                                                                 |       | 732                                       |       | 1,363                                     |       | (631 | ) | 1,363 |   | 1,565 |   | (202 | ) |
| Restructuring and other  recovery                                            |       | —                                    |       | —                                    |       | — |   | — |   | (4 | ) | 4 |   |
| Total costs of revenue and  operating expenses                               |       | 31,512                                    |       | 33,912                                    |       | (2,400 | ) | 33,912 |   | 33,515 |   | 397 |   |
| Income from operations                                                       |       | 6,684                                     |       | 3,909                                     |       | 2,775 |   | 3,909 |   | 2,438 |   | 1,471 |   |
|                                                                         |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest income                                                              |       | 25                                        |       | 161                                       |       | (136 | ) | 161 |   | 304 |   | (143 | ) |
| Interest expense                                                             |       | (547                                      | )          | (1,171                                    | )          | 624 |   | (1,171 | ) | (1,747 | ) | 576 |   |
| Other income                                                                 |       | —                                    |       | 57                                        |       | (57 | ) | 57 |   | — |   | 57 |   |
| Gain (loss) on  extinguishment of debt                                       |       | —                                    |       | (290                                      | )          | 290 |   | (290 | ) | 42 |   | (332 | ) |
| Foreign currency exchange  gain (loss)                                       |       | (574                                      | )          | 823                                       |       | (1,397 | ) | 823 |   | 117 |   | 706 |   |
| Other income (expense), net                                                  |       | (1,096                                    | )          | (420                                      | )          | (676 | ) | (420 | ) | (1,284 | ) | 864 |   |
|                                                                         |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Income before income taxes                                                   |       | 5,588                                     |       | 3,489                                     |       | 2,099 |   | 3,489 |   | 1,154 |   | 2,335 |   |
| Income tax expense                                                           |       | 764                                       |       | 560                                       |       | 204 |   | 560 |   | 556 |   | 4 |   |
| Net income                                                                   |       | $                                         | 4,824      |                                      | $          | 2,929 |   | $ | 1,895 |   | $ | 2,929 |   | $ | 598 |   | $ | 2,331 |   |

 

***Revenue***

 

Revenue iscomprised of license fees and services and customer support.  License fees and services revenue representthe fees we receive from the licensing of our software products and thoseservices directly related to the delivery of the licensed product as well asintegration services and time and materials work.  Customer support revenue includes annualsupport fees, recurring maintenance fees, minor product upgrades and warrantyfees.  Warranty fees are typicallybundled with a license sale and the related revenue, based on vendor specificobjective evidence (“VSOE”), is deferred and recognized ratably over thewarranty period.  The following tablepresents our revenue by product line (in thousands).

 
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| **Revenue**         | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Activation          |       | $                                         | 23,307     |   | $ | 20,639 |   | $ | 19,533 |   |
| Numbering solutions |       | 12,823                                    |       | 13,270 |   | 11,919 |   |
| Mediation           |       | 2,066                                     |       | 3,912 |   | 4,501 |   |
| Total revenue       |       | $                                         | 38,196     |   | $ | 37,821 |   | $ | 35,953 |   |

 

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***License Fees andServices***

 

License fees and services revenue increased 6%, or $1.2 million to$21.6 million for the year ended December 31, 2009 compared to $20.3million for the year ended December 31, 2008.  The increase was a result of an increase of$2.7 million in revenue from our activation products, partially offset by a$1.4 million decrease in revenue from our mediation products and a $0.1 milliondecrease in revenue from our numbering solutions products. This growth inactivation is due to increased revenue from our DSA solution. The $1.4 milliondecrease in mediation revenue is due to lower revenue from our existingmediation account base. The $0.1 million decrease in numbering solutionsrevenue is due to decreased sales of our legacy products, offset by increasedsales of our International *NumeriTrack*solution.License fees and services revenue in 2009 was negatively affected by the strengthenedU.S. Dollar.

 

License fees and services revenue increased 14%, or $2.4 million, to$20.3 million for the year ended December 31, 2008 compared to $17.9million for the year ended December 31, 2007.  The increase was a result of an increase of$1.3 million in revenue from our numbering solutions products and an increaseof $1.2 million in revenue from our activation products, partially offset by a$0.1 million decrease in revenue from our mediation products.  This growth is due to increased revenue fromour DSA solution and our expansion into new international markets for bothactivation and numbering solutions (NumeriTrack), partially offset byslightly lower revenue from our existing mediation account base and thenegative effects of foreign currency fluctuations during the fourth quarter of2008.

 

***Customer Support***

 

Customer support revenue decreased 5%, or $0.9 million, to $16.6million for the year ended December 31, 2009 from $17.5 million for theyear ended December 31, 2008.  Thedecrease in customer support revenue was primarily the result of thestrengthened U.S. Dollar and the cancellation of a mediation customer supportcontract.

 

Customer support revenue decreased 3%, or $0.6 million, to $17.5million for the year ended December 31, 2008 from $18.1 million for theyear ended December 31, 2007.  Thedecrease in customer support revenue was a result of the expiration of amediation customer support contract.

 

***Costs of Revenue, excluding depreciation and amortization***

 

Costs of revenueconsist primarily of personnel costs, facilities costs, the costs ofthird-party software and all other direct costs associated with thesepersonnel. Costs of revenue, excluding depreciation and amortization were $13.2million, $13.9 million and $14.3 million for the years ended December 31,2009, 2008 and 2007, respectively.

 

***Costs of LicenseFees and Services, excluding depreciation and amortization***

 

Costs of revenue for license fees and services decreased 2%, or $0.2million, to $7.6 million for the year ended December 31, 2009 from $7.8million for the year ended December 31, 2008.  The decrease in costs was primarily due tothe effects of the strengthened U.S. Dollar during 2009.  As a percentage of license fees and servicesrevenue, costs of license fees and services, excluding depreciation andamortization, decreased to 35% for the year ended December 31, 2009 from38% for the year ended December 31, 2008. This decrease was primarily due to increased license sales in 2009 plusthe aforementioned effects of the strengthened U.S. Dollar.

 

Costs of revenue for license fees and services decreased 3%, or $0.2million, to $7.8 million for the year ended December 31, 2008 from $8.0million for the year ended December 31, 2007.  The decrease in costs was primarily due toincreased reliance on our less expensive Indian labor plus lower overhead andtravel expenses.  As a percentage oflicense fees and services revenue, costs of license fees and services,excluding depreciation and amortization, decreased to 38% for the year ended December 31,2008 from 45% for the year ended December 31, 2007.  This decrease was primarily due to increasedlicense sales in 2008 plus the aforementioned reliance on our Indian work forceand expense reductions.

 

***Costs of Customer Support, excluding depreciation andamortization***

 

Costs of revenue for customer support decreased 9%, or $0.6 million, to$5.5 million for the year ended December 31, 2009 from $6.1 million forthe year ended December 31, 2008. The decrease was primarily due to increased reliance on our lessexpensive Indian labor, the decrease in revenue and the effects of thestrengthened U.S. Dollar during 2009. As a percentage of customer supportrevenue, costs of customer support revenue, excluding depreciation andamortization, decreased to 33% for the year ended December 31, 2009 from35% for the year ended December 31, 2008. The decrease as a percentage ofcustomer support revenue was primarily due to the effects of the strengthenedU.S. Dollar partially offset by the decrease in customer support revenue.

 

Costs of revenue for customer support decreased 2%, or $0.1 million, to$6.1 million for the year ended December 31, 2008 from $6.2 million forthe year ended December 31, 2007. The decrease was primarily due to the effects of the strengthened U.S.Dollar during the fourth quarter of 2008. As a percentage of customer supportrevenue, costs of customer support revenue,

 

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excludingdepreciation and amortization, remained at 35% for the year ended December 31,2008.

 

***Sales and Marketing***

 

Sales andmarketing expenses primarily consist of compensation costs, including incentivecompensation and commissions, other employee related costs, travel expenses,advertising and occupancy expenses. Sales and marketing expenses decreased 9%, or $0.8 million, to $7.7million for the year ended December 31, 2009 from $8.5 million for theyear ended December 31, 2008.  As apercentage of total revenue, sales and marketing expenses for the year ended December 31,2009 decreased to 20% from 22% for the year ended December 31, 2008.  These decreases were primarily the result ofstrengthened U.S. Dollar, partially offset by higher commission expense relatedto improved results.

 

Sales andmarketing expenses decreased 1%, or $0.1 million, to $8.5 million for the yearended December 31, 2008 from $8.6 million for the year ended December 31,2007.  As a percentage of total revenue,sales and marketing expenses for the year ended December 31, 2008decreased to 22% from 24% for the year ended December 31, 2007.  These decreases were primarily the result ofthe lower occupancy and overhead expenses plus foreign currency effectspartially offset by higher commission expense related to improved results.

 

***General andAdministrative***

 

General andadministrative expenses consist principally of employee related costs,professional fees and occupancy costs for the following departments:facilities, finance, legal, human resources and executive management.  General and administrative expenses increased1%, or $61,000, for the year ended December 31, 2009 compared to the yearended December 31, 2008.  The slightincrease in costs was primarily due to higher professional fees partiallyoffset by lower bad debt expense. As a percentage of total revenue, general andadministrative expenses remained at 15% for the years ended December 31,2009 and 2008.

 

General andadministrative expenses decreased 3%, or $0.2 million, to $5.7 million for theyear ended December 31, 2008 from $5.9 million for the year ended December 31,2007.  As a percentage of total revenue,general and administrative expenses for the year ended December 31, 2008decreased to 15% from 16% for the year ended December 31, 2007. Thesedecreases were the result of lower professional fees, as well as lower landlordcosts related to our headquarters facility lease, partially offset by higherbonus expense related to improved results from operations and increased baddebt expense.

 

***Product Development***

 

Productdevelopment expenses consist primarily of employee-related costs for productdevelopment.  Product developmentexpenses decreased 2%, or $0.1 million, to $3.5 million for the year ended December 31,2009 from $3.6 million for the year ended December 31, 2008.  As a percentage of total revenue, productdevelopment expenses decreased to 9% in 2009 from 10% in 2008.  These decreases were the result of thestrengthened U.S. Dollar during 2009, partially offset by increased productdevelopment efforts primarily on our DSA product.

 

Productdevelopment expenses increased 52%, or $1.2 million, to $3.6 million for theyear ended December 31, 2008 from $2.4 million for the year ended December 31,2007.  As a percentage of total revenue,product development expenses increased to 10% in 2008 from 7% in 2007.  These increases were the result of increasedinvestments made in our DSA product, Tertio product portfolio and our LNP coreproducts.

 

***Depreciation***

 

Depreciationexpense consists of depreciation of long-lived property and equipment.  Depreciation expenses decreased 25%, to $0.6million for the year ended December 31, 2009 from $0.8 million for theyear ended December 31, 2008.  Thisdecrease was a result of certain assets becoming fully depreciated and theeffects of the strengthened U.S. Dollar. As a percentage of revenue,depreciation expense remained at 2% for the years ended December 31, 2009and 2008.

 

Depreciationexpenses decreased 6%, to $0.8 million for the year ended December 31,2008 from $0.9 million for the year ended December 31, 2007.  As a percentage of revenue, depreciationexpense decreased to 2% for the year ended December 31, 2009 from 3% forthe year ended December 31, 2008. These decreases were a result of certainassets becoming fully depreciated.

 

***Amortization***

 

Amortization expense consists of amortizationof identifiable intangibles related to our acquisitions of CMS, TSE andEvolving Systems U.K.  Amortizationexpenses decreased 46%, or $0.6 million, to $0.7 million for the year ended December 31,2009 from $1.4 million for the year ended December 31, 2008.  As a percentage of revenue, amortizationexpense decreased to 2% for the year ended December 31, 2009 from 4% forthe year ended December 31, 2008. The decrease in amortization expense wasdue to all CMS, and some TSE intangible assets being fully amortized during2008 and the effects of the strengthened U.S. Dollar.

 

Amortization expenses decreased 13%, or $0.2million, to $1.4 million for the year ended December 31, 2008 from $1.6million for the year ended December 31, 2007.  The decrease in amortization expense wasattributable to certain intangible assets becoming fully amortized. As a percentage of revenue, amortizationexpense remained at 4% for the years ended December 31, 2008 and 2007.

 

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***InterestIncome***

 

Interest income includesinterest income earned on cash and cash equivalents.  Interest income for the year ended December 31,2008 decreased $0.1 million to $25,000 for the year ended December 31,2009 from $0.2 million for the year ended December 31, 2008. The decreasewas a result of lower rates of return earned on our cash balances.

 

Interest income for theyear ended December 31, 2008 decreased $143,000 as compared to the yearended December 31, 2007 as a result of lower cash and cash equivalentsbalances resulting from additional principal payments we paid on long-term debtduring 2008 as well as lower rates of return.

 

***InterestExpense***

 

Interest expense includesinterest expense on our long-term debt and capital lease obligations as well asamortization of debt issuance costs. Interest expense for the year ended December 31, 2009 decreased 53%or $0.6 million to $0.6 million as compared to $1.2 million for the year ended December 31,2008.  This decrease was a result oflower debt balances due to the early retirement of our subordinated debt andaccrued interest during 2009 and the continued payments on our senior termloan.

 

Interest expense for theyear ended December 31, 2008 decreased 33% or $0.6 million to $1.2 millionas compared to $1.7 million for the year ended December 31, 2007.  This decrease was a result of the repaymentof our outstanding revolver balance of $2.0 million with an additional $1.0million applied to early repayment on the our 14% subordinated notes, as wellas lower interest rates on our new senior term note.

 

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

 

In February 2008, wewrote-off the remaining debt issuance costs of $297,000 related to our seniorterm note payable that was replaced during the three months ended March 31,2008.  This loss related to the debtissuance cost write-off was partially offset by a $7,000 gain resulting from uspaying $272,000 to retire $279,000 of subordinated debt and related accruedinterest held by two of our subordinated note holders.  The retirements included principal of$217,000 and accrued interest of $62,000.

 

In March 2007, wepaid $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.

 

***Gain(Loss) on Foreign Exchange Transactions***

 

Gain (loss) onforeign exchange transactions consists primarily of realized foreign currencytransaction gains and losses.  Foreigncurrency transaction gains and losses result from transactions denominated in acurrency other than the functional currency of the respective subsidiary.  Foreign currency transaction expenseincreased $1.4 million to a foreign currency loss of $0.6 million for the yearended December 31, 2009 compared to a $0.8 million foreign currency gainfor the year ended December 31, 2008. These losses were primarily generated by Evolving Systems U.K.transactions denominated in currencies other than its functional currency(mainly U.S. Dollars), which caused losses as the British Pound Sterlingstrengthened during 2009.

 

Foreign currencytransaction gain increased $0.7 million to a foreign currency gain of $0.8million for the year ended December 31, 2008 compared to a $0.1 millionforeign currency gain for the year ended December 31, 2007.  These gains were primarily generated in thefourth quarter by Evolving Systems U.K. transactions denominated in currenciesother than its functional currency.

 

***Income Tax Expense***

 

We recorded netincome tax expense of $0.8 million, $0.6 million and $0.6 million during theyears ended December 31, 2009, 2008 and 2007, respectively.  In the U.S. we have net operating losscarryforwards of $46.6 million which are used to offset most U.S. taxliabilities. Our current tax expense primarily relates to our foreignsubsidiaries in the U.K., Germany and India as well as non-recoverable foreignwithholding tax and Alternative Minimum Tax (“AMT”) due in the U.S.

 

We recorded net incometax expense of $0.8 million and $0.6 million for the years ended December 31,2009 and 2008, respectively. The net income tax expense for the year ended December 31,2009 of $0.8 million consisted of current tax expense of $1.0 million,partially offset by a deferred tax benefit of $0.2 million. The current taxexpense for the year ended December 31, 2009, primarily related to ourU.K. and India based operations and non-recoverable foreign withholding tax andAMT in the U.S. The deferred tax benefit was related to the intangible assetsrelated to our U.K.-based operations. Our effective tax rate of 14% for the year ended December 31, 2009was down from an effective rate of 16% for the year ended December 31,2008.  This decrease in our effective taxrate relates principally to increased income in the U.S., where our tax rate isthe least.

 

The net income taxexpense for the year ended December 31, 2008 of $0.6 million consisted ofcurrent tax expense of $0.9 million, partially offset by a deferred tax benefitof $0.3 million. The current tax expense for the year ended December 31,2008 primarily related to our U.K.-based operations and non-recoverable foreignwithholding tax and AMT in the U.S. The deferred tax benefit was related to theintangible assets related to our U.K.-based operations. Our effective tax rateof 16% for the year ended December 31, 2008 was down from an effectiverate of 49% for the year ended December 31, 2007.  This decrease in our effective tax 

 

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rate relates principallyto a decreased effective tax rate at our U.K.-based operations.

 

The net income taxexpense for the year ended December 31, 2007 of $0.6 million consisted ofcurrent tax expense of $0.9 million, partially offset by a deferred tax benefitof $0.3 million. The current tax expense for the year ended December 31,2007, primarily related to our U.K.-based operations. The deferred tax benefitwas related to the intangible assets related to our U.K.-based operations.

