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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,  2008** |
| ** **                                            |
| **OR**                                                |
| ** **                                            | ** **                                                                                                    |
| **o**                                                 | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |

 

**For the transition period from              to**

** **

**Commission File Number: 0-24081**

** **

**EVOLVINGSYSTEMS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **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’stelephone number, including area code)

 

Securitiesregistered under Section 12(b) of the Act:

 

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

 

Securitiesregistered under Section 12(g) of the Act: **None**

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

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act.

Yes o 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 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

 

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

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).                             Yes o  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 $32.7 million as of June 30,2008.

 

The number of shares of Common Stock outstanding was 19,529,415 as of March 9,2009.

 

**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 2009 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission within 120 daysafter the close of the 2008 year.

 

 

 

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**EVOLVINGSYSTEMS, INC.**

**AnnualReport on Form 10-K**

**For theyear ended December 31, 2008**

**Table ofContents**

 
| ** **        | ** **                                                                                                          | ** ** | **Page** |
|-------------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
|              |                                                                                                                |       |     |
| **PART I**   |
| Item 1            | Business                                                                                                            |       | 1        |
| Item 1A           | Risk Factors                                                                                                        |       | 8        |
| Item 1B           | Unresolved Staff  Comments                                                                                          |       | 16       |
| Item 2            | Properties                                                                                                          |       | 16       |
| Item 3            | Legal Proceedings                                                                                                   |       | 17       |
| Item 4            | Submission of  Matters to a Vote of Security Holders                                                                |       | 17       |
|              |                                                                                                                |       |     |
| **PART II**  |
| Item 5            | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 17       |
| Item 6            | Selected Financial  Data                                                                                            |       | 18       |
| Item 7            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 20       |
| Item 7A           | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 31       |
| Item 8            | Financial  Statements and Supplementary Data                                                                        |       | 32       |
|              | Report of  Independent Registered Public Accounting Firm                                                            |       | 32       |
|              | Report of Independent Registered Public Accounting  Firm                                                            |       | 33       |
|              | Consolidated  Balance Sheets                                                                                        |       | 34       |
|              | Consolidated Statements of Operations                                                                               |       | 35       |
|              | Consolidated Statements of Changes in Stockholders’  Equity and Comprehensive Income (Loss)                    |       | 36       |
|              | Consolidated Statements of Cash Flows                                                                               |       | 37       |
|              | Notes to Consolidated Financial Statements                                                                          |       | 38       |
| Item 9            | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               |       | 56       |
| Item 9A           | Controls and  Procedures                                                                                            |       | 56       |
| Item 9B           | Other Information                                                                                                   |       | 56       |
|              |                                                                                                                |       |     |
| **PART III** |
| Item 10           | Directors,  Executive Officers and Corporate Governance                                                             |       | 56       |
| Item 11           | Executive  Compensation                                                                                             |       | 57       |
| Item 12           | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 57       |
| Item 13           | Certain  Relationships and Related Transactions, and Director Independence                                          |       | 57       |
| Item 14           | Principal  Accounting Fees and Services                                                                             |       | 57       |
|              |                                                                                                                |       |     |
| **PART IV**  |
| Item 15           | Exhibits,  Financial Statement Schedules                                                                            |       | 57       |
|              | Signatures                                                                                                          |       | 60       |

 

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**FORWARD-LOOKING STATEMENTS**

 

*Except for the historical information contained in thisdocument, this report contains forward-looking statements including estimates,projections, statements relating to our business plans, objectives and expectedoperating results and assumptions. These forward-looking statements generallyare identified by the words “believes,” “goals,” “projects,” “expects,” “anticipates,”“estimates,” “intends,” “strategy,” “plan” and similar expressions.Forward-looking statements are based on current expectations and assumptionsand are subject to risks and uncertainties which may cause our actual resultsto differ materially from those discussed here. Factors that could cause orcontribute to such differences include, but are not limited to those discussedin this section, in the sections entitled “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and “Risk Factors.” Weundertake no obligation to update or revise publicly any forward-lookingstatements, whether as 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 and wireline networks;

 

·                  SIM card activation solutionsused to dynamically allocate and assign resources to a wireless device when itis first used;

 

·                  numbering solutions productsused by carriers to manage their telephone number inventory and numberassignment processes and products that comply with government-mandatedrequirements regarding local number portability in North America; and

 

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

 

Historically, our products have been used to support wireless andwireline network telephony capabilities; however, as a result of our on-goinginvestment in and improvement of our products, we now offer products tocarriers to support both their convergent offerings over Internet Protocol (“IP”)and advanced broadband 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 the aforementioned core areas, althoughwe do not report SIM card activation solutions separately, it is an early stageproduct and still reported within activation and numbering solutions. Wefurther report geographic information based upon revenues and long-lived assetsin the United States, United Kingdom and all other foreign countries.   Further information regarding our operatingsegments and geographical information is contained in Note 11 to our ConsolidatedFinancial Statements included in Item 8 of this Annual Report on Form 10-K.

 

**COMPANY BACKGROUND**

 

Founded in 1985, we initially focused on providing custom softwaredevelopment and professional services to telecommunications companies in theUnited States. In 1996, concurrent with the passage of the TelecommunicationsAct of 1996 (“the Telecom Act”), we made a strategic decision to add softwareproducts to our established professional services offerings. The outcome ofthat decision was the creation of a comprehensive product portfolio, of whichwe are best known in North America, for our Local Number Portability and NumberManagement solutions.