 

In conjunctionwith the acquisition of Evolving Systems U.K., we recorded certain identifiableintangible assets.  Since theamortization of these identifiable intangibles is not deductible for income taxpurposes, we established a long-term deferred tax liability of $4.6 million atthe acquisition date for the expected difference between what would be expensedfor financial reporting purposes and what would be deductible for income taxpurposes.  As of December 31, 2009and 2008, this deferred tax liability was $0.5 million and $0.7 million,respectively.  The deferred tax liabilityrelates to Evolving Systems U.K. and has no impact on our ability to recoverthe U.S. based deferred tax assets.  Thisdeferred tax liability will be recognized as the identifiable intangibles areamortized.

 

We recorded a fullvaluation allowance against our U.S. net deferred tax assets as of December 31,2009 and 2008 as we determined that it was more likely than not that we willnot realize our U.S. deferred tax assets. Such assets primarily consist of certain net operating losscarryforwards. We made our assessment of the realizability of our domesticdeferred tax assets using all available evidence. In particular, we consideredboth historical results and projections of profitability for only thereasonably foreseeable future periods and any tax planning strategies. Shouldwe continue to generate taxable income in the U.S., we may need to reassess ourvaluation allowance.

 

Effective January 1,2007, we adopted a recognition threshold and a measurement attribute for thefinancial statement recognition and measurement of tax positions taken orexpected to be taken in a tax return. For those benefits to be recognized, a tax position must bemore-likely-than-not to be sustained upon examination by taxingauthorities.  There was no materialimpact on the company’s consolidated financial position and results ofoperations as a result of the adoption of this adoption.

 

Upon adoption, werecorded an adjustment consisting of a $0.4 million decrease in our deferredtax assets related to Research and Development Tax Credits that was offset by acorresponding decrease in our valuation allowance.  As of December 31, 2009 and 2008, we hadno liability for unrecognized tax benefits. We do not believe there will be any material changes to our unrecognizedtax positions over the next twelve months.

 

**FINANCIALCONDITION**

 

Our workingcapital position of $4.8 million at December 31, 2009 reflects an increaseof $3.0 million from our working capital position of $1.8 million at December 31,2008.  Our working capital positionincreased at December 31, 2009 despite $6.2 million in existing cash usedto retire our subordinated notes, including accrued non-current interest. Thesepayments were made from cash on hand and $1.5 million in borrowings on our U.K.revolving credit facility. The subordinated debt payments were unscheduled andreduced balances classified as long-term as of December 31, 2008.

 

These debt payments wereunscheduled and reduced balances classified as long-term as of December 31,2008.  We were in compliance with all ofour debt covenants as of December 31, 2009 and 2008.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

We havehistorically financed operations through cash flows from operations as well asdebt and equity transactions.  At December 31,2009, our principal source of liquidity was $5.4 million in cash and cashequivalents and $4.5 million of unused availability under our revolving creditfacilities.  The revolving creditfacilities are available through February 2011.

 

Net cash providedby operating activities for the years ended December 31, 2009, 2008 and2007 was $3.6 million, $5.5 million and $4.8 million, respectively.  Our increased profitability in 2009 wasoffset by optional pre-payments of accrued interest on our subordinated debt,which is classified as other long-term obligations and the change in the timingof our unearned revenue billings.

 

The primarycontribution to the improvement in cash provided by operating activities forthe year ended December 31, 2008 was due primarily to an improved netincome of $2.9 million compared to net income of $0.6 million for the yearended December 31, 2007. Additionally, the net change in operating assets and liabilitiesdecreased $1.5 million in 2008 versus 2007.

 

Net cash used byinvesting activities was $0.5 million, $0.9 million and $0.4 million for theyears ended December 31, 2009, 2008 and 2007, respectively.  During 2009 and 2008, we purchased $0.5million and $0.9 million in property and equipment to support operations.During 2007, we purchased $0.5 million in property and equipment to supportoperations, partially offset by reductions in restricted cash of $0.2million.  Historically, capitalexpenditures have been financed by cash from operating activities.

 

Net cash used infinancing activities was $4.3 million, $4.6 million and $2.1 million for theyears ended December 31, 2009, 2008 and 2007, respectively.  The net cash used in financing activitiesduring 2009 was primarily the result of net payments of long-term debt of $5.1million, partially offset by cash received from the exercise of stock optionsof $0.8 million. The net cash used in financing activities during 2008 wasprimarily the result of $8.3 million of principal payments on long-term debt,offset by borrowings on our new

 

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senior term loan ofapproximately $3.7 million, net of issuance costs. The net cash used infinancing activities during 2007 is the result of $2.1 million in principalpayments on our senior debt facility.

 

We believe thatour current cash and cash equivalents, together with anticipated cash flow fromoperations will be sufficient to meet our working capital and capitalexpenditure requirements for at least the next twelve months. In making thisassessment, we considered the following:

 

·                  Our cash and cash equivalents balance at December 31, 2009 of$5.4 million;

 

·                  The availability under our revolving credit facility of $4.5 million atDecember 31, 2009;

 

·                  Our improved working capital balance of $4.8 million;

 

·                  Our demonstrated ability to generate positive operating cash flows;

 

·                  Our backlog of approximately $20.8 million, including $8.5 million inlicense fees and services and $12.3 million in customer support at December 31,2009; and

 

·                  Our planned capital expenditures of less than $1.0 million during 2010.

 

Our revolving credit facility contains certainaffirmative and negative covenants that, if breached, could result in anyoutstanding amounts becoming immediately due and payable. If we are required topay the debt on an accelerated basis, it could have a significant adverseimpact on our liquidity and financial condition.

 

We are exposed to foreign currency rate risks whichimpact the carrying amount of our foreign subsidiaries and our consolidatedequity, as well as our consolidated cash position due to translationadjustments.  For the year ended December 31,2009, the effect of exchange rate changes resulted in a $0.7 million increaseto consolidated cash.  For the year endedDecember 31, 2008, the effect of exchange rate changes resulted in a $1.5million reduction to consolidated cash.   We do not currently hedge our foreign currency exposure, but we closelymonitor the rate changes and may hedge our exposures in the future.

 

**Off-BalanceSheet Arrangements**

 

We have no off-balance sheet arrangements that have amaterial current effect, or that are reasonably likely to have a materialfuture effect, on our financial condition, changes in financial condition,revenue or expenses, results of operations, liquidity, capital expenditures, orcapital resources.

 

**ContractualObligations and Commercial Commitments**

 

The followingsummarizes our significant contractual obligations as of December 31,2009, which are comprised of a capital lease, operating leases and principaland interest payments on our current and long-term debt, assuming noprepayments are made (in thousands).

 
| ** **           | ** ** | **Payments due by period** | ** ** |
|----------------------|------------|----------------------------|------------|
| ** **           | ** ** | **Total**                  | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013 and thereafter** | ** ** |
| Long-term debt       |       | $                          | 1,500      |   | $ | — |   | $ | 1,500 |   | $ | — |   | $ | — |   |
| Current debt         |       | 333                        |       | 333 |   | — |   | — |   | — |   |
| Interest on debt (1) |       | 65                         |       | 56 |   | 9 |   | — |   | — |   |
| Capital lease        |       | 68                         |       | 30 |   | 30 |   | 8 |   | — |   |
| Operating leases     |       | 2,157                      |       | 886 |   | 712 |   | 559 |   | — |   |
| Total commitments    |       | $                          | 4,123      |   | $ | 1,305 |   | $ | 2,251 |   | $ | 567 |   | $ | — |   |

 

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(1)  Interest on debt represents cash interest payment obligationsassuming all indebtedness at December 31, 2009 will be paid in accordancewith its contractual terms and maturity and assumes interest rates on variableinterest debt as of December 31, 2009 will remain unchanged in futureperiods.

 

**CRITICALACCOUNTING POLICIES**

 

Our significantaccounting policies are disclosed in Note 1 of our Consolidated FinancialStatements included elsewhere in this Annual Report on Form 10-K.  The following discussion addresses our mostcritical accounting policies, which are those that are both important to theportrayal of our financial condition and results of operations and that requiresignificant judgment or use of complex estimates.

 

***Revenue Recognition***

 

We recognizerevenue when an agreement is signed, the fee is fixed or determinable and collectabilityis reasonably assured. We 

 

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recognize revenue fromtwo primary sources: license fees and services, and customer support.   Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting. We estimate thepercentage-of-completion for each contract based on the ratio of direct labor hoursincurred to total estimated direct labor hours and recognize revenue based onthe percent complete multiplied by the contract amount.  Since estimated direct labor hours, andchanges thereto, can have a significant impact on revenue recognition, theseestimates are critical and we review them regularly.  We record amounts billed in advance ofservices being performed 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 encounterbudget and schedule overruns on fixed-price contracts caused by increasedlabor or overhead costs. We make adjustments to cost estimates in the period inwhich the facts requiring such revisions become known. We record estimatedlosses, if any, in the period in which current estimates of total contractrevenue and contract costs indicate a loss. If revisions to cost estimates areobtained after the balance sheet date but before the issuance of the interim orannual financial statements, we make adjustments to the interim or annualfinancial statements accordingly.

 

In arrangementswhere the services are not essential to the functionality of the deliveredsoftware, we recognize license revenue when a license agreement has beensigned, delivery has occurred, the fee is fixed or determinable andcollectability is reasonably assured. Where applicable, we unbundle and recordas revenue fees from multiple element arrangements as the elements aredelivered to the extent that vendor specific objective evidence (“VSOE”) offair value of the undelivered elements exist. If VSOE for the undeliveredelements does not exist, we defer fees from such arrangements until the earlierof the date that VSOE does exist on the undelivered elements or all of theelements have been delivered.

 

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

 

***Allowance forDoubtful Accounts***

 

We make judgmentsrelated to our ability to collect outstanding accounts receivable. We provideallowances for receivables when their collection becomes doubtful by recordingan expense. We determine the allowance based on our assessment of therealization of receivables using historical information and current economictrends, including assessing the probability of collection from customers. Ifthe financial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments owed to us, an increase in theallowance for doubtful accounts would be required. We evaluate the adequacy ofthe allowance regularly and make adjustments accordingly. Adjustments to theallowance for doubtful accounts could materially affect our results ofoperations.

 

***Income Taxes***

 

Significantjudgment is required in determining our provision for income taxes. We assessthe likelihood that our deferred tax asset will be recovered from futuretaxable income, and to the extent we believe that recovery is not likely, weestablish a valuation allowance. We consider future taxable income projections,historical results and ongoing tax planning strategies in assessing therecoverability of deferred tax assets. However, adjustments could be requiredin the future if we determine that the amount to be realized is less or greaterthan the amount that we recorded. Such adjustments, if any, could have amaterial impact on our results of our operations.

 

Effective January 1,2007, we adopted a recognition threshold and a measurement attribute for thefinancial statement recognition and measurement of tax positions taken orexpected to be taken in a tax return. For those benefits to be recognized, a tax position must bemore-likely-than-not to be sustained upon examination by taxingauthorities.  There was no materialimpact on the company’s consolidated financial position and results ofoperations as a result of this adoption.

 

On January 1, 2007,we recorded a transition adjustment consisting of a $0.4 million decrease inour deferred tax assets related to Research and Development Tax Credits thatwas offset by a corresponding decrease in our valuation allowance.  As of December 31, 2009 and 2008, we hadno liability for unrecognized tax benefits. We do not believe there will be any material changes to our unrecognizedtax positions over the next twelve months.

 

***Goodwill***

 

Goodwill is theexcess of acquisition cost of an acquired entity over the fair value of theidentifiable net assets acquired. Goodwill is not amortized, but tested for impairment annually orwhenever indicators of impairment exist. These indicators may include a significantchange in the business climate, legal factors, operating performanceindicators, competition, sale or disposition of a significant portion of thebusiness or other factors. For purposes of the goodwill evaluation, we comparethe fair value of each of our

 

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reporting units to itsrespective carrying amount. If the carrying value of a reporting unit were toexceed its fair value, we would then compare the fair value of the reportingunit’s goodwill to its carrying amount, and any excess of the carrying amountover the fair value would be charged to operations as an impairment loss.

 

***IntangibleAssets***

 

We allocate thecost of an acquired company to the tangible and identifiable intangible assetsand liabilities acquired, with the remaining amount being recorded asgoodwill.  We amortize certain intangibleassets over their estimated lives.

 

We assess theimpairment of identifiable intangibles if events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable. Factorsthat we consider important which could trigger an impairment review include thefollowing:

 

·                  Significant under-performance relative to historical or projectedfuture operating results;

·                  Significant changes in the manner of use of the acquired assets or thestrategy of the overall business;

·                  Significant negative industry or economic trends;

·                  Significant decline in our stock price for a sustained period; and/or

·                  Our market capitalization relative to net book value.

 

If we determinethat the carrying value of intangibles and/or long-lived assets may not berecoverable based on the existence of one or more of the above indicators ofimpairment, we measure any impairment based on the estimated discounted cashflows expected to result from the use of the asset and its eventual dispositionand compare that to the asset’s carrying amount. Any impairment loss recognizedwould represent the excess of the asset’s carrying value over its estimatedfair value. Significant estimates and judgments are required when estimatingsuch fair values. If we determine that the intangibles are impaired, we willrecord an impairment charge and the amount could be material.

 

Amortizable intangible assets consist primarily of purchased software andlicenses, customer contracts and relationships, trademarks and tradenames, andbusiness partnerships acquired in conjunction with our purchases of CMSCommunications, Inc. (“CMS”), Telecom Software Enterprises, LLC (“TSE”)and Tertio Telecoms Ltd. (“Evolving Systems U.K.”).  These definite life assets are amortizedusing the straight-line method over their estimated lives.

 

***Capitalizationof Internal Software Development Costs***

 

We expend amountson research and development, particularly for new products and/or forenhancements of existing products. For internal development of softwareproducts that are to be licensed by us, we expense the cost of developingsoftware prior to establishing technological feasibility and those costs arecapitalized once technological feasibility has been established. Capitalizationceases upon general release of the software. The determination of whetherinternal software development costs are subject to capitalization is, by itsnature, highly subjective and involves significant judgments. This decisioncould significantly affect earnings during the development period. Further, once capitalized, the software costs are generally amortized ona straight-line basis over the estimated economic life of the product. Thedetermination of the expected useful life of a product is highly judgmental.Finally, capitalized software costs must be assessed for impairment if factsand circumstances warrant such a review.

 

We did notcapitalize any internal software development costs during the years ended December 31,2009, 2008, or 2007. In addition, we did not have any capitalized internalsoftware development costs included in our December 31, 2009 and 2008Consolidated Balance Sheets. We believe that during these periods no materialinternal software development costs were required to be capitalized. Ourconclusion is primarily based on the fact that the feature-rich,pre-integrated, and highly-scalable nature of our products requiresthat our development efforts include complex design, coding and testingmethodologies, which include next generation software languages and developmenttools. Development projects of this nature carry a high degree of developmentrisk. Substantially all of our internal software development efforts are ofthis nature, and therefore, we believe the period between achievingtechnological feasibility and the general release of the software to operationsis so short that any costs incurred during this period are not material.

 

***Stock-based Compensation***

 

We account for stock-based compensation by applying a fair-value-basedmeasurement method to account for share-based payment transactions withemployees and directors and record compensation cost for all stock awardsgranted after January 1, 2006 and awards modified, repurchased, orcancelled after that date. We record compensation costs associated with thevesting of unvested options on a straight-line basis over the vestingperiod.  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 use the Black-Scholes model to estimatethe fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In October 2009,the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements — aconsensus of the FASB 

 

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Emerging Issues TaskForce, to amend certain guidance in FASB ASC 605, RevenueRecognition, 25, “Multiple-Element Arrangements”. The amended guidance inASC 605-25 (1) modifies the separation criteria by eliminating thecriterion that requires objective and reliable evidence of fair value for theundelivered item(s), and (2) eliminates the use of the residual method ofallocation and instead requires that arrangement consideration be allocated, atthe inception of the arrangement, to all deliverables based on their relativeselling price. The amended guidance in ASC 605-25 is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010, with early applicationand retrospective application permitted. The Company expects to prospectivelyapply the amended guidance in ASC 605-25 beginning January 1, 2010.The Company does not believe that the adoption of the amendments toASC 605-25 will have a significant effect on its consolidated financialstatements.

 

In October 2009,the FASB issued ASU 2009-14, Certain Revenue Arrangements That IncludeSoftware Elements — a consensus of the FASB Emerging Issues Task Force, toamend the scope of arrangements under ASC 985, Software, 605, “RevenueRecognition” to exclude tangible products containing software components andnon-software components that function together to deliver a product’s essentialfunctionality. The amended guidance in ASC 605-25 and ASC 985-605 iseffective prospectively for revenue arrangements entered into or materiallymodified in fiscal years beginning on or after June 15, 2010, with earlyapplication and retrospective application permitted. The Company expects toprospectively apply the amended guidance in ASC 985-605, concurrently withthe amended guidance in ASC 605-25, beginning on January 1, 2010. TheCompany does not believe that the adoption of the amended guidance inASC 605-25 and ASC 985-605 will have a significant effect on itsconsolidated financial statements.

 

**ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

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

 

Our cash balancesare subject to interest rate fluctuations and as a result, interest incomeamounts may fluctuate from current levels. We are exposed to interest rate risk related to our senior revolvingcredit facilities entered into in February 2008.  These obligations are variable interest ratefacilities based on Prime Rate. Fluctuations in Prime Rate affect our interest rate risk.  We currently have $1.5 million outstandingunder these credit facilities, but future borrowings will subject us tointerest rate risk.

 

We are exposed tofluctuations of the U.S. dollar (our functional currency) against thecurrencies of our operating subsidiaries. Any increase (decrease) in thevalue of the U.S. dollar against any foreign currency that is the functionalcurrency of one of our operating subsidiaries will cause the parent company toexperience unrealized foreign currency translation losses (gains) withrespect to amounts already invested in such foreign currencies.  In addition, we and our operatingsubsidiaries are exposed to foreign currency risk to the extent that we enterinto transactions denominated in currencies other than our respectivefunctional currencies, such as revenue and related accounts receivable(including intercompany amounts) that are denominated in a currency other thantheir own functional currency. Changes in exchange rates with respect to theseitems will result in unrealized (based upon period-end exchange rates) orrealized foreign currency transaction gains and losses upon settlement of thetransactions. In addition, we are exposed to foreign exchange rate fluctuationsrelated to our operating subsidiaries’ monetary assets and liabilities and thefinancial results of foreign subsidiaries and affiliates when their respectivefinancial statements are translated into U.S. dollars for inclusion in ourconsolidated financial statements. We record cumulative translation adjustmentsin accumulated other comprehensive income (loss) as a separate componentof equity. As a result of foreign currency risk, we may experience economicloss and a negative impact on earnings and equity with respect to our holdingssolely as a result of foreign currency exchange rate fluctuations.

 

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

 
| ** **          | ** ** | **December 31,** | ** ** |
|---------------------|------------|-----------------------|------------|
| **Spot rates:**     | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Great British pound |       | 0.62792               |       | 0.69096 |   |
| Indian rupee        |       | 46.75082              |       | 49.21259 |   |

 
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| **Average rates:**  | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Great British pound |       | 0.64138                                   |       | 0.54485 |   | 0.49992 |   |
| Indian rupee        |       | 48.44708                                  |       | 43.30325 |   | 41.28177 |   |

 

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.  We continuallymonitor our foreign currency exchange risk and we may consider various optionsto reduce this risk in the future.

 

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**ITEM 8.    FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors and Shareholders

Evolving Systems, Inc.

 

We have audited the accompanying consolidated balance sheetsof Evolving Systems, Inc. (a Delaware corporation) and subsidiaries(collectively, the “Company”) as of December 31, 2009 and 2008, and therelated consolidated statements of operations, changes in stockholders’ equityand comprehensive income (loss), and cash flows for each of the three years inthe period ended December 31, 2009. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. The Companyis not required to have, nor were we engaged to perform an audit of itsinternal control over financial reporting. Our audits included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of the Company as of December 31, 2009 and 2008, and the resultsof its operations and its cash flows for each of the three years in the periodended December 31, 2009 in conformity with accounting principles generallyaccepted in the United States of America.

 

GRANT THORNTON LLP

 

Denver, Colorado

March 8, 2010

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(in thousands except share data)**

 
| ** **                                                                                                                                                                | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                | ** ** | **2009**              | ** ** | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                                | ** ** | ** **            |       |                  |       |
| Current assets:                                                                                                                                                           |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                                 |       | $                     | 5,369      |                  | $          | 5,783 |   |
| Contract receivables, net of allowance for doubtful  accounts of $534 at December 31, 2009 and 2008                                                                  |       | 11,344                |       | 11,484                |       |
| Unbilled work-in-progress                                                                                                                                                 |       | 1,720                 |       | 1,910                 |       |
| Deferred income taxes                                                                                                                                                     |       | 8                     |       | 5                     |       |
| Prepaid and other current  assets                                                                                                                                         |       | 1,909                 |       | 1,304                 |       |
| Total current assets                                                                                                                                                      |       | 20,350                |       | 20,486                |       |
| Property and equipment, net                                                                                                                                               |       | 1,196                 |       | 1,277                 |       |
| Amortizable intangible  assets, net                                                                                                                                       |       | 1,864                 |       | 2,374                 |       |
| Goodwill                                                                                                                                                                  |       | 22,295                |       | 20,811                |       |
| Long-term restricted cash                                                                                                                                                 |       | 50                    |       | 100                   |       |
| Long-term deferred income taxes                                                                                                                                           |       | —                |       | 56                    |       |
| Other long-term assets                                                                                                                                                    |       | 82                    |       | 307                   |       |
| Total assets                                                                                                                                                              |       | $                     | 45,837     |                  | $          | 45,411 |   |
|                                                                                                                                                                      |       |                  |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                             |       |                  |       |                  |       |
| Current liabilities:                                                                                                                                                      |       |                  |       |                  |       |
| Current portion of capital  lease obligations                                                                                                                             |       | $                     | 24         |                  | $          | 21 |   |
| Current portion of  long-term debt                                                                                                                                        |       | 333                   |       | 2,000                 |       |
| Accounts payable and  accrued liabilities                                                                                                                                 |       | 4,502                 |       | 5,198                 |       |
| Deferred income taxes                                                                                                                                                     |       | 29                    |       | 20                    |       |
| Unearned revenue                                                                                                                                                          |       | 10,688                |       | 11,445                |       |
| Total current liabilities                                                                                                                                                 |       | 15,576                |       | 18,684                |       |
| Long-term liabilities:                                                                                                                                                    |       |                  |       |                  |       |
| Capital lease obligations,  net of current portion                                                                                                                        |       | 35                    |       | 59                    |       |
| Other long-term obligations                                                                                                                                               |       | —                |       | 1,402                 |       |
| Long-term debt, net of  current portion                                                                                                                                   |       | 1,500                 |       | 4,883                 |       |
| Deferred income taxes                                                                                                                                                     |       | 257                   |       | 441                   |       |
| Total liabilities                                                                                                                                                         |       | 17,368                |       | 25,469                |       |
|                                                                                                                                                                      |       |                  |       |                  |       |
| Commitments and  contingencies (Note 10)                                                                                                                                  |       |                  |       |                  |       |
|                                                                                                                                                                      |       |                  |       |                  |       |
| Stockholders’ equity:                                                                                                                                                |       |                  |       |                  |       |
| Preferred stock, $0.001 par value; 2,000,000 shares  authorized; no shares issued and outstanding as of December 31, 2009 and  2008                                  |       | —                |       | —                |       |
| Common stock, $0.001 par value; 40,000,000 shares  authorized; 9,930,682 and 9,753,392 shares issued and outstanding as of December 31,  2009 and 2008, respectively |       | 10                    |       | 10                    |       |
| Additional paid-in capital                                                                                                                                                |       | 83,499                |       | 81,824                |       |
| Accumulated other  comprehensive loss                                                                                                                                     |       | (3,242                | )          | (5,270                | )          |
| Accumulated deficit                                                                                                                                                       |       | (51,798               | )          | (56,622               | )          |
| Total stockholders’ equity                                                                                                                                           |       | 28,469                |       | 19,942                |       |
| Total liabilities and  stockholders’ equity                                                                                                                          |       | $                     | 45,837     |                  | $          | 45,411 |   |

 

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

 

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands except per share data)**

 
| ** **                                                                   | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                    |       | $                                         | 21,561     |   | $ | 20,324 |   | $ | 17,895 |   |
| Customer support                                                             |       | 16,635                                    |       | 17,497 |   | 18,058 |   |
| Total revenue                                                                |       | 38,196                                    |       | 37,821 |   | 35,953 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING  EXPENSES**                                 |       |                                      |       |   |   |   |   |
| Costs  of license fees and services, excluding depreciation and amortization |       | 7,642                                     |       | 7,816 |   | 8,023 |   |
| Costs  of customer support, excluding depreciation and amortization          |       | 5,543                                     |       | 6,103 |   | 6,237 |   |
| Sales and marketing                                                          |       | 7,696                                     |       | 8,500 |   | 8,557 |   |
| General and administrative                                                   |       | 5,737                                     |       | 5,676 |   | 5,862 |   |
| Product development                                                          |       | 3,530                                     |       | 3,607 |   | 2,376 |   |
| Depreciation                                                                 |       | 632                                       |       | 847 |   | 899 |   |
| Amortization                                                                 |       | 732                                       |       | 1,363 |   | 1,565 |   |
| Restructuring and other recovery                                             |       | —                                    |       | — |   | (4 | ) |
| Total costs of revenue and operating expenses                                |       | 31,512                                    |       | 33,912 |   | 33,515 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| Income from operations                                                       |       | 6,684                                     |       | 3,909 |   | 2,438 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| Other income (expense)                                                       |       |                                      |       |   |   |   |   |
| Interest income                                                              |       | 25                                        |       | 161 |   | 304 |   |
| Interest expense                                                             |       | (547                                      | )          | (1,171 | ) | (1,747 | ) |
| Other income                                                                 |       | —                                    |       | 57 |   | — |   |
| Gain (loss) on extinguishment of debt                                        |       | —                                    |       | (290 | ) | 42 |   |
| Foreign currency exchange gain (loss)                                        |       | (574                                      | )          | 823 |   | 117 |   |
| Other income (expense), net                                                  |       | (1,096                                    | )          | (420 | ) | (1,284 | ) |
|                                                                         |       |                                      |       |   |   |   |   |
| Income before income taxes                                                   |       | 5,588                                     |       | 3,489 |   | 1,154 |   |
| Income tax expense                                                           |       | 764                                       |       | 560 |   | 556 |   |
| Net income                                                                   |       | $                                         | 4,824      |   | $ | 2,929 |   | $ | 598 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| Basic income per common share                                                |       | $                                         | 0.49       |   | $ | 0.30 |   | $ | 0.06 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| Diluted income per common share                                              |       | $                                         | 0.48       |   | $ | 0.30 |   | $ | 0.06 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| Weighted average basic shares outstanding                                    |       | 9,816                                     |       | 9,695 |   | 9,599 |   |
| Weighted average diluted shares outstanding                                  |       | 10,145                                    |       | 9,878 |   | 9,788 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)**

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

 
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-------------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**         | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated**   | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income (Loss)** | ** ** | **(Deficit)**          | ** ** | **Equity** | ** ** |
| **Balance at  December 31, 2006**                            | ** ** | **8,116,823**    | ** ** | **$**       | **8**      | ** **        | **$**      | **68,833**        | ** ** | **$**                  | **1,466**  | ** ** | **$**      | **(60,149** | **)** | **$** | **10,158** | ** ** |
| Stock option exercises                                            |       | 9,844            |       | —      |       | 19                |       | —            |       | —                 |       | 19         |       |
| Common Stock issued pursuant to the Employee Stock  Purchase Plan |       | 30,094           |       | —      |       | 71                |       | —            |       | —                 |       | 71         |       |
| Stock-based compensation  expense                                 |       |             |       | —      |       | 710               |       | —            |       | —                 |       | 710        |       |
| Preferred stock conversion                                        |       | 731,873          |       | 1           |       | 5,693             |       | —            |       | —                 |       | 5,694      |       |
| Restricted stock issuance                                         |       | 68,750           |       | —      |       | —            |       | —            |       | —                 |       | —     |       |
| Comprehensive income  (loss):                                     |       |             |       |        |       |              |       |              |       |                   |       |       |       |
| Net income                                                        |       | —           |       | —      |       | —            |       | —            |       | 598                    |       |       |       |
| Foreign currency  translation adjustment                          |       | —           |       | —      |       | —            |       | 678               |       |                   |       |       |       |
| Comprehensive income                                              |       |             |       |        |       |              |       |              |       |                   |       | 1,276      |       |
| **Balance at  December 31, 2007**                            | ** ** | **8,957,384**    | ** ** | **9**       | ** ** | **75,326**        | ** ** | **2,144**         | ** ** | **(59,551**            | **)**      | **17,928** | ** ** |
| Stock option exercises                                            |       | 2,527            |       | —      |       | 4                 |       | —            |       | —                 |       | 4          |       |
| Common Stock issued pursuant to the Employee Stock  Purchase Plan |       | 22,856           |       | —      |       | 69                |       | —            |       | —                 |       | 69         |       |
| Stock-based compensation  expense                                 |       |             |       | —      |       | 839               |       | —            |       | —                 |       | 839        |       |
| Preferred stock conversion                                        |       | 718,125          |       | 1           |       | 5,586             |       | —            |       | —                 |       | 5,587      |       |
| Restricted stock issuance                                         |       | 52,500           |       | —      |       | —            |       | —            |       | —                 |       | —     |       |
| Comprehensive income  (loss):                                     |       |             |       |        |       |              |       |              |       |                   |       |       |       |
| Net income                                                        |       | —           |       | —      |       | —            |       | —            |       | 2,929                  |       |       |       |
| Foreign currency translation  adjustment                          |       | —           |       | —      |       | —            |       | (7,414            | )          |                   |       |       |       |
| Comprehensive loss                                                |       |             |       |        |       |              |       |              |       |                   |       | (4,485     | )          |
| **Balance at  December 31, 2008**                            | ** ** | **9,753,392**    | ** ** | **10**      | ** ** | **81,824**        | ** ** | **(5,270**        | **)**      | **(56,622**            | **)**      | **19,942** | ** ** |
| Stock option exercises                                            |       | 141,804          |       | —      |       | 743               |       | —            |       | —                 |       | 743        |       |
| Common Stock issued pursuant to the Employee Stock  Purchase Plan |       | 35,486           |       | —      |       | 68                |       | —            |       | —                 |       | 68         |       |
| Stock-based compensation  expense                                 |       | —           |       | —      |       | 864               |       | —            |       | —                 |       | 864        |       |
| Comprehensive income  (loss):                                     |       |             |       |        |       |              |       |              |       |                   |       |       |       |
| Net income                                                        |       | —           |       | —      |       | —            |       | —            |       | 4,824                  |       |       |       |
| Foreign currency  translation adjustment                          |       | —           |       | —      |       | —            |       | 2,028             |       | —                 |       |       |       |
| Comprehensive income                                              |       |             |       |        |       |              |       |              |       |                   |       | 6,852      |       |
| **Balance at  December 31, 2009**                            | ** ** | **9,930,682**    | ** ** | **$**       | **10**     | ** **        | **$**      | **83,499**        | ** ** | **$**                  | **(3,242** | **)**      | **$**      | **(51,798** | **)** | **$** | **28,469** | ** ** |