 

In 2003 and 2004, we significantly expanded our portfolio of productsas a result of three acquisitions that were made over the periods of November 2003through November 2004.  The firstacquisition was CMS Communications, Inc. (“CMS”) in November 2003,where we acquired a network mediation and service assurance solution.  In October 2004, we acquired TelecomSoftware Enterprises, LLC (“TSE”) adding Local Number Portability (“LNP”) andWireless Number Portability (“WNP”) number ordering and provisioning

 

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monitoringand testing products.  Finally, in November 2004,we acquired Tertio Telecoms Ltd. (“Evolving Systems U.K.”), a supplier of OSSsoftware solutions for service activation and mediation to communication carriersthroughout Europe, the Middle East, Africa and Asia. With this acquisition weexpanded our markets beyond North America and added a service activationsolution, *TertioTM,*and a billing mediationsolution, *EvidentTM*, to our product portfolio. Theconsequence of these acquisitions is a significantly expanded product andservice capability to address a larger portion of our customers’ OSSapplication needs with a balanced mix of products and product enhancements, aswell as services.

 

Since the acquisition of Evolving Systems U.K., with our growingproduct portfolio and geographic reach, we enhanced our sales model to includeboth direct and indirect channels.  Weformed new relationships with network equipment providers and systemintegrators to extend our reach to new geographical regions as well as help usfurther penetrate our existing territories.  Recently, we have added more regional partners to help with both localselling and deployments in emerging markets.

 

**RECENT DEVELOPMENTS**

 

·                  As part of our announced strategy, we continue toinvest in expanding our sales and support capabilities to support our entryinto the emerging markets.  In 2008 wewere successful in expanding our customer base, notably in Africa and inCentral America.  We also showed continuedsuccess in the Balkans.

 

·                  We continued to make advances in the development,deployment and selling of our new product Dynamic SIM AllocationTM (DSA).  In addition in 2008, we announced a newpartnership with a SIM card manufacturer for the sales, support anddistribution of DSA.

 

·                  During 2008, we replaced our existing seniorterm note and senior revolving facility with a new 8.25%, $4.0 million seniorterm loan, a $2.5 million U.S. revolving credit facility (“U.S. RevolvingFacility”) and a $3.5 million U.K. revolving credit facility (“U.K. RevolvingFacility”).  Both the U.S and U.KRevolving Facilities bear interest at Prime plus 0.5%. The interest rates onthe senior term note and the U.S. and U.K. Revolving Facilities are lower thanthe previous loans. The proceeds from the $4.0 million senior term loan wereused to pay down the previous senior term note balance of approximately $3.8million.  The new $6.0 million revolvingcredit facility replaces the prior $4.5 million revolver. The new revolver hasno mandatory borrowings, which allows improved management of interest expense.Cash from our balance sheet was used to repay the outstanding revolver balanceof $2.0 million with an additional $1.0 million applied to early repayment onthe Company’s 14% subordinated notes.

 

**INDUSTRY DYNAMICS**

 

The deregulation of the telecommunications industry in many countrieshas stimulated competition which has led to an increase in the number oftelecommunications carriers that operate in a given market.  This increase in competition coupled with theemergence of new technologies in telecommunications networks and end-userdevices, consumer electronics, and personal computers, has created an industrythat is in the midst of significant change. Carriers not only compete withcompanies from other industries, such as media and entertainment, but also withcompanies providing applications and services over the Internet.  In such a competitive market, companies areincreasingly bundling voice, messaging, data access, and music and videoservices in order to try and 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 carrying out avariety of network transformation programs that include: the migration topacket-switching transmission networks based on the Internet protocol (oftencalled all-IP networks); the migration to new service creation and deliveryplatforms that enable the provision of multimedia services over IP-basednetworks; and the introduction of one or more broadband access networks overexisting wired infrastructure, new fiber deployments, cable access networks,and evolved wireless broadband networks including Global System for MobileCommunication (“GSM”)/EDGE, 3G/WCDMA/HSPA, and WiMAX. Along with the continueddevelopment of new technologies and competitors, carriers are faced with thevarying demand and hence growth or decline in connections, subscribers andservice usage, as well pricing declines due to regulatory and competitivepressures.  Many carriers are currentlyemphasizing cost reduction, increased sales efficiency, and a focus on growthfrom emerging markets, in addition to the development of new converged devicesand services.  This complex and rapidlychanging landscape is furthermore affected by the continued consolidation ofcarriers and their suppliers.

 

**OPERATIONS SUPPORT SYSTEMS (“OSS”)**

 

OSS encompasses a broad array of software and systems that performcritical functions for telecommunications carriers, such as servicefulfillment, service assurance, and billing. Service fulfillment encompasses ordering, provisioning andactivation.  Ordering systems collectcustomer information, retrieve current service information, capture andvalidate new service requests, verify the availability of selected services andtransmit completed orders to one or more provisioning OSS.  Inventory systems maintain both physical andlogical views of all the telecommunications assets required to turn up aservice.  Carriers use provisioning andactivation systems to turn up

 

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networkservice and turn services off and on for customers, as well as change or addservices.  Service assurance systemsallow carriers to perform the testing, monitoring and reporting necessary tomaintain appropriate network availability and feed operational data to otherbusiness systems. Service assurance systems also allow carriers to track andreport on service conditions or outages in order to dispatch the carrier’slarge work force for necessary repairs. Carriers use billing systems tocollate, manage and report usage information for partner and customer billing.OSS systems typically operate in a 24x7 environment to support the real-timecommunication networks that facilitate the carriers’ service offerings.

 

Traditionally, as carriers have added new services, such as wireless orInternet-based services, they have either developed their own in-house OSSapplications or added new OSS applications from product vendors. Theseadditional OSS systems can be difficult 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 to work.  Because of these challenges, carriers havedifficulty replacing existing OSS due to the large investment and vast amountsof historical data contained in these systems. As a result, carriers continueto make incremental modifications to these OSS, in some cases furtherincreasing their complexity and making it more difficult for the applicationsto be replaced.  However, a trend overthe past decade has been the replacement of a portion of the carrier’s legacyOSS environment with OSS software packages designed to meet growing complexprocesses in the areas of service fulfillment, service assurance and billing.

 

**PRODUCT PORTFOLIO**

 

# ***Dynamic SIM Allocation***

# *** ***

In 2007, weannounced our *Dynamic SIM Allocation* solutionthat offers carriers a new way to provision wireless services by dynamicallyactivating and assigning resources to the wireless device when it is firstused. The wireless Subscriber Identity Module (SIM) card is central to theprovision of wireless access and services for GSM/EDGE and 3G/WCDMA networks.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 *Dynamic SIM Allocation*solution offers carriers the user experience and resource efficiency benefitsof provisioning at the point-of-sale without demanding the retail andback-office infrastructure usually required. The solution offers a number ofbenefits including:

 

·                 Improve efficiency and utilization: Carriers canexperience a high wastage of SIM cards that are never activated for arevenue-generating subscriber. The 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.

 

# ***Service Activation***

# *** ***

Our service activation 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 integrated solution comprised of the following components:

 

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·                  Tertio Service Composer — a modeling toolthat simplifies the creation of new services;

 

·                  Tertio Content Connector — a tool used foractivation of next-generation services;

 

·                  Tertio Activation Designer — a tool that isdesigned to speed network feature activation;

 

·                  Tertio Service Activation — the platform thatprovides scalability and performance, flexibility and a graphical interface;

 

·                  Tertio Service Verification — a module thatallows carriers to verify that the services implemented in the network matchthose that were in the original service order. By providing this capability, carriers can continually check theaccuracy of their order/activation processes; and.

 

·                  Tertio Process Management — a module thatallows carriers to manage long running transactions.  Long running transactions can often occurwhen a carrier is implementing a converged activation solution that encompassesthe activation of both a wireless and fixed line (or IP) component.

 

Our Tertio solution addresses the entire service lifecycle, enablingservice providers to better plan, manage and execute the introduction of newservices. Tertio allows carriers to introduce new network technologies andeases the burden of integration with existing devices and systems.

 

***Numbering Solutions***

 

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

 

***LNP and WNP***

 

Our Number Portability software solution enables carriers to complywith U.S. and Canadian mandates for regulations implementing LNP and WNP.  Number porting allows customers the abilityto retain, or “port”, their phone numbers when changing from one serviceprovider to another. Our LNP software which includes the functionality tosupport ordering, provisioning, reporting, testing and exchanging informationbetween carriers is widely used by wireline, wireless and cable serviceproviders in North America. Over time, we have expanded our number portabilityproduct features and developed other number portability related OSS softwareproducts for the wireline, wireless and cable markets.  Our full LNP and WNP product line comprisesthe following collection 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 FCC mandated number conservation and number poolingregulations 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 by changing the wayphone numbers are allocated to carriers and specifying rules regarding theassignment and classification of those numbers. The regulations also require regular utilization reporting by carriersand articulation of circumstances under which previously underutilizedtelephone numbers must be returned to the “pool” to be reallocated to othercarriers. Our *NumeriTrack* solution, which hasbeen licensed to seven carriers, facilitates compliance with the FCC mandatesfor both wireline and wireless carriers (and cable carriers providing telephonyservices).  Our solution provides inventorymanagement of phone numbers and other assets such as SIM cards and supportsinventory assignments and integration with carriers’ existing back-officesystems. The *NumeriTrack* solution alsocontains features for the inventory of, and assignment logic for, numbersassociated with IP addresses and is used by a large carrier in the U.S. fordeployment of a Voice over Internet Protocol (“VoIP”) service offering. As isthe 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.  During 2006 and 2007, weenhanced our *NumeriTrack* Internationalapplication to address markets outside of North America.

 

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Our investments in our International *NumeriTrack*solution allow us to sell and deploy this solution in markets outside of theUnited States with a version of the product that we call International *NumeriTrack*.  Theresource management and assignment capabilities of International *NumeriTrack* enables carriers around the globe to acquire andtrack phone numbers and other logical and physical assets for their products onboth traditional and next generation wireline and wireless networks.  The system will efficiently manage thoseassets through the lifecycle of the service, allowing carriers to spend less inacquiring new resources such as IP addresses, phone numbers and SIM cards, forvarious products and regions.

 

***Mediation***

 

Our mediation portfolio consists of network data mediation products andbilling mediation.  Our billing mediationproduct, *Evident*, was acquired as part of theEvolving Systems U.K. acquisition.  Ournetwork mediation products are Traffic Data Management System (“TDMS”) and *Mediation CentralTM*.

 

# ***Billing Mediation***

# *** ***

Billing mediation is the process of collecting network usage data andverifying that usage data is accurate, and is a required pre-condition forgenerating accurate bills for a carrier’s customers. Billing mediation’simportance lies in its ability to provide a systematic point of reliability andassurance between network consumption and the billing system input. Our Evidentproduct supports convergent voice, data, and content services. Evident softwareenables the accurate management of data, allowing reconciliation of data inputsand outputs.  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 bring new services to market they often need a newmediation process to support those new services.  Our Evident solution has been designed withthe flexibility to support new service concepts and designs.