** **

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

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                         | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| **CASH FLOWS  FROM OPERATING ACTIVITIES:**                                         |       |                                      |       |   |   |   |   |
| Net income                                                                         |       | $                                         | 4,824      |   | $ | 2,929 |   | $ | 598 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                      |       |   |   |   |   |
| Depreciation                                                                       |       | 632                                       |       | 847 |   | 899 |   |
| Amortization of intangible  assets                                                 |       | 732                                       |       | 1,363 |   | 1,565 |   |
| Amortization of debt  issuance costs                                               |       | 142                                       |       | 147 |   | 235 |   |
| Stock-based compensation  expense                                                  |       | 864                                       |       | 839 |   | 710 |   |
| Gain on disposal of  property and equipment                                        |       | —                                    |       | — |   | (4 | ) |
| (Gain) loss on  extinguishment of debt                                             |       | —                                    |       | 290 |   | (42 | ) |
| Unrealized foreign currency  transaction (gains) and losses, net                   |       | 574                                       |       | (823 | ) | (117 | ) |
| Provision for (recovery of)  bad debt                                              |       | —                                    |       | 512 |   | (5 | ) |
| Benefit from foreign  deferred income taxes                                        |       | (197                                      | )          | (320 | ) | (279 | ) |
| Change in operating assets  and liabilities:                                       |       |                                      |       |   |   |   |   |
| Contract receivables                                                               |       | (283                                      | )          | (1,007 | ) | (1,265 | ) |
| Unbilled work-in-progress                                                          |       | 341                                       |       | (1,465 | ) | 153 |   |
| Prepaid and other assets                                                           |       | (525                                      | )          | (291 | ) | 327 |   |
| Accounts payable and  accrued liabilities                                          |       | (939                                      | )          | 607 |   | 778 |   |
| Unearned revenue                                                                   |       | (1,118                                    | )          | 1,989 |   | 492 |   |
| Other long-term obligations                                                        |       | (1,403                                    | )          | (73 | ) | 728 |   |
| Net cash provided by operating  activities                                         |       | 3,644                                     |       | 5,544 |   | 4,773 |   |
|                                                                               |       |                                      |       |   |   |   |   |
| **CASH FLOWS  FROM INVESTING ACTIVITIES:**                                         |       |                                      |       |   |   |   |   |
| Purchase of property and  equipment                                                |       | (524                                      | )          | (898 | ) | (546 | ) |
| Proceeds from sale of  property and equipment                                      |       | —                                    |       | — |   | 4 |   |
| Business combinations and  earnout payments                                        |       | —                                    |       | — |   | (24 | ) |
| Restricted cash                                                                    |       | 50                                        |       | — |   | 200 |   |
| Net cash used in investing  activities                                             |       | (474                                      | )          | (898 | ) | (366 | ) |
|                                                                               |       |                                      |       |   |   |   |   |
| **CASH FLOWS  FROM FINANCING ACTIVITIES:**                                         |       |                                      |       |   |   |   |   |
| Capital lease payments                                                             |       | (21                                       | )          | (20 | ) | (21 | ) |
| Principal payments on  long-term debt                                              |       | (6,550                                    | )          | (8,298 | ) | (2,141 | ) |
| Proceeds from issuance of  long-term debt                                          |       | 1,469                                     |       | 4,000 |   | — |   |
| Payments for debt issuance  costs                                                  |       | —                                    |       | (347 | ) | — |   |
| Proceeds from the issuance  of stock                                               |       | 811                                       |       | 72 |   | 89 |   |
| Net cash used in financing  activities                                             |       | (4,291                                    | )          | (4,593 | ) | (2,073 | ) |
|                                                                               |       |                                      |       |   |   |   |   |
| Effect of exchange rate  changes on cash                                           |       | 707                                       |       | (1,541 | ) | (139 | ) |
|                                                                               |       |                                      |       |   |   |   |   |
| Net increase (decrease) in  cash and cash equivalents                              |       | (414                                      | )          | (1,488 | ) | 2,195 |   |
| Cash and cash equivalents  at beginning of year                                    |       | 5,783                                     |       | 7,271 |   | 5,076 |   |
| Cash and cash equivalents  at end of year                                          |       | $                                         | 5,369      |   | $ | 5,783 |   | $ | 7,271 |   |
|                                                                               |       |                                      |       |   |   |   |   |
| Supplemental disclosure of  other cash and non-cash financing transactions:        |       |                                      |       |   |   |   |   |
| Interest paid                                                                      |       | $                                         | 1,822      |   | $ | 1,096 |   | $ | 819 |   |
| Income taxes paid                                                                  |       | 844                                       |       | 671 |   | 180 |   |
| Conversion of preferred  stock into common stock                                   |       | —                                    |       | 5,587 |   | 5,694 |   |
| Property and equipment  acquired under capital lease agreements                    |       | —                                    |       | — |   | 84 |   |
| Property and equipment  purchased and included in accounts payable                 |       | 10                                        |       | 99 |   | 792 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 1- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Organization -**Weare a provider of software solutions and services to the wireless, wireline andIP cable markets. We maintain long-standing relationships with many of thelargest wireline, wireless and cable companies worldwide. Our customers rely onus to develop, deploy, enhance, maintain and integrate complex, highly reliablesoftware solutions for a range of Operations Support Systems (“OSS”).  We offer software products and solutions infour core areas:  service activationsolutions used to activate complex bundles of voice, video and dataservices for traditional and next generation wireless and wirelinenetworks;  numbering solutionsthat enable carriers to comply with government-mandated requirements regardingnumber portability as well as providing phone number management and assignmentcapabilities; SIM card activation solutions used to dynamically allocateand assign resources to a wireless device when it is first used, and mediationsolutions supporting data collection for both service assurance and billingapplications.

 

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

 

**Useof 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-of-completionmethod, allowance for doubtful accounts, income tax valuation allowance, fairvalues of long-lived assets, valuation of intangible assets and goodwill,useful lives for property, equipment and intangible assets, business combinations,capitalization of internal software development costs and fair value ofstock-based compensation amounts.  Actualresults could differ from these estimates.

 

**ForeignCurrency Translation -**Our functional currency is the U.S. dollar.  The functional currency of our foreignoperations, generally, is the respective local currency for each foreignsubsidiary.  Assets and liabilities offoreign operations denominated in local currencies are translated at the spotrate 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 unrealized cumulativetranslation adjustment, net of applicable income taxes, is recorded as acomponent 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.

 

**Cash and Cash Equivalents -**Allhighly liquid investments and investments with an original maturity of threemonths or less when purchased are considered to be cash equivalents.  All cash equivalents are carried at cost,which approximates fair value. We have cash investment policies that limitinvestments to investment grade securities and certificates of deposit. Cashbalances in UK and India as of December 31, 2009 were $3.5 million and$0.3 million, respectively, and as of December 31, 2008 were $4.6 millionand $0.1 million, respectively.

 

**RestrictedCash -**Asof December 31, 2009 and 2008, we had $50,000 and $100,000, respectively,of restricted cash, related to our headquarters lease. The restricted cashrequirement was reduced by $50,000 during 2009 as part of the lease with ourexisting landlord.  The remainder of therestricted cash will become unrestricted within 60 days of the expiration ofour lease.

 

**ContractReceivables and Allowance for Doubtful Accounts -**Contract receivables are recorded at theinvoiced amount and do not bear interest. Credit is extended based on theevaluation of a customer’s financial condition and collateral is not required.The allowance for doubtful accounts is our best estimate of the amount ofprobable credit losses in accounts receivable. We determine the allowance basedon historical write-off experience and information received during collectionefforts. We review our allowance for doubtful accounts monthly and past duebalances over 90 days are reviewed individually for collectibility.Account balances are charged against the allowance after all means ofcollection have been exhausted and the potential for recovery is consideredremote. We do not have any off-balance-sheet credit exposure related to ourcustomers.

 

The followingtable reflects the activity in the allowance for doubtful accounts:

 
| ** ** | ** ** | ** **                       | ** ** | ** **     | ** ** | ** **     | ** ** | **Write-**        | ** ** | **Effects of**        | ** ** | ** **      | ** ** |
|------------|------------|----------------------------------|------------|----------------|------------|----------------|------------|-------------------|------------|-----------------------|------------|-----------------|------------|
| ** ** | ** ** | ** **                       | ** ** | **Balance at** | ** ** | **Bad Debt**   | ** ** | **Offs  Charged** | ** ** | **Foreign  Currency** | ** ** | **Balance  at** | ** ** |
| **Fiscal** | ** ** | ** **                       | ** ** | **Beginning**  | ** ** | **Expense/**   | ** ** | **to**            | ** ** | **Exchange**          | ** ** | **End of**      | ** ** |
| **Year**   | ** ** | **Description**                  | ** ** | **of Period**  | ** ** | **(Recovery)** | ** ** | **Allowance**     | ** ** | **Rates**             | ** ** | **Period**      | ** ** |
| 2009       |       | Allowance for  doubtful accounts |       | $              | 534        |           | $          | —            |       | $                     | —     |            | $          | — |   | $ | 534 |   |
| 2008       |       | Allowance for  doubtful accounts |       | $              | 66         |           | $          | 512               |       | $                     | (28        | )               | $          | (16 | ) | $ | 534 |   |
| 2007       |       | Allowance for  doubtful accounts |       | $              | 70         |           | $          | (5                | )          | $                     | —     |            | $          | 1 |   | $ | 66 |   |

 

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**Concentrationof Credit Risk -**Financial instruments that potentially subject us to concentrations ofcredit risk consist primarily of contract receivables and unbilledwork-in-progress. We perform on-going evaluations of customers’ financialcondition and, generally, require no collateral from customers.

 

A substantialportion of our revenue is from a limited number of customers, all in thetelecommunications industry.  Thefollowing tables depict the percentage of revenue and percentage of contractreceivables generated from significant customers (defined as contributing atleast 10%):

 
| ** **                 | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Customer A— U.S.      |       | 19                                        | %          | 20 | % | 22 | % |
| Customer B — U.K. (1) |       | —                                    |       | 14 | % | 13 | % |
| Total % of Revenue         |       | 19                                        | %          | 34 | % | 35 | % |

 

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(1)  CustomerB contributed revenue in 2009, but less than the 10% threshold.

 
| ** **                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Customer A — U.S.                                         |       | 38                    | %          | 45 | % |
| Total % of contract receivables and unbilled  work-in-progress |       | 38                    | %          | 45 | % |

 

We are subject toconcentration of credit risk with respect to our cash and cash equivalents,which we attempt to minimize by maintaining our cash and cash equivalents withinstitutions of sound financial quality. At times, cash balances may exceedlimits federally insured by the Federal Deposit Insurance Corporation (“FDIC”).No losses related to such balances have been incurred to date. In October 2008,through the temporary Transaction Account Guarantee Program (“TAGP”), fullcoverage is offered for non-interest bearing deposit accounts at FDIC-insuredinstitutions that agree to participate in the program and will remain in effectfor participating institutions until June 30, 2010. As of December 31,2009 and 2008, our U.S. funds are held with a bank that is participating in theTAGP.

 

Our funds not under anyFDIC or TAGP program were $3.9 million and $4.7 million as of December 31,2009 and 2008, respectively.

 

**FairValue of Financial Instruments -**The carrying amounts for certain financialinstruments, including cash and cash equivalents, contract receivables andaccounts payable, approximate fair value due to their short maturities.  We estimate the fair value of our debt basedon current rates offered to us for debt of the same remaining maturities, ifavailable, or if not available, based on discounted future cash flows usingcurrent market interest rates.  As of December 31,2009, we estimated the fair value of our fixed rate senior term loan andrevolver was $0.3 million and $1.5 million. As of December 31, 2008, weestimated the fair value of our fixed rate senior term loan and subordinatednotes was $2.4 million and $6.0 million, respectively.

 

**RevenueRecognition -**Werecognize revenue when an agreement is signed, the fee is fixed or determinableand collectability is reasonably assured. We recognize revenue from two primarysources: license fees and services, and customer support.   Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting. We estimate thepercentage-of-completion for each contract based on the ratio of direct laborhours incurred to total estimated direct labor hours and recognize revenuebased on the percent complete multiplied by the contract amount.  Since estimated direct labor hours, andchanges thereto, can have a significant impact on revenue recognition, theseestimates are critical and we review them regularly.  We record amounts billed in advance ofservices being performed 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. We make adjustments to cost estimates in the period in whichthe facts requiring such revisions become known. We record estimated losses, ifany, in the period in which current estimates of total contract revenue andcontract costs indicate a loss. If revisions to cost estimates are obtainedafter the balance sheet date but before the issuance of the interim or annualfinancial statements, we make adjustments to the interim or annual financialstatements accordingly.

 

In arrangementswhere the services are not essential to the functionality of the deliveredsoftware, we recognize license revenue when a license agreement has beensigned, delivery has occurred, the fee is fixed or determinable andcollectability is reasonably assured. Where applicable, we unbundle and recordas revenue fees from multiple element arrangements as the elements aredelivered to the extent that vendor specific objective evidence (“VSOE”) offair value of the undelivered elements exist. If VSOE for the undeliveredelements does not exist, we defer fees from such arrangements until the earlierof the date that VSOE does exist on the undelivered elements or all of theelements have been delivered.

 

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We recognize revenue from fixed-price servicecontracts using the proportional performance method of accounting, which issimilar to the percentage-of-completion method described above. We recognizerevenue from professional services provided pursuant to time-and-materialsbased contracts and training services as the services are performed, as that iswhen our obligation to our customers under such arrangements is fulfilled.

 

We recognize customer support, including maintenancerevenue, ratably over the service contract period. When maintenance is bundledwith the original license fee arrangement, its fair value, based upon VSOE, isdeferred and recognized during the periods when services are provided.

 

**Sales, Use and Other Value AddedTax** — Revenue isrecorded net of applicable state, use and other value added taxes.

 

**Advertisingand Promotion Costs -**All advertising and promotion costs are expensed asincurred. Advertising costs totaled approximately $304,000, $338,000 and$322,000, for the years ended December 31, 2009, 2008 and 2007,respectively.

 

**Stock-based Compensation -**We account for stock-based compensation by applying a fair-value-basedmeasurement method to account for share-based payment transactions withemployees and directors and record compensation cost for all stock awardsgranted after January 1, 2006 and awards modified, repurchased, orcancelled after that date. We record compensation costs associated with thevesting of unvested options on a straight-line basis over the vestingperiod.  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 use the Black-Scholes model to estimatethe fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**Capitalization of Internal Software DevelopmentCosts -**We expend amounts on research and development,particularly for new products and/or for enhancements of existing products. Forinternal development of software products that are to be licensed by us, weexpense the cost of developing software prior to establishing technologicalfeasibility and those costs are capitalized once technological feasibility hasbeen established. Capitalization ceases upon general release of the software.The determination of whether internal software development costs are subject tocapitalization is, by its nature, highly subjective and involves significantjudgments. This decision could significantly affect earnings during thedevelopment period.  Further, once capitalized, the software costs aregenerally amortized on a straight-line basis over the estimated economic lifeof the product. The determination of the expected useful life of a product ishighly judgmental. Finally, capitalized software costs must be assessed forimpairment if facts and circumstances warrant such a review.

 

We did notcapitalize any internal software development costs during the years ended December 31,2009, 2008, or 2007. In addition, we did not have any capitalized internalsoftware development costs included in our December 31, 2009 and 2008 ConsolidatedBalance Sheets. We believe that during these periods no material internalsoftware development costs were required to be capitalized. Our conclusion isprimarily based on the fact that the feature-rich, pre-integrated,and highly-scalable nature of our products requires that our developmentefforts include complex design, coding and testing methodologies, which includenext generation software languages and development tools. Development projectsof this nature carry a high degree of development risk. Substantially all ofour internal software development efforts are of this nature, and therefore, webelieve the period between achieving technological feasibility and the generalrelease of the software to operations is so short that any costs incurredduring this period are not material.

 

**Propertyand Equipment and Long-Lived Assets -**Property and equipment are stated at cost or estimatedfair value if acquired in an acquisition, less accumulated depreciation, andare depreciated over their estimated useful lives, or the lease term, ifshorter, using the straight-line method. Leasehold improvements are stated atcost, less accumulated amortization, and are amortized over the shorter of thelease term or estimated useful life of the asset. Maintenance and repair costsare expensed as incurred.

 

We review our long-livedassets, such as property and equipment and purchased intangible assets subjectto amortization for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset or asset group may not berecoverable. We evaluate the recoverability of an asset or asset group bycomparing its carrying amount to the estimated undiscounted future cash flowsexpected to be generated by the asset or asset group. If the carrying amount ofan asset or asset group exceeds its estimated future cash flows, we recognizean impairment charge as the amount by which the carrying amount of the assetexceeds the estimated fair value of the asset.

 

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

 

**Intangible Assets -**Amortizable intangible assets consistprimarily of purchased software and licenses, customer contracts andrelationships, trademarks and tradenames, and business partnerships acquired inconjunction with our purchases of CMS

 

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Communications, Inc.(“CMS”), Telecom Software Enterprises, LLC (“TSE”) and Evolving SystemsU.K.  These definite life assets areamortized using the straight-line method over their estimated lives.

 

We assess the impairmentof identifiable intangibles if events or changes in circumstances indicate thatthe carrying value of the asset may not be recoverable. Factors that weconsider significant which could trigger an impairment analysis include thefollowing:

 

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

 

·      Significantchanges in the manner of use of the acquired assets or the strategy of theoverall business;

 

·      Significantnegative industry or economic trends; and/or

 

·      Significantdecline in our stock price for a sustained period.

 

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

 

**IncomeTaxes -**Significantjudgment is required in determining our provision for income taxes. We assessthe likelihood that our deferred tax asset will be recovered from futuretaxable income, and to the extent we believe that recovery is not likely, weestablish a valuation allowance. We consider future taxable income projections,historical results and ongoing tax planning strategies in assessing therecoverability of deferred tax assets. However, adjustments could be requiredin the future if we determine that the amount to be realized is less or greaterthan the amount that we recorded. Such adjustments, if any, could have amaterial impact on our results of our operations.

 

Effective January 1, 2007, we adopted arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return.  For those benefits to berecognized, a tax position must be more-likely-than-not to be sustained uponexamination by taxing authorities.  Therewas no material impact on the company’s consolidated financial position andresults of operations as a result of this adoption.

 

On January 1, 2007, we recorded a transitionadjustment consisting of a $0.4 million decrease in our deferred tax assetsrelated to Research and Development Tax Credits that was offset by acorresponding decrease in our valuation allowance.  As of December 31, 2009, we had noliability for unrecognized tax benefits.  We do not believe there will be any materialchanges to our unrecognized tax positions over the next twelve months.

 

**Recent Accounting Pronouncements**- In October 2009, the FASBissued ASU 2009-13, Multiple-Deliverable Revenue Arrangements — aconsensus of the FASB Emerging Issues Task Force, to amend certain guidance inFASB ASC 605, Revenue Recognition, 25, “Multiple-Element Arrangements”.The amended guidance in ASC 605-25 (1) modifies the separationcriteria by eliminating the criterion that requires objective and reliableevidence of fair value for the undelivered item(s), and (2) eliminates theuse of the residual method of allocation and instead requires that arrangementconsideration be allocated, at the inception of the arrangement, to alldeliverables based on their relative selling price. The amended guidance inASC 605-25 is effective prospectively for revenue arrangements enteredinto or materially modified in fiscal years beginning on or after June 15,2010, with early application and retrospective application permitted. TheCompany expects to prospectively apply the amended guidance in ASC 605-25beginning January 1, 2010. The Company does not believe that the adoptionof the amendments to ASC 605-25 will have a significant effect on itsconsolidated financial statements.