 

# ***Network Assurance and DataCollection Solutions***

# *** ***

A common challenge for telecommunications carriers is to create anintegration layer between network element (“NE”) devices and the OSSapplications that provision, monitor and control these devices. Deploying newdevices needed for extending service offerings into the network can thereforebe difficult, time consuming and expensive. Our mediation solutions provide acommon framework for simplifying the collection and distribution of criticalnetwork data.  Our network mediationproduct, Mediation Central, supports a broad array of technologies thatcarriers typically deploy in their network. Mediation Central provides support for wireline, broadband, transportand wireless networks. Our Mediation Central product supports both centralizedand distributed configurations allowing, for example, carriers to deploy asingle solution for all their data collection and distribution needs.  Our TDMS product is a legacy product thathelps traditional wireline carriers collect usage data from their circuitswitch networks.

 

**PROFESSIONAL AND INTEGRATION SERVICES**

 

Our Professional and Integration Services team provides expertconsulting services and advice for the design, customization, integration anddeployment for our Service Activation, Numbering Solutions, and Mediationproduct portfolios.  The Professional and Integration Services team worksclosely with the Product Engineering and Development teams to ensure we are upto date with the latest product developments. These services cover all aspects of the project lifecycle includingsystem architecture and design, component design, development andcustomization, system integration and testing, deployment and productionsupport, program and project level management, domain and productexpertise.  Our teams work closely with customers and integration partnersand have established close, long-term relationships with operators in theAmericas, Europe, the Middle East, Africa and Asia Pacific regions.

 

**RESEARCH AND DEVELOPMENT**

 

We expend amounts on research and development (“R&D”), particularlyfor new products and/or for enhancements of existing products. R&D isexpensed as incurred.  For the yearsended December 31, 2008, 2007 and 2006, we expensed $3.6 million, $2.4million and $3.1 million, respectively, in R&D costs.  The majority of all new R&D investmentsin 2008 have gone into enhancing our core service activation solutions andnumbering solutions products as well as the further development of our *Dynamic SIM Allocation* solution.

 

We focus our product development efforts on identifying specificindustry and customer business needs as well as market requirements and thendeveloping solutions that leverage our existing product capabilities.  Based upon the identified customer business

 

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needs,our research and development efforts comprise a combination of design anddevelopment of new products or features to enhance our existing products, anddesign 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.

 

**BUSINESS STRUCTURE AND STRATEGY FOR GROWTH**

 

We have developed a combination product/solutions business model thatleverages our products and strong telecommunications domain expertise with a worldwidework force.  This business model combinesour U.S. and United Kingdom presence with the cost effective offshoredevelopment capabilities provided by our Indian subsidiary.

 

Our strategy for growth revolves around Tertio, our wireless serviceactivation product, our international version of our *NumeriTrack*product, and our recently released *Dynamic SIM Allocation*product.  We continue to make investmentsin these products and will focus on both traditional and emerging markets as webuild plans to add significant new functionality to these products.  These investments target growth in the marketaround wireless and wireline convergence of services on IP networks.

 

**SALES AND MARKETING**

 

The primary objective of our marketing team is to identify markets forour products and to establish an awareness of our offerings in those marketsthrough a combination of direct marketing, web marketing, and through ourparticipation in shows, conferences, and industry bodies. The marketing teamalso creates electronic and print based sales collateral to support theseactivities, as well as maintaining a permanent presence on the web. Themarketing group is responsible for running the annual customer forum eventwhich is attended by customers from around the world. The forum is designed tofacilitate sharing of ideas among customers, to promote new product concepts toour customers, as well as to stimulate new ideas and concepts which may becomethe products of the future.

 

Our sales force is primarily a field-based organization and we arestructured to focus on specific geographical territories. There are specialistteams to focus on the following regions: North America, Europe, Middle East andAfrica, Russia and the CIS, Asia Pacific, and Central and Latin America. Our salesactivities cover both direct sales to the end user customer as well as salesthrough system integrator channel partners such as Accenture, 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.

 

Evolving Systems offers a complex product set and as a result a highdegree of on-site consultative selling with the prospect is required as part ofthe sales process. Our sales efforts also cover a large amount of interactionwith existing 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 competitivetenders.

 

**COMPETITION**

 

The market for telecommunications OSS products is intensely competitiveand is subject to rapid technological change, changing industry standards,regulatory developments and consolidation. We face increasing demand forimproved product performance, reduced prices and rapid integrationcapabilities, and pricing pressures. Our existing and potential competitorsinclude many large domestic and international companies that often havesubstantially greater financial, technological, marketing, distribution andother resources, larger installed customer bases and longer-standingrelationships with telecommunications customers than we do. The market fortelecommunications OSS software and services is extremely large. And, wecurrently hold only a small portion of total market share.  Our increased focus on numbering solutionsand activation solutions has resulted in our achieving a measurable andreasonable market share in those two areas.

 

Our principal competitors in service activation are Comptel Corporation(“Comptel”), Oracle Corporation, Synchronoss Technologies, Inc., andEricsson.  Our principal competitors inthe numbering solutions market include Telcordia Technologies, Inc.,Neustar, Inc. and Syniverse Technologies. In mediation, we compete withmany different companies including Intec Telecom Systems PLC (“Intec”), Amdocsand Comptel.