 

In October 2009, theFASB issued ASU 2009-14, Certain Revenue Arrangements That IncludeSoftware Elements — a consensus of the FASB Emerging Issues Task Force, toamend the scope of arrangements under ASC 985, Software, 605, “RevenueRecognition” to exclude tangible products containing software components andnon-software components that function together to deliver a product’s essentialfunctionality. The amended guidance in ASC 605-25 and ASC 985-605 iseffective prospectively for revenue arrangements entered into or materiallymodified in fiscal years beginning on or after June 15, 2010, with earlyapplication and retrospective application permitted. The Company expects toprospectively apply the amended guidance in ASC 985-605, concurrently withthe amended guidance in ASC 605-25, beginning on January 1, 2010. TheCompany does not believe that the adoption of the amended guidance inASC 605-25 and ASC 985-605 will have a significant effect on itsconsolidated financial statements.

 

**NOTE 2- GOODWILL AND INTANGIBLE ASSETS**

 

Changesin the carrying amount of goodwill by reporting unit were as follows (inthousands):

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|----------------------|------------|-----------|------------|
| ** **                                             | ** ** | **US**                   | ** ** | **UK**               | ** ** | **US**    | ** ** | **UK** | ** ** | **Goodwill** | ** ** |
| Balance as of  December 31, 2007                  |       | $                        | —     |                 | $          | 9,118     |       | $ | 6,033 |   | $ | 11,266 |   | $ | 26,417 |   |
| Effects of  changes in foreign currency exchange rates |       | —                   |       | (2,508               | )          | —    |       | (3,098 | ) | (5,606 | ) |
| Balance as of  December 31, 2008                  |       | $                        | —     |                 | $          | 6,610     |       | $ | 6,033 |   | $ | 8,168 |   | $ | 20,811 |   |
| Effects of  changes in foreign currency exchange rates |       | —                   |       | 664                  |       | —    |       | 820 |   | 1,484 |   |
| Balance as of  December 31, 2009                  |       | $                        | —     |                 | $          | 7,274     |       | $ | 6,033 |   | $ | 8,988 |   | $ | 22,295 |   |

 

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Weconducted our annual goodwill impairment test as of July 31, 2009, and wedetermined that goodwill was not impaired as of the test date. From July 31,2009 through December 31, 2009, we believe no events have occurred thatmay have impaired goodwill.

 

Identifiableintangible assets are amortized on a straight-line basis over estimated livesranging from one to seven years and include the cumulative effects of foreigncurrency exchange rates.  As of December 31,2009 and 2008, identifiable intangibles were as follows (in thousands):

 
| ** **                 | ** ** | **December 31, 2009** | ** ** | **December 31, 2008**    | ** ** | **Weighted-**             | ** ** |
|----------------------------|------------|----------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **(1)  Gross  Amount**     | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average  Amortization  Period** | ** ** |
| Purchased software         |       | $                          | 1,712      |                          | $          | 1,287                     |       | $ | 425 |   | $ | 1,583 |   | $ | 902 |   | $ | 681 |   | 4.6 yrs |   |
| Purchased licenses         |       | 227                        |       | 227                           |       | —                    |       | 227 |   | 227 |   | — |   | 2.3 yrs |   |
| Trademarks and  tradenames |       | 715                        |       | 357                           |       | 358                       |       | 649 |   | 232 |   | 417 |   | 7.0 yrs |   |
| Business partnerships      |       | 116                        |       | 82                            |       | 34                        |       | 106 |   | 53 |   | 53 |   | 5.0 yrs |   |
| Customer relationships     |       | 3,177                      |       | 2,130                         |       | 1,047                     |       | 2,986 |   | 1,763 |   | 1,223 |   | 5.3 yrs |   |
|                       |       | $                          | 5,947      |                          | $          | 4,083                     |       | $ | 1,864 |   | $ | 5,551 |   | $ | 3,177 |   | $ | 2,374 |   | 5.2 yrs |   |

 

----

(1)     Increases in intangiblevalues as of December 31, 2009 compared to December 31, 2008 are thedirect result of changes in foreign currency exchange rates for the years thenended.

 

Amortization expense ofidentifiable intangible assets was $0.7 million, $1.4 million and $1.6 millionfor the years ended December 31, 2009, 2008 and 2007, respectively.  As Evolving Systems U.K. uses the BritishPound Sterling 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 to identifiable intangibles basedon our carrying amount as of December 31, 2009 was as follows (inthousands):

 
| **Years ending** | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| 2010             |       | $          | 708        |   |
| 2011             |       | 555        |       |
| 2012             |       | 401        |       |
| 2013             |       | 200        |       |
|             |       | $          | 1,864      |   |

 

**NOTE 3- BALANCE SHEET COMPONENTS**

 

The components of certainbalance sheet line items are as follows (in thousands):

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2009**              | ** ** | **2008** | ** ** |
| **Property  and equipment:**                    |       |                  |       |   |   |
| Computer equipment and  purchased software      |       | $                     | 20,303     |   | $ | 25,769 |   |
| Furniture, fixtures and  leasehold improvements |       | 2,437                 |       | 2,610 |   |
|                                            |       | 22,740                |       | 28,379 |   |
| Less accumulated  depreciation                  |       | (21,544               | )          | (27,102 | ) |
|                                            |       | $                     | 1,196      |   | $ | 1,277 |   |

 
| ** **                                | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| **Assets  acquired under capital lease:** |       |     |       |     |       |
| Original book value                       |       | $        | 58         |     | $          | 58 |   |
| Accumulated amortization                  |       | (39      | )          | (24      | )          |
| Net book value                            |       | $        | 19         |     | $          | 34 |   |

 

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Depreciationexpense was $0.6 million, $0.8 million and $0.9 million for the years ended December 31,2009, 2008 and 2007, respectively.

 

Included inproperty and equipment at December 31, 2009 and 2008 are assets undercapital lease. Depreciation expense related to assets under capital leases was$15,000, $14,000 and $21,000 for the years ended December 31, 2009, 2008and 2007, respectively.

** **
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2009**              | ** ** | **2008** | ** ** |
| **Accounts  payable and accrued liabilities:** |       |                  |       |   |   |
| Accounts payable                               |       | $                     | 1,008      |   | $ | 760 |   |
| Accrued compensation  and related expenses     |       | 2,227                 |       | 2,101 |   |
| Accrued liabilities                            |       | 1,267                 |       | 2,337 |   |
|                                           |       | $                     | 4,502      |   | $ | 5,198 |   |

 

**NOTE 4 - LONG-TERM DEBT**

 

Our notes payable consist of the following (inthousands):

 
| ** **                                                                                                                                                                                                                                                                                                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                      | ** ** | **2009**              | ** ** | **2008**              | ** ** |
| Senior term loan with  financial institution, interest at a fixed rate of 8.25%, principal  installments and interest payments are due monthly with final maturity on  February 22, 2010. The loan is secured by substantially all of our  assets.                                                         |       | $                     | 333        |                  | $          | 2,333 |   |
|                                                                                                                                                                                                                                                                                                            |       |                  |       |                  |       |
| $3.5 million U.K.  revolving credit facility payable to financial institution, interest at Prime  Rate plus 0.5%; interest rate was 3.75% at December 31, 2009. Interest  is payable monthly with remaining principal due February 22, 2011. The  loan is secured by substantially all of our assets. |       | 1,500                 |       | —                |       |
|                                                                                                                                                                                                                                                                                                            |       |                  |       |                  |       |
| Long-term unsecured  subordinated notes payable, interest ranges from 11-14% with a weighted  average rate of 12.62% and 13.72% at December 31, 2009 and  December 31, 2008, respectively. Paid in full on November 19, 2009.                                                                    |       | —                |       | 4,550                 |       |
| Total debt                                                                                                                                                                                                                                                                                                      |       | 1,833                 |       | 6,883                 |       |
| Less current portion                                                                                                                                                                                                                                                                                            |       | (333                  | )          | (2,000                | )          |
| Long-term debt,  excluding current portion                                                                                                                                                                                                                                                                      |       | $                     | 1,500      |                  | $          | 4,883 |   |

 

On February 22, 2008,we replaced our existing senior term note and senior revolving facility with anew $4.0 million senior term loan, a $1.0 million U.S. revolving creditfacility (“U.S. Revolving Facility”) and a $5.0 million U.K. revolving creditfacility (“U.K. Revolving Facility”).  OnDecember 18, 2008 we modified our U.S. and U.K. Revolving Facilities. TheU.S. Revolving Facility is now a $2.5 million credit facility and the U.K.Revolving Facility is now a $3.5 million facility. All other terms andconditions remained the same.

 

We used proceeds from the$4.0 million senior term loan to pay down our existing senior term note balanceof approximately $3.8 million.  The $4.0million senior term loan bears interest at a fixed rate of 8.25% and is payablein 24 equal monthly installments of principal, plus all accrued interest,beginning March 10, 2008, and was paid in full on February 22,2010.  The senior term loan is secured bysubstantially all assets of Evolving Systems, Inc. and subjects us tocertain affirmative and negative covenants, including financial covenantsrelated to maintaining a specified ratio of debt to EBITDA, as defined, minimumEBITDA, minimum liquidity, and a specified fixed charge ratio.

 

The remaining scheduled principal payments as of December 31,2009 on our debt are as follows (in thousands):

 
| **Years ending December 31,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2010                               |       | $          | 333        |   |
| 2011                               |       | 1,500      |       |
|                               |       | $          | 1,833      |   |

 

Our $2.5 million U.S. RevolvingFacility bears interest at Prime Rate plus 0.5%.  Prime Rate was 3.25% as of December 31,

 

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2009. Borrowings under the senior revolving facilities are limited to apercentage of our eligible accounts receivable and cash.  The U.S. Revolving Facility is secured by allassets of Evolving Systems, Inc. and is subject to the same covenants asthe senior term loan.  All accruedinterest on outstanding borrowings under the U.S. Revolving Facility is paidmonthly, with any outstanding balance due with a final maturity of February 22,2011.  As of December 31, 2009, wehad $2.5 million in availability, but no borrowing outstanding under this U.S.Revolving Facility.

 

Our $3.5 million U.K.Revolving Facility bears interest at Prime Rate plus 0.5%.  Prime Rate was 3.25% as of December 31,2009.  Borrowings under the U.K.Revolving Facility are limited to a percentage of our eligible accountsreceivable and cash.  The U.K. RevolvingFacility is secured by all assets of Evolving Systems Holdings Ltd. andEvolving Systems Ltd. and is subject to the same covenants as the Senior TermLoan.  All accrued interest on outstandingborrowings under the Senior Revolving Facility is paid monthly, with anyoutstanding balance due with a final maturity of February 22, 2011.  As of December 31, 2009, we had $2.0million in availability and $1.5 million outstanding under this U.K. RevolvingFacility.

 

During 2009, we made optional pre-payments of $6.2 million against oursubordinated notes, including accrued non-current interest. The notes were paidin full as of November 19, 2009. All of the payments were unscheduled andreduced balances that otherwise would have been classified as long-term as of December 31,2009.

 

Inconnection with the replacement of our existing senior term note and seniorrevolving facility with the new senior term loan and U.S. Revolving Facilityand the U.K. Revolving Facility, we recorded a write-off of debt issuance costsassociated with the retired senior debt of approximately $0.3 million.  Additionally, we capitalized debt issuancecosts related to our senior debt of approximately $0.3 million.  Capitalized debt issuance costs are amortizedover the term of the senior debt.

 

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

 

In March 2007, we paid $77,000 to retire $119,000of subordinated debt and related accrued interest held by one of oursubordinated note holders.  Theretirement included principal of $103,000 and accrued interest of $16,000.  The $42,000 gain on extinguishment of thisdebt was reflected within our other income (expense) on the consolidatedstatement of operations.    Accruedinterest on the unsecured subordinated notes payable is separately reflected onthe balance sheet under “Other long-term obligations.”

 

We were in compliance with all of our debt covenantsas of December 31, 2009 and 2008.

 

**NOTE 5- INCOME TAXES**

 

Thepre-tax income (loss) on which the provision for income taxes was computed isas follows (in thousands):

 
| ** ** | ** ** | **For the Years Ended December 31** | ** ** |
|------------|------------|------------------------------------------|------------|
| ** ** | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| Domestic   |       | $                                        | 1,638      |   | $ | (115 | ) | $ | (2,398 | ) |
| Foreign    |       | 3,950                                    |       | 3,604 |   | 3,552 |   |
| Total      |       | $                                        | 5,588      |   | $ | 3,489 |   | $ | 1,154 |   |

 

The expense (benefit) forincome taxes consists of the following (in thousands):

 
| ** **     | ** ** | **For the Years Ended December 31** | ** ** |
|----------------|------------|------------------------------------------|------------|
| ** **     | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| Current:       |       |                                     |       |   |   |   |   |
| Federal        |       | $                                        | 38         |   | $ | 25 |   | $ | — |   |
| Foreign        |       | 923                                      |       | 855 |   | 835 |   |
| State          |       | —                                   |       | — |   | — |   |
| Total current  |       | $                                        | 961        |   | $ | 880 |   | $ | 835 |   |
| Deferred:      |       |                                     |       |   |   |   |   |
| Federal        |       | $                                        | —     |   | $ | — |   | $ | — |   |
| Foreign        |       | (197                                     | )          | (320 | ) | (279 | ) |
| State          |       | —                                   |       | — |   | — |   |
| Total deferred |       | (197                                     | )          | (320 | ) | (279 | ) |
| Total          |       | $                                        | 764        |   | $ | 560 |   | $ | 556 |   |

 

As of December 31, 2009 and 2008, we had netoperating loss carryforwards (“NOL”) of approximately $46.6 million and

 

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$49.5 million, respectively, related to U.S. federal and statejurisdictions.  The federal net operatingloss expires at various times beginning in 2019 and ending in 2029.  In addition, we have research andexperimentation credit carryforwards of approximately $0.8 million which mayexpire at various times beginning in 2012. Of our $46.6 million NOL, $9.6 million of the NOL is related to stockcompensation expense, the benefit of which, if realized, will be an increase toequity as opposed to a reduction in tax expense.  For the years ended December 31, 2009and 2008, Evolving Systems was subject to alternative minimum tax in the amountof $38,000 and $25,000, respectively.  Adeferred tax asset in this amount has been established but has a full valuationallowance against it at this time.  TheInternal Revenue Code places certain limitations on the annual amount of netoperating loss carry forwards which can be utilized if certain changes inownership occur.  Changes in ourownership have occurred that will limit the future utilization of the NOL’s.

 

Deferred tax assets andliabilities reflect the net tax effects of temporary differences between thecarrying amount of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are asfollows (in thousands):

 
| ** **                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Deferred tax assets:                                      |       |                  |       |   |   |
| Net operating loss  carryforwards                         |       | $                     | 17,398     |   | $ | 18,493 |   |
| Research &  experimentation credit carryforwards |       | 841                   |       | 854 |   |
| Equity compensation                                       |       | 603                   |       | 422 |   |
| AMT Credit                                                |       | 73                    |       | 81 |   |
| Depreciable assets                                        |       | 417                   |       | 409 |   |
| Acquired intangibles                                      |       | 594                   |       | 673 |   |
| Other                                                     |       | 160                   |       | 136 |   |
| Total deferred tax  assets                                |       | $                     | 20,086     |   | $ | 21,068 |   |
|                                                      |       |                  |       |   |   |
| Deferred tax  liabilities                                 |       |                  |       |   |   |
| Undistributed foreign  earnings                           |       | $                     | (904       | ) | $ | (698 | ) |
| Acquired intangibles                                      |       | (522                  | )          | (691 | ) |
| Total deferred tax  liability                             |       | (1,426                | )          | (1,389 | ) |
| Net deferred tax  assets, before valuation allowance      |       | 18,660                |       | 19,679 |   |
| Valuation allowance                                       |       | (18,938               | )          | (20,079 | ) |
| Net deferred tax  liability                               |       | $                     | (278       | ) | $ | (400 | ) |
|                                                      |       |                  |       |   |   |
| Financial statement  classification:                      |       |                  |       |   |   |
| Current deferred tax  asset/liability                     |       | $                     | (21        | ) | $ | (15 | ) |
| Long-term deferred tax  liability                         |       | (257                  | )          | (385 | ) |
| Net deferred tax  liability                               |       | $                     | (278       | ) | $ | (400 | ) |

 

In conjunction with theacquisition of Evolving Systems U.K., we recorded certain identifiableintangible assets. We established a deferred tax liability of $4.6 million atthe acquisition date for the expected difference between what would be expensedfor financial reporting purposes and what would be deductible for income taxpurposes. This deferred tax liability related to Evolving Systems U.K. and hasno impact on our ability to recover our U.S. based deferred tax assets. As of December 31,2009 and 2008, this deferred tax liability was $0.5 million and $0.7 million,respectively. This deferred tax liability will be recognized as theidentifiable intangibles are amortized.