 

We believe that our ability to compete successfully depends on a widerange of factors.  We compete by offeringquality solutions at a competitive price that are tailored specifically to thecustomer. Furthermore, once our customer has implemented one of our coresoftware products, we are in a preferable position as the incumbentvendor.  Many of our customerrelationships span five years or more with some extending beyond ten years.  We believe these long-term relationships giveus a competitive advantage and represent a barrier to

 

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entryfor our competitors.

 

**SIGNIFICANT CUSTOMERS**

 

In 2008, approximately 34% of our consolidated revenues came from twounrelated customers in the telecommunications industry, each of which accountedfor more than 10% of our consolidated revenues. Of these customers, one is located in the U.S. and the other is locatedin the U.K.   The loss of either of thesecustomers would have a material adverse effect on our business as a whole.

 

**INTELLECTUAL PROPERTY**

 

We rely on a combination of copyright, trademark and trade secret laws,as well as confidentiality agreements and licensing arrangements, to establishand protect our proprietary rights. We presently have U.S. and Canadian patentson elements of our principal LNP OSS products, *NumberManager* and *OrderPath***and have aU.S. patent pending on elements of our**Dynamic SIMAllocation**product.

 

**BACKLOG**

 

We define backlog as firm non-cancelable sales orders that areanticipated to be delivered and recognized in revenue over the next twelvemonths. As of December 31, 2008 and 2007, our backlog was approximately$20.6 and $19.7 million, respectively. Our backlog at December 31, 2008 was comprised of license fees andservices of $8.7 million and customer support of $11.9 million compared tolicense fees and services of $6.5 million and customer support of $13.2 millionat December 31, 2007.

 

**EMPLOYEES**

 

As of December 31, 2008, we employed 238 people including 57 inthe United States, 71 in the United Kingdom and 110 in Bangalore, India.  Of our worldwide staff, 86% are involved inproduct delivery, development, support and professional services, 6% in salesand marketing, and 8% in general administration.

 

**ACCELERATEDFILER STATUS**

 

Companiesconsidered accelerated or large accelerated filers under Securities ExchangeAct Rule 12b-2, are required to comply with the internal control reportingand disclosure requirements of Section 404 of the Sarbanes-Oxley Act of2002. An accelerated or large accelerated filer is defined as a company thatmeets the following conditions:

 

·                  Has a common equity public float of $75million or more as of the last business day of its most recently completedsecond fiscal quarter;

 

·                  Has been subject to the reportingrequirements of Section 13(a) or 15(d) of the Exchange Act for aperiod of at least 12 calendar months;

 

·                  Previously filed at least one annual reportpursuant to 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.

 

Asof the last business day of our most recently completed second fiscal quarter, June 30,2008, 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, 2008 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, 2009.

 

**AVAILABLE INFORMATION**

 

You can find out more information about us at our Internet websitelocated at www.evolving.com*.* The information on our website is notincorporated into this Annual Report on Form 10-K. Our AnnualReports on Form 10-K, our Quarterly Reports on Form 10-Q, and ourCurrent Reports on Form 8-K and any amendments to those reports areavailable free of charge on our Internet website as soon as reasonablypracticable after we electronically file such material with the SEC.Additionally, these reports are available at the SEC’s Public Reference Room at100 F Street, N.E., Washington, D.C. 20549 or on the SEC’s website atwww.sec.gov.  Information on theoperation of the Public Reference Room can be obtained by calling the SECat 1-800-SEC-0330.

 

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**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.***

 

Ouroperating results have fluctuated significantly in the past and may continue tofluctuate significantly in the future. Fluctuations in operating results mayresult in volatility of the price of our common stock. These quarterly andannual fluctuations may result from a number of factors, including:

 

·                  the size of new contracts and when we areable to recognize 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 therenewal of support agreements;

·                  the mix of products and services sold;

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

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

·                  changes in our strategy;

·                  general economic conditions.

 

Personnelcosts are a significant component of our budgeted expense levels and,therefore, our expenses are, to a degree, variable based upon our expectationsregarding future revenue. As discussed above, our revenue is difficult toforecast and our sales cycle and the size and timing of significant contractsvary substantially among customers. Accordingly, we may be unable to adjustspending in a timely manner to compensate for any unexpected shortfall inrevenue. Any significant shortfall from anticipated levels of demand for ourproducts and services could adversely affect our business, financial condition,results of operations and cash flows.

 

Basedon these factors, we believe our future quarterly and annual operating resultsmay vary significantly 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.

 

***Our results of operations could be negativelyimpacted if we are unable to manage our liquidity.***

 

Our cash forecast indicates that we will have sufficient liquidity tocover anticipated operating costs as well as debt service payments for at leastthe next twelve months, but this could be negatively impacted to the extent weare unable to invoice and collect from our customers in a timely manner, or anunexpected adverse event, or combination of events occurs. Therefore, if thetiming of cash generated from operations is insufficient to satisfy ourliquidity requirements, we may require access to additional funds to supportour business objectives through another debt restructuring, a credit facilityor possibly the issuance of additional equity. Additional financing may not beavailable at all or, if available, may not be obtainable on terms that arefavorable to us and not dilutive.

 

***The indebtedness incurred in connection with the EvolvingSystems U.K. acquisition may limit our ability to grow and could adverselyaffect our financial condition.***

 

In February 2008, we restructured the remaining debt associatedwith our 2004 acquisition of Evolving Systems U.K.  We replaced our existing senior term note andsenior revolving facility with a new $4.0 million senior term loan, a $1.0million U.S. Revolving Facility and a $5.0 million U.K. RevolvingFacility.  We used proceeds from the $4.0million senior term loan to pay down our existing senior term note balance ofapproximately $3.8 million.  As part ofthis restructuring, we used $1.0 million in existing cash to pay downapproximately $0.2 million and $0.8 million in principal and interest,respectively, on our subordinated notes. In December 2008, we increased the U.S. Revolving Facility to $2.5million and we reduced the U.K. Revolving Facility to $3.5 million.  No borrowings have been made under either theU.S. or U.K. revolving credit facilities. See Note 4, Long-Term Debt, to our Consolidated Financial Statements includedelsewhere in this annual Report on Form 10-K for further details relatedto changes in our Long-Term Debt.

 

The indebtedness incurred with respect to the acquisition of EvolvingSystems U.K. is material in relation to prior levels of indebtedness.  Wemay not have sufficient funds available to meet our operating needs or to paythe interest due on our secured debt.

 

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This debt is secured by a general lien on all of our assets.  Ifwe are unable to pay the debt as it becomes due, the holders of the debt couldforeclose on all of our assets.  Theincreased level of our indebtedness, among other things, could:

 

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

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

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

 

If we incur new indebtedness in the future, the relatedrisks that we now face could intensify. Whether we are able to make requiredpayments on our outstanding indebtedness and to satisfy any other future debtobligations will depend on our future operating performance and our ability toobtain additional debt or equity financing.

 

***Certain provisions of the senior debt and subordinated notespayable issued in conjunction with the restructuring of our debt resulting fromour acquisition of Evolving Systems U.K. call for the acceleration of paymentsif certain covenants are breached or cash balance thresholds are achieved.***

 

Theoutstanding senior debt, as well as the subordinated notes, contain certain affirmativeand negative covenants that, if breached, could result in such notes becomingimmediately due and payable. The covenants include our agreement to do thefollowing:

 

·                  maintain a specified ratio of debt to EBITDA,minimum EBITDA for the trailing twelve months, minimum liquidity, and ratio offixed charges 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 our agreement 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.

 

Thecovenants may limit our flexibility in planning for, or reacting to changes in,our business. Failure to comply with the covenants, if not waived, could resultin the acceleration of the debt. If we are required to pay the debt on anaccelerated basis, it would have a significant adverse impact on our liquidityand financial condition and could cause us to incur additional indebtedness.

 

Additionally,the unsecured notes related to the Evolving Systems U.K. acquisition require usto offer the note holders a prepayment on such notes at the end of any fiscalquarter if we achieve certain minimum cash thresholds. Such a requirement willrestrict our liquidity and cash management flexibility. Until the notes arerepaid, our ability to engage in transactions or to enter into agreementsrequiring significant cash investments may be adversely affected.

 

***If we are unable to properly supervise oursoftware development subsidiary in India, or if political or otheruncertainties interfere,******we may beunable to satisfactorily perform our customer contracts and our business couldbe 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.

 

***We operate a global business thatexposes 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

 

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inherent in the conduct of internationalbusiness, including:

 

·                   fluctuations in currency exchange rates;

·                   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. Dollar hasrecently strengthened against foreign currencies and approximately half of ourrevenue is transacted in non-Dollar denominated currencies (e.g. British PoundSterling and Euro).  As a result, whenthe dollar strengthens, the Company’s revenue, when converted to U.S. dollars,is reduced.  At the same time, with morethan 50% of the Company’s operating expenses originating overseas, thestrengthening 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 involving floating currency exchange rates and income taxexpenses.  Any of the foregoing factorsmay have a material adverse impact on our international operations and,therefore, our business, 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 RegionalBell Operating Companies (“RBOCs”) to implement LNP 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.  With ouracquisition of Evolving Systems U.K., we are now also subject to numerousregulatory 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.

 

***Consolidation in the communications industry may impact our financialperformance.***

 

The communications industryhas experienced and continues to experience significant consolidation, both inthe United States and internationally.  Theseconsolidations have caused us to lose customers and may result in fewerpotential customers requiring OSS solutions in the future.  In addition, combining companies mayre-evaluate their OSS solutions and their capital expenditures and may choose acompetitive OSS solution used by one of the combining companies.  As our customers become larger, theygenerally have stronger purchasing power, which can result in reduced pricesfor our products, lower margins on our products and longer sales cycles.  Because of the uncertainty resulting fromthese consolidations and the variations in our quarterly operating results, itis extremely difficult for us to forecast our quarterly and annual revenue andwe 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 senior securednotes.  If we were unsuccessful inamending the agreements or obtaining a waiver from our senior lender in futurereporting periods, these violations could result in such notes becoming immediatelydue and payable.  We may not besuccessful in amending the agreements or obtaining a waiver of any covenantviolation.

 

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

 

In the past, and currently,we earn a significant portion of our revenue from a small number of customersin the communications industry. This has been mitigated somewhat by theexpansion 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 our solutionscan be a relatively complex and lengthy process since we typically customizethese solutions for each customer’s unique environment. Often our customers mayalso require rapid deployment of our software solutions, resulting in pressureon us to meet demanding delivery and implementation schedules. Delays inimplementation may result in customer dissatisfaction and/or damage ourreputation which could materially harm our business.