 

We continue to maintain a full valuation allowance onthe 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 assetsprimarily consist of certain net operating loss carryforwards. We assessed therealizability of our domestic deferred tax assets using all available evidence.In particular, we considered both historical results and projections ofprofitability for the reasonably foreseeable future periods. We are required toreassess our conclusions regarding the realization of our deferred tax assetsat each financial reporting date. A future evaluation could result in aconclusion that all or a portion of the valuation allowance is no longernecessary which could have a material impact on our results of operations andfinancial position.

 

The income tax benefit differs from the amountcomputed by applying the U.S. federal income tax rate of 34% to income beforeincome taxes as follows (in thousands):

 

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| ** **                                                 | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| U.S. federal income tax  expense at statutory rates        |       | $                                         | 1,902      |   | $ | 1,186 |   | $ | 393 |   |
| State income tax  expense (benefit), net of federal impact |       | 98                                        |       | 28 |   | (50 | ) |
| Goodwill impairment                                        |       | —                                    |       | — |   | — |   |
| Non-deductible meals                                       |       | 8                                         |       | 10 |   | 13 |   |
| Foreign rate  differential                                 |       | 63                                        |       | (61 | ) | (4 | ) |
| Foreign deemed  dividends                                  |       | 303                                       |       | 125 |   | 63 |   |
| Change in valuation  allowance                             |       | (1,141                                    | )          | (351 | ) | (47 | ) |
| Equity compensation                                        |       | 27                                        |       | 118 |   | 79 |   |
| Research and  development expenses                         |       | (644                                      | )          | (564 | ) | (312 | ) |
| FIN 48 adjustment                                          |       | —                                    |       | — |   | 433 |   |
| Foreign taxes                                              |       | 122                                       |       | 84 |   | 33 |   |
| Other, net                                                 |       | 26                                        |       | (15 | ) | (45 | ) |
| Income tax expense                                         |       | $                                         | 764        |   | $ | 560 |   | $ | 556 |   |

 

Effective January 1, 2007, we adopted arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return.  For those benefits to berecognized, a tax position must be more-likely-than-not to be sustained uponexamination by taxing authorities.  Therewas no material impact on the company’s consolidated financial position andresults of operations as a result of the adoption of this provision.

 

On January 1, 2007, we recorded a decrease of$0.4 million in our deferred tax assets related to Research and Development TaxCredits that was offset by a corresponding decrease in our valuation allowanceas we determined that it was not more likely than not that our deferred taxassets will be realized.  As of December 31,2009 and 2008, we had no liability for unrecognized tax benefits.  We do not believe there will be any materialchanges to our unrecognized tax positions over the next twelve months.

 

We conduct business globally and, as a result,Evolving Systems, Inc. or one or more of our subsidiaries file income taxreturns in the U.S. federal jurisdiction and various state and foreignjurisdictions.  In the normal course ofbusiness, we are subject to examination by taxing authorities throughout theworld, namely the United Kingdom, Germany and India.

 

During2004, we formedEvolving Systems India, a wholly owned subsidiary of Evolving Systems, Inc.which is used for offshore product development.  We were granted a tax holiday byIndia which extends through March 2010. Under the terms of the tax holiday, we are only liable for a MinimumAlternative Tax (“MAT”).

 

**NOTE 6- STOCKHOLDERS’ EQUITY**

 

## ***(a)***                                  Series B ConvertibleRedeemable Preferred Stock

## *** ***

On February 25, 2008,holders of 461,758 shares of Series B Preferred Stock with a carryingvalue of $5.4 million, or approximately 96% of the outstanding preferred stock,converted their shares of preferred stock into 692,637 shares of our commonstock in accordance with the conversion provisions of the Series BPreferred Stock.  On March 19, 2008,a holder of 16,992 shares of Series B Preferred Stock with a carryingvalue of $0.2 million, which represented the remainder of the outstandingpreferred stock, converted his shares of preferred stock into 25,488 shares ofour common stock in accordance with the conversion provisions of the Series BPreferred Stock.  As we previouslyincluded the Series B Convertible Preferred Stock as a participatingsecurity for basic EPS purposes, these conversions did not change our basic ordiluted EPS calculations.

 

Based on the specificfeatures of the Series B Preferred Stock, the issuance date fair value wasestimated to be approximately the same as its value upon redemption, which isthe same as its value upon liquidation. The Series B Preferred Stock wasentitled to dividends on an as-converted basis with the common stock and was,therefore, considered a participating security and shares issuable uponconversion were included in weighted average shares outstanding for purposes ofcalculating basic earnings per share. Upon the occurrence of certain material events (liquidation, merger,etc.), the holders of Series B Preferred Stock were entitled to receive apreference payment that was senior to the common stock, but subordinate to oursenior and unsecured subordinate debt, equal to the sum of the number of sharesof common stock into which each share of Series B Preferred Stock isconvertible as of the date of such event multiplied by $3.89 per share (subjectto adjustment for stock splits and combinations), or $0 at December 31,2009 and 2008.

 

**(b)****                                 ****Certain****Anti-TakeoverProvisions/Agreements with Stockholders**

 

Our restated certificateof incorporation allows the board of directors to issue up to 2,000,000 sharesof preferred stock and to determine the price, rights, preferences andprivileges of those shares without any further vote or action by ourstockholders. The rights of the holders of our common stock will be subject to,and may be adversely affected by, the rights of the holders of any preferredstock that may be issued in the future. Issuance of preferred stock, whileproviding desired flexibility in connection with possible acquisitions andother corporate purposes, could make it more difficult for a third party toacquire a majority of our outstanding voting stock. In connection with theEvolving Systems U.K. acquisition, we issued 966,666 shares of Series BPreferred Stock.  As of December 31,2009 no shares

 

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of Series BPreferred Stock are outstanding.

 

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

 

On February 25,2008 we entered into a Standstill Agreement (the “Standstill Agreement”) withKaren Singer, Trustee of the Singer Children’s Management Trust (the “Singer Trust”)in which the Board of Directors agreed to appoint two independent members tothe Board of Directors and to waive the provisions of Section 203 of theDelaware General Corporation Law (“Section 203”), as it related to theSinger Trust’s acquisition of our stock, provided that the Singer Trust and itsaffiliates would beneficially own less than 20% of our outstandingshares.  In exchange, the Singer Trust agreed for a period of 18 monthsfollowing the appointment of the Singer Nominees to the Board of Directors (the“Standstill Period”), not to seek or propose, among other things, anacquisition of the Company, a business combination or any other extraordinarytransaction with respect to the Company.  The Singer Trust also agreedthat during the Standstill Period it would not nominate any person as adirector of the Company (other than the Singer Nominees) or propose any matterto be voted on by stockholders of the Company and it would vote its shares infavor of the Company’s nominees for directors. The Standstill Agreement expiredon September 30, 2009.

 

On March 4, 2009 ourBoard of Directors adopted a Stockholder Rights Plan (the “Rights Agreement)that is designed to strengthen the ability of the Board of Directors to protectEvolving Systems’ stockholders.  The Rights Agreement was not adopted inresponse to any unsolicited offer or takeover attempt. Under the plan, eachcommon stockholder at the close of business on March 16, 2009 received adividend of one right for each share of our common stock held of record on thatdate.  Each right will entitle the holder to purchase, in certaincircumstances, two one-hundredths of a share of newly-created Series Cjunior participating preferred stock for an initial purchase price of $8.00 pershare. The rights distribution will not be taxable to stockholders and thedistribution of rights under the plan will not interfere with the Company’sbusiness plans or be dilutive to or affect our reported per share results.The rights will generally becomeexercisable ten business days after any person has become the beneficial ownerof 22.5% or more of our common stock or has commenced a tender or exchangeoffer which, if consummated, would result in any person becoming the beneficialowner of 22.5% or more of our common stock.

 

On December 10,2009, the Board of Directors approved an amendment to the RightsAgreement.  The amendment increases, from 22.5% to 25.0%, the percentageof our common stock that a person or group of affiliated or associated personsmay beneficially own without triggering the exercisability of the RightsAgreement.  All other provisions of the Rights Agreement remain unchanged.

 

On December 11,2009, we received a letter from the Singer Trust informing us that as theresult of the appointment of John B. Spirtos to our Board of Directors and ourapproval of the amendment to the Rights Agreement the Singer Trust will vote infavor of the reelection of Philip Neches and Richard Ramlall to our Board ofDirectors at our 2010 annual meeting of stockholders and the Singer Trust willnot seek or otherwise support additional stockholder protections or reforms atthe meeting.

 

**NOTE 7  — SHARE-BASED COMPENSATION**

 

We account forstock-based compensation by applying 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, using themodified prospective method. We record compensation costs associated with thevesting of unvested options on a straight-line basis over the vesting period.We recognized $0.9 million, $0.8 million and $0.7 million for the years ended December 31,2009, 2008 and 2007, respectively, of compensation expense in the consolidatedstatements of operations, with respect to our stock-based compensationplans.  The following table summarizesstock-based compensation expenses recorded in the statement of operations (inthousands):

 
| ** **                                                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Cost of license fees and services, excluding  depreciation and amortization |       | $                                         | 67         |   | $ | 62 |   | $ | 59 |   |
| Cost of customer support, excluding depreciation and  amortization          |       | 8                                         |       | 7 |   | 2 |   |
| Sales and marketing                                                         |       | 142                                       |       | 137 |   | 151 |   |
| General and administrative                                                  |       | 557                                       |       | 551 |   | 478 |   |
| Product development                                                         |       | 90                                        |       | 82 |   | 20 |   |
|                                                                        |       | $                                         | 864        |   | $ | 839 |   | $ | 710 |   |

 

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**StockOption/Incentive Plans**

 

In January 1996,our stockholders approved an Amended and Restated Stock Option Plan (the “OptionPlan”).  Under the Option Plan, asamended, and after the reverse stock split, 4,175,000 shares were reserved forissuance.  Options issued under theOption Plan were at the discretion of the Board of Directors, including thevesting provisions of each stock option granted. Options were granted with anexercise price equal to the closing price of our common stock on the date ofgrant, generally vest over four years and expire no more than ten years fromthe date of grant. The Option Plan terminated on January 18, 2006; optionsgranted before that date were not affected by the plan termination.    At December 31, 2009 and 2008, 1.7million and 1.8 million options remained outstanding under the Option Plan,respectively.

 

In March 2007upon the hiring of our Vice President of World Wide Sales and Marketing, inaccordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv) the boardof directors approved an inducement award under a stand-alone equity incentiveplan.  We granted 50,000 non-qualifiedoptions to purchase shares of our common stock at an exercise price equal tothe closing price of our common stock on the date of grant.  The options vest over four years and expireten years from the date of grant. At December 31, 2009 and 2008, 50,000options remained outstanding under this plan.

 

In June 2007,our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”).  As a result of the reverse stock split on July 21,2009, a maximum of 1,000,000 shares can be issued under the 2007 Stock Plan.Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights,Restricted Stock, Restricted Stock Units, Performance Awards and OtherStock-Based Awards.  Awards issued underthe 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with anexercise price equal to the closing price of our common stock on the date ofgrant, generally vest over four years and expire no more than ten years fromthe date of grant.  At December 31,2009 and 2008, 0.6 million and 0.5 million options remained outstanding underthe 2007 Stock Plan, respectively.

 

In December 2008,under the 2007 Stock Plan, we awarded a total of 52,500 shares of restrictedstock to members of our board of directors and senior management. During theyears ended December 31, 2009 and 2008, 42,000 and 28,000 shares ofrestricted stock vested, respectively. There were no forfeitures of restricted stock during the years ended December 31,2009 or 2008. The fair market value for share-based compensation expensing isequal to the closing price of our common stock on the date of grant.  The restrictions on the stock awards arereleased generally over four years for senior management and over one year forboard members.

 

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

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected term (years)   |       | 5.4                                       |       | 6.1 |   | 6.1 |   |
| Risk-free interest rate |       | 2.38                                      | %          | 1.77 | % | 3.98 | % |
| Expected volatility     |       | 77.32                                     | %          | 83.95 | % | 105.74 | % |
| Expected dividend yield |       | 0                                         | %          | 0 | % | 0 | % |

 

The following is asummary of stock option activity under the stock option plans for the yearended December 31, 2009:

 
| ** **                                    | ** ** | **Number of  Shares  (in thousands)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Options outstanding at December 31, 2008 |       | 2,327                                 |       | $                                       | 5.62       |                                                          |       |                                            | $          | 78 |   |
| Options granted                               |       | 90                                    |       | $                                       | 3.87       |                                                          |       |                                            |       |   |
| Less options forfeited                        |       | (3                                    | )          | $                                       | 1.97       |                                                          |       |                                            |       |   |
| Less options expired                          |       | (8                                    | )          | $                                       | 7.13       |                                                          |       |                                            |       |   |
| Less options exercised                        |       | (142                                  | )          | $                                       | 5.25       |                                                          |       |                                            |       |   |
| Options outstanding at December 31, 2009 |       | 2,264                                 |       | $                                       | 5.57       |                                                          | 5.17       |                                            | $          | 4,304 |   |
|                                          |       |                                  |       |                                    |       |                                                          |       |                                            |       |
| Options exercisable at December 31, 2009 |       | 1,965                                 |       | $                                       | 5.92       |                                                          | 4.65       |                                            | $          | 3,411 |   |

 

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The following is asummary of stock options outstanding under the plans as of December 31,2009:

 
| **Stock Options Outstanding** | ** ** | **Stock Options  Exercisable** | ** ** |
|-------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | ** **                     | ** ** | **Weighted Avg.** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Number of**                  | ** ** | **Remaining** | ** ** | **Weighted Avg.** | ** ** | **Number of** | ** ** | **Weighted Avg.** | ** ** |
| **Range of**                  | ** ** | **Shares**                     | ** ** | **Contractual Life** | ** ** | **Exercise** | ** ** | **Shares** | ** ** | **Exercise** | ** ** |
| **Exercise Prices**           | ** ** | **(in thousands)**             | ** ** | **(years)** | ** ** | **Price** | ** ** | **(in thousands)** | ** ** | **Price** | ** ** |
| $1.16 - $1.90                 |       | 461                            |       | 5.60 |   | $ | 1.50 |   | 333 |   | $ | 1.47 |   |
| $2.04 - $4.30                 |       | 654                            |       | 5.86 |   | $ | 4.02 |   | 616 |   | $ | 4.06 |   |
| $4.34 - $5.70                 |       | 494                            |       | 5.05 |   | $ | 5.09 |   | 376 |   | $ | 5.23 |   |
| $5.86 - $9.28                 |       | 519                            |       | 4.29 |   | $ | 7.64 |   | 504 |   | $ | 7.67 |   |
| $10.08 - $28.30               |       | 136                            |       | 4.07 |   | $ | 20.55 |   | 136 |   | $ | 20.55 |   |
|                          |       | 2,264                          |       | 5.17 |   | $ | 5.57 |   | 1,965 |   | $ | 5.92 |   |

 

Theweighted-average grant-date fair value of stock options granted during theyears ended December 31, 2009, 2008 and 2007 was $2.53, $1.48 and $3.66respectively.

 

As of December 31,2009, there were approximately $0.9 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 2.0 years.

 

The totalintrinsic value of stock option exercises for the years ended December 31,2009, 2008 and 2007 was $0.2 million, $5,000 and $23,000, respectively.  The total fair value of stock awards vestedduring the years ended December 31, 2009, 2008 and 2007 was $0.9 million,$1.0 million and $0.7 million, respectively.

 

The deferredincome tax benefits from stock options expense related to Evolving Systems U.K.totaled approximately $61,000, $58,000 and $41,000 for the years ended December 31,2009, 2008 and 2007, respectively.

 

Cash received fromstock option exercises was $0.7 million, $4,000 and $19,000 for the years endedDecember 31, 2009, 2008 and 2007, respectively.

 

Prior to theadoption of SFAS 123R on January 1, 2006, we applied theintrinsic-value-based method in accounting for the recognition of employeestock-based compensation arrangements and the fair value method for disclosurepurposes.

 

**EmployeeStock Purchase Plan**

 

Under the EmployeeStock Purchase Plan (“ESPP”), we are authorized to issue up to 550,000(adjusted for the reverse stock split) shares of our common stock to full-timeemployees, nearly all of whom are eligible to participate. Under the terms ofthe ESPP, employees may elect to have up to 15% of their gross salarieswithheld through payroll deduction to purchase our common stock, capped at$25,000 annually and no more than 10,000 shares in any offering period. Thepurchase price of the stock is 85% of the lower of the market price at the beginningor end of each three-month participation period.  As of December 31, 2009, there were88,000 shares available for purchase. For the years ended December 31, 2009, 2008 and 2007, we recordedcompensation expense of $20,000, $21,000 and $22,000, respectively, associated with grants under the ESPP whichincludes the fair value of the look-back feature of each grant as well as the15% discount on the purchase price.  Thisexpense fluctuates each period based upon employee participation.

 

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

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected term (years)   |       | 0.25                                      |       | 0.25 |   | 0.25 |   |
| Risk-free interest rate |       | 0.12                                      | %          | 0.86 | % | 4.58 | % |
| Expected volatility     |       | 65.30                                     | %          | 66.81 | % | 67.52 | % |
| Expected dividend yield |       | 0                                         | %          | 0 | % | 0 | % |

 

Cash received fromemployee stock plan purchases was $68,000, $69,000 and $71,000 for the yearsended December 31, 2009, 2008 and 2007, respectively.  We issued shares related to the ESPP of35,000, 23,000 and 30,000 for the years ended December 31, 2009, 2008 and2007, respectively.

 

44

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**NOTE 8  — BENEFIT PLANS**

 

We haveestablished a defined contribution retirement plan for our employees undersection 401(k) of the Internal Revenue Code (the “401(k) Plan”) thatis available to all U.S. employees 21 years of age or older with a monthof service. Employees may contribute up to 20% of gross compensation not toexceed the maximum statutory contribution amount. We may make discretionarymatching contributions. All employee contributions are fully vested immediatelyand employer contributions vest over a period of three years.  For the year ended December 31, 2007, wemade a discretionary matching contribution using funds available in the 401(k) Plan’sforfeiture account. For the year ended December 31, 2008, we made amatching contribution using our cash balances of $0.2 million during the firstquarter of 2009. For the year ended December 31, 2009, we will make amatching contribution using our cash balances. This contribution will be madein the first quarter of 2010.

 

Evolving SystemsU.K. has established a defined contribution pension scheme that is available toall employees in their first full month of employment.  Employees may contribute a percentage oftheir earnings, the amount of which is dependent upon the age of the employee,not to exceed the maximum statutory contribution amount.  We match 5% of employee contributions.  All contributions are immediately vested intheir entirety.

 

During 2009, 2008and 2007, we recorded a consolidated expense of $0.5 million for each period,under the aforementioned plans.

 

**NOTE 9 —EARNINGS PER SHARE**

 

Basic earnings pershare (“EPS”) is computed by dividing net income or loss available to commonstockholders by the weighted average number of shares of common stockoutstanding during the period, including common stock issuable underparticipating securities, such as the Series B Preferred Stock. DilutedEPS is computed using the weighted average number of shares of common stockoutstanding, including participating securities, plus all potentially dilutivecommon stock equivalents using the treasury stock method. Common stockequivalents consist of stock options. The following is the reconciliation ofthe numerators and denominators of the basic and diluted EPS computations (inthousands except per share data):

 
| ** **                                                 | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Basic income per common and preferred share:               |       |                                      |       |   |   |   |   |
| Net income available to common and preferred  stockholders |       | $                                         | 4,824      |   | $ | 2,929 |   | $ | 598 |   |
| Weighted average common shares outstanding                 |       | 9,816                                     |       | 9,571 |   | 7,868 |   |
| Participating securities                                   |       | —                                    |       | 124 |   | 1,731 |   |
| Basic weighted average shares outstanding                  |       | 9,816                                     |       | 9,695 |   | 9,599 |   |
| Basic income per common and preferred share                |       | $                                         | 0.49       |   | $ | 0.30 |   | $ | 0.06 |   |
|                                                       |       |                                      |       |   |   |   |   |
| Diluted income per common and preferred share:             |       |                                      |       |   |   |   |   |
|                                                       |       |                                      |       |   |   |   |   |
| Net income available to common and preferred  stockholders |       | $                                         | 4,824      |   | $ | 2,929 |   | $ | 598 |   |
| Weighted average common shares outstanding                 |       | 9,816                                     |       | 9,571 |   | 7,868 |   |
| Participating securities                                   |       | —                                    |       | 124 |   | 1,731 |   |
| Effect of dilutive securities — options               |       | 329                                       |       | 183 |   | 189 |   |
| Diluted weighted average shares outstanding                |       | 10,145                                    |       | 9,878 |   | 9,788 |   |
| Diluted income per common and preferred share              |       | $                                         | 0.48       |   | $ | 0.30 |   | $ | 0.06 |   |

 

Weighted averageoptions to purchase 1.1 million, 3.5 million and 3.2 million shares of commonstock equivalents were excluded from the computation of diluted weightedaverage shares outstanding for the years ended December 31, 2009, 2008 and2007, respectively, because the effect would have been anti-dilutive sincetheir exercise prices were greater than the average market value of our commonstock for the period.

 

**NOTE 10  — COMMITMENTS AND CONTINGENCIES**

 

**(a)****                                 ****Lease Commitments**

 

We lease officeand operating facilities and equipment under non-cancelable operating leases.Current facility leases include our headquarters; the London and Bath, Englandand Munich, Germany offices which were assumed as part of the Evolving SystemsU.K. acquisition; the Bangalore, India office; the Kuala Lumpur, Malaysiaoffice and the Windsor, England office. Rent expense was $1.1 million, $1.1million and $1.4 million for the years ended December 31, 2009, 2008 and2007, respectively. Rent expense is net of sublease rental income of $7,000, $0and $0.1 million for the years ended December 31, 2009, 2008 and 2007,respectively.

 

45

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Our headquartersfacility lease contains a clause that adjusts the lease rate every year. Thelease rate increases annually as of November 1.  We account for the effect of such escalatinglease payments as if the lease rate were consistent over the lease term.

 

Future minimumcommitments under non-cancelable operating leases and capital leases as of December 31,2009 are as follows (in thousands):

 
| ** **                                         | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
| 2010                                               |       | $                     | 886        |                | $          | 30 |   |
| 2011                                               |       | 712                   |       | 30                  |       |
| 2012                                               |       | 559                   |       | 8                   |       |
| Total minimum lease payments                       |       | $                     | 2,157      |                | 68         |   |
| Less: Amount representing interest                 |       |                  |       | (9                  | )          |
| Principal balance of capital lease obligations     |       |                  |       | 59                  |       |
| Less: Current portion of capital lease obligations |       |                  |       | (24                 | )          |
| Long-term portion of capital lease obligations     |       |                  |       | $                   | 35         |   |

 

**(b)****                                 ****Other Commitments**

 

As permitted underDelaware law, we have agreements with officers and directors under which weagree to indemnify them for certain events or occurrences while the officer ordirector is, or was serving, at our request in this capacity. The term of theindemnification period is indefinite. There is no limit on the amount of futurepayments we could be required to make under these indemnification agreements;however, we maintain Director and Officer insurance policies, as well as anEmployment Practices Liability Insurance Policy, that may enable us to recovera portion of any amounts paid. As a result of our insurance policy coverage, webelieve the estimated fair value of these indemnification agreements isminimal. Accordingly, we did not record any liabilities for these agreements asof December 31, 2009 and 2008.

 

We enter into standardindemnification terms with customers and suppliers, as discussed below, in theordinary course of business.  As we maysubcontract the development of deliverables under customer contracts, we couldbe required to indemnify customers for work performed by subcontractors.Depending upon the nature of the customer indemnification, the potential amountof future payments we could be required to make under these indemnificationagreements may be unlimited. We may be able to recover damages from asubcontractor if the indemnification to customers results from thesubcontractor’s failure to perform. To the extent we are unable to recoverdamages from a subcontractor, we could be required to reimburse the indemnifiedparty for the full amount. We have never incurred costs to defend lawsuits orsettle claims relating to indemnification arising out of subcontractors’ failureto perform. As a result, we believe the estimated fair value of theseagreements is minimal.  Accordingly, wedid not record any liabilities for these agreements as of December 31,2009 and 2008.

 

Our standard licenseagreements contain product warranties that the software will be free ofmaterial defects and will operate in accordance with the stated requirementsfor a limited period of time.  Theproduct warranty provisions require us to cure any defects through anyreasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, we did not record anyliabilities for these product warranty provisions as of December 31, 2009and 2008.

 

Our software arrangementsgenerally include a product indemnification provision whereby we will indemnifyand defend a customer in actions brought against the customer for claims thatour products infringe upon a copyright, trade secret, or valid patent. We havenot historically incurred any significant costs related to productindemnification claims. Accordingly, we did not record any liabilities forthese indemnification provisions as of December 31, 2009 and 2008.

 

In relation to theacquisitions of Evolving Systems U.K., Telecom Software Enterprises, LLC (“TSE”)and CMS Communications, Inc. (“CMS”), we agreed to indemnify certainparties from any losses, actions, claims, damages or liabilities (or actions inrespect thereof) resulting from any claim raised by a third party.  We do not believe that there will be anyclaims related to these indemnifications. Accordingly, we did not record anyliabilities for these agreements as of December 31, 2009 and 2008.

 

**(c)****                                 ****Litigation**

 

During the fourthquarter of 2006, a previous vendor filed a complaint in the Superior Court ofNew Jersey against us asserting we breached certain provisions of a licenseagreement.  On April 10, 2009, wesettled our litigation with this previous vendor for an immaterial amount andthe matter pending in the United States District Court of New Jersey wasdismissed with prejudice.

 

We are involved invarious other legal matters arising in the normal course of business.  We recorded losses, including estimated coststo defend, for these matters to the extent they were probable of loss and theamount of loss could be reasonably estimated.

 

46

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**NOTE 11  — SEGMENT INFORMATION**

 

We define operatingsegments as components of our enterprise for which separate financialinformation is reviewed regularly by the chief operating decision-makers toevaluate performance and to make operating decisions. We have identified ourChief Executive Officer and Chief Financial Officer as our chief operatingdecision-makers (“CODM”). These chief operating decision makers review revenueby segment and review overall results of operations.

 

We currently operate ourbusiness as two operating segments based on revenue type:  license fees and services revenue andcustomer support revenue (as shown on the consolidated statements ofoperations).  License fees and services (“L&S”)revenue represents the fees received from the license of software products andthose services directly related to the delivery of the licensed products, suchas fees for custom development and integration services.  Customer support (“CS”) revenue includesannual support fees, recurring maintenance fees, fees for maintenance upgradesand warranty services.  Warranty servicesthat are similar to software maintenance services are typically bundled with alicense sale. Total assets by segment have not been disclosed as theinformation is not available to the chief operating decision-makers.

 

Revenueinformation by segments was as follows (in thousands):

 
| ** **                                                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Revenue**                                                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                   |       | $                                         | 21,561     |   | $ | 20,324 |   | $ | 17,895 |   |
| Customer support                                                            |       | 16,635                                    |       | 17,497 |   | 18,058 |   |
| Total revenue                                                               |       | 38,196                                    |       | 37,821 |   | 35,953 |   |
|                                                                        |       |                                      |       |   |   |   |   |
| **Revenue less costs of revenue, excluding depreciation and  amortization** |       |                                      |       |   |   |   |   |
| License fees and services                                                   |       | 13,919                                    |       | 12,508 |   | 9,872 |   |
| Customer support                                                            |       | 11,092                                    |       | 11,394 |   | 11,821 |   |
|                                                                        |       | 25,011                                    |       | 23,902 |   | 21,693 |   |
| **Unallocated Costs**                                                       |       |                                      |       |   |   |   |   |
| Other operating expenses                                                    |       | 16,963                                    |       | 17,783 |   | 16,795 |   |
| Depreciation and amortization                                               |       | 1,364                                     |       | 2,210 |   | 2,464 |   |
| Restructuring and other recovery                                            |       | —                                    |       | — |   | (4 | ) |
| Interest income                                                             |       | (25                                       | )          | (161 | ) | (304 | ) |
| Interest expense                                                            |       | 547                                       |       | 1,171 |   | 1,747 |   |
| Other income                                                                |       | —                                    |       | (57 | ) | — |   |
| (Gain) loss on extinguishment of debt                                       |       | —                                    |       | 290 |   | (42 | ) |
| Foreign currency exchange (gain) loss                                       |       | 574                                       |       | (823 | ) | (117 | ) |
| **Income before income taxes**                                              |       | $                                         | 5,588      |   | $ | 3,489 |   | $ | 1,154 |   |

 

***Geographic Regions***

 

Weare headquartered in Englewood, a suburb of Denver, Colorado.  We use customer locations as the basis forattributing revenue to individual countries. We provide products and services on a global basis through our office inColorado and U.K.-based Evolving Systems U.K. subsidiary.  Additionally, personnel in Bangalore, India,provide software development services to our global operations.  Financial information relating to operationsby geographic region, is as follows (in thousands):

 
| ** **     | ** ** | **For the Year Ended December 31, 2009** | ** ** |
|----------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **L&S**                                   | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                          |       |   |   |   |   |
| United States  |       | $                                             | 2,005      |   | $ | 9,201 |   | $ | 11,206 |   |
| United Kingdom |       | 2,650                                         |       | 2,124 |   | 4,774 |   |
| Indonesia      |       | 2,966                                         |       | 123 |   | 3,089 |   |
| Nigeria        |       | 2,606                                         |       | 285 |   | 2,891 |   |
| Other          |       | 11,334                                        |       | 4,902 |   | 16,236 |   |
| Total revenue  |       | $                                             | 21,561     |   | $ | 16,635 |   | $ | 38,196 |   |

 

47

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| ** **     | ** ** | **For the Year Ended December 31, 2008** | ** ** |
|----------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **L&S**                                   | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                          |       |   |   |   |   |
| United States  |       | $                                             | 2,569      |   | $ | 10,221 |   | $ | 12,790 |   |
| United Kingdom |       | 5,354                                         |       | 2,485 |   | 7,839 |   |
| Other          |       | 12,401                                        |       | 4,791 |   | 17,192 |   |
| Total revenue  |       | $                                             | 20,324     |   | $ | 17,497 |   | $ | 37,821 |   |

 
| ** **     | ** ** | **For the Year Ended December 31, 2007** | ** ** |
|----------------|------------|------------------------------------------------------------------------|------------|
| ** **     | ** ** | **L&S**                                                            | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                                                   |       |   |   |   |   |
| United States  |       | $                                                                      | 2,619      |   | $ | 10,744 |   | $ | 13,363 |   |
| United Kingdom |       | 6,144                                                                  |       | 2,863 |   | 9,007 |   |
| Other          |       | 9,132                                                                  |       | 4,451 |   | 13,583 |   |
| Total revenue  |       | $                                                                      | 17,895     |   | $ | 18,058 |   | $ | 35,953 |   |

 
| ** **                 | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2009**              | ** ** | **2008**              | ** ** |
| **Long-lived assets, net** | ** ** | ** **            | ** ** | ** **            | ** ** |
| United States              |       | $                     | 6,759      |                  | $          | 7,060 |   |
| United Kingdom             |       | 18,422                |       | 17,327                |       |
| Other                      |       | 174                   |       | 75                    |       |
|                       |       | $                     | 25,355     |                  | $          | 24,462 |   |

 

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

 
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| ** **          | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Revenue**         |       |                                      |       |   |   |   |   |
| Activation          |       | $                                         | 23,307     |   | $ | 20,639 |   | $ | 19,533 |   |
| Numbering solutions |       | 12,823                                    |       | 13,270 |   | 11,919 |   |
| Mediation           |       | 2,066                                     |       | 3,912 |   | 4,501 |   |
| Total revenue       |       | $                                         | 38,196     |   | $ | 37,821 |   | $ | 35,953 |   |

 

**NOTE 12  — QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**

 

Quarterlyfinancial information is as follows (in thousands, except per share data):

 
| ** **                                        | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|---------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                        | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| **Year Ended December 31, 2009**             |       |        |       |        |       |        |       |        |       |
| Total revenue                                     |       | $           | 8,843      |        | $          | 9,629       |       | $           | 9,913      |   | $ | 9,811 |   |
| Less: cost of revenue and operating expenses      |       | 7,452       |       | 7,834       |       | 8,287       |       | 7,939       |       |
| Income from operations                            |       | 1,391       |       | 1,795       |       | 1,626       |       | 1,872       |       |
| Income (loss) before income taxes                 |       | 974         |       | 1,155       |       | 1,708       |       | 1,751       |       |
| Net income (loss)                                 |       | $           | 969        |        | $          | 1,102       |       | $           | 1,328      |   | $ | 1,425 |   |
| Net income (loss) per common and preferred share: |       |        |       |        |       |        |       |        |       |
| Basic                                             |       | $           | 0.10       |        | $          | 0.11        |       | $           | 0.14       |   | $ | 0.14 |   |
| Diluted                                           |       | $           | 0.10       |        | $          | 0.11        |       | $           | 0.13       |   | $ | 0.14 |   |
|                                              |       |        |       |        |       |        |       |        |       |
| **Year Ended December 31, 2008**             |       |        |       |        |       |        |       |        |       |
| Total revenue                                     |       | $           | 9,127      |        | $          | 9,645       |       | $           | 9,029      |   | $ | 10,020 |   |
| Less: cost of revenue and operating expenses      |       | 9,007       |       | 8,545       |       | 8,195       |       | 8,165       |       |
| Income from operations                            |       | 120         |       | 1,100       |       | 834         |       | 1,855       |       |
| Income (loss) before income taxes                 |       | (318        | )          | 888         |       | 715         |       | 2,204       |       |
| Net income (loss)                                 |       | $           | (244       | )           | $          | 775         |       | $           | 593        |   | $ | 1,805 |   |
| Net income (loss) per common and preferred share: |       |        |       |        |       |        |       |        |       |
| Basic                                             |       | $           | (0.02      | )           | $          | 0.08        |       | $           | 0.06       |   | $ | 0.18 |   |
| Diluted                                           |       | $           | (0.02      | )           | $          | 0.08        |       | $           | 0.06       |   | $ | 0.18 |   |

 

48

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**NOTE 13 —RELATED PARTY TRANSACTIONS**

 

Effective January 1, 2008, we entered into a one-year consultingagreement with Stephen K. Gartside, Jr., our previous President and CEO andcurrent Chairman of the Board.  Under theagreement, we paid Mr. Gartside a fee of $20,000 for consulting servicesprovided to us during 2008.  We hadcurrent obligations in the consolidated balance sheets, under the agreement, of$5,000 as of December 31, 2008.  Werecorded $20,000 of general and administrative expense in the consolidatedstatements of operations, related to this agreement, for the year ended December 31,2008.  This contract terminated December 31,2008.