 

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The majority of our existingcontracts provide for acceptance testing by the customer, which can be alengthy process. Unanticipated difficulties or delays in the customer acceptanceprocess could result in higher costs, delayed payments, and deferral of revenuerecognition. In addition, if our software contains defects or we otherwise failto satisfy acceptance criteria within prescribed times, the customer may beentitled to cancel its contract and receive a refund of all or a portion ofamounts paid or other amounts as damages, which could exceed related contractrevenue and which could result in a future charge to earnings. Any failure ordelay in achieving final acceptance of our software and services could harm ourbusiness, financial condition, results of operations and cash flows.

 

***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 revenues 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 acceptance reviews may cause potential customers todelay or forego a purchase. The delay or failure to complete one or more largecontracts could materially harm our business, financial condition, results ofoperations and cash flows and cause our operating results to vary significantlyfrom quarter to quarter and year to year.

 

Mergers and acquisitions oflarge communications companies, as well as the formation of new alliances, haveresulted in a constantly changing marketplace for our products and services.Purchasing delays and pricing pressures associated with these changes arecommon. In addition, many of the companies in the communications industry havekept capital expenditures at historically low levels in response to changes inthe communications marketplace; some companies have declared bankruptcy,cancelled contracts, delayed payments to their suppliers or delayed additionalpurchases.  The delay or failure tocomplete one or more large contracts, or the loss of a significant customer,could materially harm our business, financial condition, results of operations,or cash flows, and cause our operating results to vary significantly fromquarter 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 large portionof our revenue is from contracts that are on a fixed-price basis. We anticipatethat customers will continue to request we provide software and integrationservices as a total solution on a fixed-price basis. These contracts specifycertain obligations and deliverables we must meet regardless of the actualcosts we incur. Projects done on a fixed-price basis are subject to budgetoverruns. On occasion, we have experienced budget overruns, resulting in lowerthan anticipated margins. We may incur similar budget overruns in the future,including overruns that result in losses on these contracts. If we incur budgetoverruns, our margins may be harmed, thereby affecting our overallprofitability.

 

***Percentage-of-completion accounting used for most of our projects canresult in overstated or understated profits or losses.***

 

The revenue for most of ourcontracts is accounted for on the percentage-of-completion method ofaccounting.  This method of accountingrequires us to calculate revenues and profits to be recognized in eachreporting period for each project based on our predictions of future outcomes,including our estimates of the total cost to complete the project, projectschedule and completion date, the percentage of the project that is completedand the amounts 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 our productsand services is subject to rapid technological changes, evolving industrystandards, changes in carrier requirements and preferences and frequent newproduct introductions and enhancements. The introduction of products thatincorporate new technologies and the emergence of new industry standards canmake existing products obsolete and unmarketable. In addition, “internationalizing”products that we have developed for our U.S. customer carriers is a complexprocess. 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 ourproducts to become obsolete or noncompetitive. If we fail to anticipate orrespond adequately 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.

 

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***The market for our number portabilityproducts is mature in the U.S. and we may not be able to successfully developnew products to remain competitive.***

 

The market for our numberportability products is mature in the U.S. and we may not be able tosuccessfully identify new product opportunities in the U.S. or abroad orachieve market acceptance of new products brought to the market.  Many of the wireless carriers in the U.S.selected solutions from our competitors and it is unclear how many newopportunities there will be with these carriers.  If we are unable to identify new productopportunities in the U.S. or areas outside of the U.S., sales and profit growthwould be adversely affected.

 

***The steps that we have taken to reducecosts may have a negative impact on our ability to grow and generate futurerevenue.***

 

We have taken steps toreduce our expenses, such as reductions in staff and general cost controlmeasures. If, as a result of such cost reductions, we have not adequatelyresponded to balance expenses against revenue, or if our fixed costs cannot bereduced enough, our financial condition could be materially harmed. Likewise,cutbacks in staff may have an adverse impact on our ability to generate futurerevenue, because we may not have sufficient staffing to meet any unexpectedincreases in customer demand for our products.

 

***The communications industry is highlycompetitive and if our products do not satisfy customer demand for performanceor price, our customers could 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.Our existing and potential competitors include many large domestic andinternational companies, including some competitors that have substantiallygreater financial, manufacturing, technological, marketing, distribution andother resources, larger installed customer bases and longer-standingrelationships with customers than we do. Our principal competitors in thenumbering solutions market include Telcordia Technologies, SyniverseTechnologies and NeuStar. Our principal competitors in activation are Oracle (asa result 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.

 

Webelieve that our ability to compete successfully depends on numerous factors,including the quality and price competitiveness of our products and servicescompared to those of our competitors, the emergence of new industry standardsand technical innovations and our ability to respond to those changes.  Some of these factors are within our control,and others are not. A variety of potential actions by our competitors, includinga reduction of product prices or increased promotion, announcement oraccelerated introduction of new or enhanced products, or cooperativerelationships among competitors and their strategic partners, could negativelyimpact the sales of our products and we may have to reduce the prices we chargefor our products.  Revenue and operatingmargins may consequently decline. We may not be able to compete successfullywith existing or new competitors or to properly identify and address thedemands of new markets. This is particularly true in new markets wherestandards are not yet established. Our failure to adapt to emerging marketdemands, respond to regulatory and technological changes or competesuccessfully with existing and new competitors would materially harm ourbusiness, financial condition, results of operations and cash flows.