 

EffectiveOctober 15, 2009, George A. Hallenbeck resigned from our Board ofDirectors and we entered into a consulting agreement with him to provideconsulting services. Mr. Hallenbeck is one of the founders of the Company.Under the consulting agreement, we will pay Mr. Hallenbeck an annual feeof $10,000 for his services through May 31, 2012. We had currentobligations in the consolidated balance sheets, under the agreement of $2,000as of December 31, 2009. We recorded approximately $2,000 of general andadministrative expense in the consolidated statements of operations, related tothis agreement, for the year ended December 31, 2009.

 

**NOTE 14 —SUBSEQUENT EVENTS**

 

We evaluated our December 31, 2009 financial statements forsubsequent events. We are not aware of any subsequent events which wouldrequire recognition or disclosure in the financial statements.

 

**ITEM9.    CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.    CONTROLS AND PROCEDURES**

 

*Evaluationof disclosure 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.

 

Ourmanagement, with the participation of the Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this Annual Report on Form 10-K. 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, we are required to apply judgment inevaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

 

*Management’sreport on internal control over financial reporting. *Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f). All internal control systems, no matter how well designed, have inherentlimitations.  Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.  Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of the effectiveness of ourinternal control over financial reporting based on the framework in InternalControl — Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”).

 

Based on ourevaluation under the framework in Internal Control — Integrated Framework, ourmanagement concluded that our internal control over financial reporting waseffective as of December 31, 2009.

 

This Annual Reporton Form 10-K does not include an attestation report of our independentregistered public accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by our independent registered public accounting firmpursuant to temporary rules of the Securities and Exchange Commission thatpermit us to provide only management’s report in this Annual Report on Form 10-K.

 

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*Changesin internal control over financial reporting. *During thethree and twelve months ended December 31, 2009, there was no change inour internal control over financial reporting or in other factors that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**ITEM 9B.    OTHERINFORMATION**

 

None.

 

**PART III**

 

**ITEM10.    DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

 

Incorporated by referenceto the sections of Evolving Systems, Inc. 2010 Proxy Statement,anticipated to be filed within 120 days of December 31, 2009,entitled “Proposal No. 1-Election of Directors,” “Management” and “InformationRegarding the Board and Its Committees.”

 

**ITEM11.    EXECUTIVE COMPENSATION**

 

Incorporated by referenceto the section of Evolving Systems, Inc. 2010 Proxy Statement, anticipatedto be filed within 120 days of December 31, 2009, entitled “ExecutiveCompensation.”

 

**ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Incorporated by referenceto the section of the Evolving Systems, Inc. 2010 Proxy Statement,anticipated to be filed within 120 days of December 31, 2009,entitled “Information RegardingBeneficial Ownership of Principal Stockholders, Directors, and Management.”

 

**ITEM13.    CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

Incorporated by reference to the sections of theEvolving Systems, Inc. 2010 Proxy Statement, anticipated to be filedwithin 120 days of December 31, 2009, entitled “Certain Relationshipsand Related Transactions” and “Information Regarding the Board and ItsCommittees.”

 

**ITEM14.    PRINCIPAL ACCOUNTING FEES ANDSERVICES**

 

Incorporated by referenceto the section of the Evolving Systems, Inc. 2010 Proxy Statement,anticipated to be filed within 120 days of December 31, 2009,entitled “Proposal No. 3-Ratification of Selection of IndependentRegistered Public Accounting Firm.”

 

**PART IV**

 

**ITEM15.    EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

 

(a)   The following documents are filed as part of thisAnnual Report on Form 10-K:

 

Consolidated FinancialStatements.

 

Consolidated FinancialStatement Schedules have been omitted because the required information is notpresent, or not present in amounts sufficient to require submission of theschedules or because the required information is provided in the ConsolidatedFinancial Statements or Notes thereto.

 

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description of Document**                                                                                                                                                                                                                        |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1†            |       | Restated Certificate of Incorporation.                                                                                                                                                                                                             |
| 3.1(a)               |       | Certificate of Designation for the Series B  Convertible Preferred Stock, as filed as Exhibit 3.1 to the Registrant’s  Form 8-K filed November 11, 2004 and incorporated herein by  reference.                            |
| 3.1(b)               |       | Certificate of Amendment to Certificate of  Designation of Series B Convertible Preferred Stock filed as  Exhibit 3.1(c) to the Registrant’s Form 8-K filed  November 17, 2005 and incorporated herein by reference. |
| 3.1(c)               |       | Certificate of Amendment to Certificate of  Designation of Series B Convertible Preferred Stock filed as  Exhibit 3.01 to the Registrant’s Form 8-K filed May 4, 2007  and incorporated herein by reference.              |
| 3.1(d)               |       | Certificate of Designation for the Series C  Junior Participating Preferred Stock, as filed as Exhibit 3.1(d) to  the Registrant’s Form 8-K filed March 9, 2009 and incorporated  herein by reference.               |
| 3.1(e)               |       | Certificate of Elimination of the Series A  Junior Participating Preferred Stock, as filed as Exhibit 3.1(e) to  the Registrant’s                                                                                              |

 

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|         |   | Form 8-K filed March 9, 2009 and  incorporated herein by reference.                                                                                                                                                                                                                    |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(f)       |   | Certificate of Amendment to the Restated Certificate  of Incorporation of Evolving Systems, Inc, as filed as Exhibit 3.1 to  the Registrant’s Form 8-K filed on July 21, 2009 and incorporated  herein by reference.                                                         |
| 3.2†    |   | Amended and Restated Bylaws.                                                                                                                                                                                                                                                                     |
| 3(ii)(1)     |   | Amended and Restated Bylaws of Evolving  Systems, Inc., as filed as Exhibit 3(ii)(1) to the  Registrant’s Form 8-K filed on August 8, 2007 and incorporated  herein by reference.                                                                                  |
| 4.1†    |   | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                  |
| 4.1 (a)*     |   | James E. King Equity Incentive Plan, as filed as  Exhibit 4.1 to the Registrant’s Form S-8 filed March 22, 2007  and incorporated herein by reference.                                                                                                                       |
| 4.1 (b)      |   | Evolving Systems, Inc. 2007 Stock Incentive  Plan, as filed as Exhibit 4.1 to the Registrant’s Form S-8 filed  July 25, 2007 and incorporated herein by reference.                                                                                                      |
| 4.2†    |   | Specimen stock certificate representing shares of  Common Stock.                                                                                                                                                                                                                                 |
| 4.3          |   | Rights Agreement dated as of March 4, 2009, by  and between Evolving Systems, Inc. and American Stock  Transfer & Trust Company LLC, as filed as Exhibit 4 .1 to the  Registrant’s Form 8-K filed on March 9, 2009 and incorporated  herein by reference. |
| 4.4          |   | First Amendment to Rights Agreement dated as of  December 10, 2009, between Evolving Systems, Inc. and American  Stock Transfer & Trust Company LLC (filed herewith).                                                                                                         |
| 10.1† * |   | Indemnification Agreement, entered into by the  Registrant and each of its directors and executive officers, dated as of  January 1, 1998.                                                                                                                                                  |
| 10.1(a)      |   | Loan and Security Agreement between Evolving  Systems, Inc. and Bridge Bank, N.A., as filed as  Exhibit 10.1(a) to the Registrant’s Form 8-K filed  February 27, 2008 and incorporated herein by reference.                                                        |
| 10.1(b)      |   | Intellectual Property Security Agreement between  Evolving Systems, Inc. and Bridge Bank, N.A., as filed as  Exhibit 10.1(b) to the Registrant’s Form 8-K filed  February 27, 2008 and incorporated herein by reference.                                           |
| 10.1(c)      |   | Loan Agreement between Evolving Systems Ltd. And  Bridge Bank, N.A., as filed as Exhibit 10.1(c) to the Registrant’s  Form 8-K filed February 27, 2008 and incorporated herein by  reference.                                                                           |
| 10.1(d)      |   | Debenture between Evolving Systems Ltd. and Bridge  Bank, N.A., as filed as Exhibit 10.1(d) to the Registrant’s  Form 8-K filed February 27, 2008 and incorporated herein by  reference.                                                                                |
| 10.1(e)      |   | Unconditional Guaranty by Evolving Systems Holdings  Ltd. in favor of Bridge Bank, N.A., as filed as Exhibit 10.1(e) to  the Registrant’s Form 8-K filed February 27, 2008 and incorporated  herein by reference.                                                       |
| 10.1(f)      |   | Charge Over Shares between Evolving Systems Holdings  Ltd. and Bridge Bank, N.A., as filed as Exhibit 10.1(f) to the  Registrant’s Form 8-K filed February 27, 2008 and incorporated  herein by reference.                                                              |
| 10.1(g)      |   | Unconditional Guaranty by Evolving  Systems, Inc. in favor of Bridge Bank, N.A., as filed as  Exhibit 10.1(g) to the Registrant’s Form 8-K filed  February 27, 2008 and incorporated herein by reference.                                                          |
| 10.1(h)      |   | Subordination Agreement among Evolving  Systems, Inc. the Junior Creditors (as listed in the agreement) and  Bridge Bank, N.A., as filed as Exhibit 10.1(h) to the Registrant’s  Form 8-K filed February 27, 2008 and incorporated herein by  reference.           |
| 10.1(i)      |   | Master Amendment to Subordination Notes among  Evolving Systems, Inc. and the holders of Subordinated Notes party  thereto, as filed as Exhibit 10.1(i) to the Registrant’s  Form 8-K filed February 27, 2008 and incorporated herein by  reference.               |
| 10.1(j)      |   | Form of Subordinated Note filed as  Exhibit 10.1(k) to the Registrant’s Form 8-K filed  November 17, 2005 and incorporated herein by reference.                                                                                                                    |
| 10.2† * |   | Amended and Restated Stock Option Plan.                                                                                                                                                                                                                                                          |
| 10.2 (a)     |   | Standstill Agreement between Evolving  Systems, Inc. and Karen Singer, Trustee of the Singer Children’s  Management Trust, as filed as Exhibit 10.2 to the Registrant’s  Form 8-K filed February 27, 2008 and incorporated herein by  reference.                   |
| 10.3† * |   | Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                    |
| 10.4         |   | Consulting Agreement entered into with Stephen K.  Gartside, Jr., as filed as Exhibit 10.1 to the Registrant’s  Form 8-K filed January 3, 2008 and incorporated herein by  reference.                                                                                   |
| 10.5         |   | Form of Amendment to Indemnification Agreement,  as filed as Exhibit 10.2 to the Registrant’s Form 8-K filed  January 3, 2008 and incorporated herein by reference.                                                                                                     |
| 10.6         |   | Form of Change in Control Agreement, as filed  as Exhibit 10.3 to the Registrant’s Form 8-K filed January 3,  2008 and incorporated herein by reference.                                                                                                                |
| 10.7         |   | Form of Executive Officer 2008 Compensation  Agreement, as filed as Exhibit 10.4 to the Registrant’s Form 8-K  filed January 3, 2008 and incorporated herein by reference.                                                                                              |
| 10.8         |   | Consulting Agreement entered into with George A.  Hallenbeck, as filed as Exhibit 10.1 to the Registrant’s Form 8-K  filed October 15, 2009 and incorporated herein by reference.                                                                                            |
| 10.9         |   | Letter from Singer Children’s Management Trust, as  filed as Exhibit 10.1 to the Registrant’s Form 8-K filed  December                                                                                                                                                  |

 

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|        |   | 14, 2009 and incorporated herein by reference.                                                                                                                                                                                                                                                                                 |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10† |   | Software Development Agreement, by and between the  Registrant and American Telephone and Telegraph Company, dated as of  May 1, 1993. (The division of American Telephone & Telegraph  Company responsible for this Agreement has split off from AT&T and is now  known as Lucent Technologies, Inc.). |
| 10.20(a)*   |   | Amendment to Management Change in Control Agreement  — Thaddeus Dupper, as filed as Exhibit 10.20(a) to the Registrant’s  Form 10-Q filed May 11, 2007 and incorporated herein by reference.                                                                                                     |
| 10.20(b)*   |   | Amendment to Management Change in Control Agreement  — Brian R. Ervine as filed as Exhibit 10.20(b) to the Registrant’s  Form 10-Q filed May 11, 2007 and incorporated herein by reference.                                                                                                      |
| 10.20(c)*   |   | Amendment to Management Change in Control Agreement  — Anita T. Moseley as filed as Exhibit 10.20(c) to the Registrant’s  Form 10-Q filed May 11, 2007 and incorporated herein by reference.                                                                                                     |
| 10.20(d)*   |   | Amendment to Management Change in Control Agreement  — Stuart Cochran as filed as Exhibit 10.20(d) to the Registrant’s  Form 10-Q filed May 11, 2007 and incorporated herein by reference.                                                                                                       |
| 10.21       |   | Fifth Amendment to Office Building Lease Agreement  as filed as Exhibit 10.21 to the Registrant’s Form 10-Q filed  May 11, 2007 and incorporated herein by reference.                                                                                                                                      |
| 21(a)       |   | Subsidiaries of the Registrant (filed herewith).                                                                                                                                                                                                                                                                               |
| 23.1        |   | Consent of Grant Thornton LLP, Independent  Registered Public Accounting Firm related to Registration Statements on Forms  S-3 and S-8 (filed herewith).                                                                                                                                                                       |
| 24.1        |   | Power of Attorney (included on signature page)                                                                                                                                                                                                                                                                                 |
| 31.1        |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                     |
| 31.2        |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                     |
| 32.1        |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                                                                                            |
| 32.2        |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                                                                                            |

 

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†                                          Incorporated by reference to theRegistrant’s Registration Statement on Form S-1 No. 333-43973.

*                                         Identifies each management contract orcompensatory plan or arrangement.

 

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**SIGNATURES**

 

**Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.**

 

**EVOLVINGSYSTEMS, INC.**

 

| By:                               | /s/ THADDEUS DUPPER |   | Chief Executive Officer, President and Director |   | March 8, 2010 |
|-----------------------------------|---------------------|--------|-------------------------------------------------|--------|--------------------|
| Thaddeus Dupper    |                |   |                                            |   |

 

 

**POWEROF ATTORNEY**

 

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Thaddeus Dupper and Anita T. Moseley, or any of them, his or herattorney-in-fact, each with the power of substitution, for him or her in anyand all capacities, to sign any amendments to this Report, and to file thesame, with exhibits thereto and other documents in connections therewith, withthe Securities and Exchange Commission, hereby ratifying and confirming allthat each of said attorneys-in-fact, or his or her substitute or substitutes,may do or cause to be done by virtue hereof.

 

**Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons n behalf of the registrant and inthe capacities and on the dates indicated.**

 

| **Signature** | ** **                              | **Title** | ** **                                        | **Date** |
|---------------|-----------------------------------------|-----------|---------------------------------------------------|----------|
|          |                                    |      |                                              |     |
| By:           | /s/ THADDEUS  DUPPER                    |      | Chief Executive Officer, President and Director   |     | March 8, 2010 |
|          | Thaddeus Dupper     |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ BRIAN R. ERVINE                     |      | Executive Vice President, Chief Financial Officer |     | March 8, 2010 |
|          | Brian R. Ervine                         |      | (Principal Financial and Accounting Officer)      |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ STEPHEN K.  GARTSIDE, JR.           |      | Chairman of the Board of Directors                |     | March 8, 2010 |
|          | Stephen K.  Gartside, Jr.          |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ DAVID J. NICOL                      |      | Director                                          |     | March 8, 2010 |
|          | David J. Nicol                          |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ PHILIP M. NECHES                    |      | Director                                          |     | March 8, 2010 |
|          | Philip M. Neches                        |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ STEVE B. WARNECKE                   |      | Director                                          |     | March 8, 2010 |
|          | Steve B. Warnecke                       |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ BRUCE W.  ARMSTRONG                 |      | Director                                          |     | March 8, 2010 |
|          | Bruce W. Armstrong                      |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ RICHARD R. RAMLALL                  |      | Director                                          |     | March 8, 2010 |
|          | Richard R. Ramlall                      |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ DAVID S. OROS                       |      | Director                                          |     | March 8, 2010 |
|          | David S. Oros                           |      |                                              |     |   |
|          |                                    |      |                                              |     |
| By:           | /s/ JOHN B.  SPIRTOS                    |      | Director                                          |     | March 8, 2010 |
|          | John B. Spritos                         |      |                                              |     |   |

 

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