 

***Our business depends largely on our abilityto attract and retain talented employees.***

 

Our ability to manage futureexpansion, if any, effectively will require us to attract, train, motivate andmanage new employees successfully, to integrate new management and employeesinto our overall operations and to continue to improve our operations,financial and management systems. We may not be able to retain personnel or tohire additional personnel on a timely basis, if at all. Because of thecomplexity of our software solutions, a significant time lag exists between thehiring date of technical and sales personnel and the time when they becomefully productive. We have at times experienced high employee turnover anddifficulty 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 haveerrors that are not detected until deployment, and litigation related towarranty and product liability claims could be expensive and could negativelyaffect our reputation and 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

 

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is possible that these limitations ofliability provisions may not be effective. We currently have errors andomissions insurance, which, subject to customary exclusions, covers claimsresulting from failure of our software products or services to perform thefunction or to serve the purpose intended. To the extent that any successfulproduct liability claim is not covered by this insurance, we may be required topay for a claim. This could be expensive, particularly since our softwareproducts may be used in critical business applications. Defending such a suit,regardless of its merits, could be expensive and require the time and attentionof key management personnel, either of which could materially harm ourbusiness, financial condition and results of operations. In addition, ourbusiness reputation could be harmed by product liability claims, regardless oftheir merit or the eventual outcome of these claims.

 

***Our measures to protect our proprietarytechnology and other intellectual property rights may not be adequate and if wefail to protect those rights, our business would be harmed.***

 

Our success and ability tocompete are dependent to a significant degree on our proprietary technology. Werely on a combination of patent, copyright, trademark and trade secret laws, aswell as confidentiality agreements and licensing arrangements, to establish andprotect our proprietary rights. We have a U.S. patent pending on elements ofour Dynamic SIM Allocation product and we have U.S. and Canadian patents onelements of our LNP products, ***NumberManager®***and ***OrderPath®***, and U.S. patents on elementsof some of our other products. In addition, we have registered or filed forregistration of certain of our trademarks. Despite these precautions, it may bepossible for a third party to copy or otherwise obtain and use our products ortechnology without authorization or to develop similar technology independentlythrough reverse engineering or other means. In addition, the laws of someforeign countries may not adequately protect our proprietary rights. Our meansof protecting our proprietary rights in the U.S. or abroad may not be adequateor others may independently develop technologies that are similar or superiorto our technology, duplicate our technology or design around any of ourpatents.

 

***In the event that we are infringing uponthe proprietary rights of others or violating licenses, we may become subjectto infringement claims that may prevent us from selling certain products and wemay incur significant expenses in resolving these claims.***

 

It is also possible that ourbusiness activities may infringe upon the proprietary rights of others, or thatother parties may assert infringement claims against us. If we become liable toany third party for infringing its intellectual property rights, we could berequired to pay substantial damage awards and to develop non-infringingtechnology, obtain licenses, or to cease selling the applications that containthe infringing intellectual property. Litigation is subject to inherentuncertainties, and any outcome unfavorable to us could materially harm ourbusiness. Furthermore, we could incur substantial costs in defending againstany intellectual property litigation, and these costs could increasesignificantly if any dispute were to go to trial. Our defense of anylitigation, regardless of the merits of the complaint, likely would betime-consuming, costly, and a distraction to our management personnel. Adversepublicity related to any intellectual property litigation also could harm thesale of our products and damage our competitive position.

 

Certain software developedor used by Evolving Systems, as well as certain software acquired in ouracquisitions of CMS, TSE or Evolving Systems U.K., may include or be derivedfrom software that is made available under an open source software license.

 

·                  Such open source software may be madeavailable under  licenses such as the GNUGeneral Public License (“GPL”) or GNU Lesser General Public License (“LGPL”)certain of which may impose obligations on us in the event we were todistribute derivative works based on the open source software.  Certain license impose obligations thatcould  require us to make source code forthese derivative works available to the public or license the derivative worksunder a particular type of open source software license, rather than thelicense terms we customarily use 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 a derivative work based on open sourcesoftware may be subject to these licenses. We believe we have complied with our obligations under the variousapplicable open source licenses. However, if the owner of any open source software were to successfullyestablish that we had not complied with the terms of an open source license fora particular derivative work based on that open source software, we may beforced to release the source code for that derivative work to the public orcease distribution of that work.

 

***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 and resultsof operations could be materially and adversely affected to the extent thatsuch disruptions result in delays or cancellations of customer orders, delaysin collecting cash, a general decrease in corporate spending on informationtechnology, or our inability to effectively market, manufacture or ship ourproducts. We are unable to predict whether war and the threat of terrorism orthe responses thereto will result in any long-term commercial disruptions or ifsuch activities or responses will have any long-term material adverse effect onour business, results of operations, financial condition or cash flows.

 

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***We face risks associated with doing business through local partners***

 

In some countries, becauseof local customs and regulations or for language reasons, we do business withour customers through local partners who resell our products and services, withor without value-added services.  Thiscan cause delays in closing contracts because of the increased complexity ofhaving another party involved in negotiations. In addition, where the local partner provides additional software,hardware and/or services to the end-user customer, our products and servicesmay 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.

 

***We face special risks associated with doing business in highly corruptenvironments.***

 

Our international businessoperations include projects in developing countries and countries torn byconflict.  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 discretionary favorabletreatment of any kind.  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) could result in sanctions that could have a material adverseeffect on our business.  While we haveprocedures and controls in place to monitor compliance, situations outside ofour control may arise that could potentially put us in violation of the FCPAinadvertently and thus negatively impact our business.

 

***The trading price of our stock has beensubject to wide fluctuations and may continue to experience volatility in thefuture; we could face possible de-listing from the NASDAQ capital market***

 

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.

 

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

 

Werecently had a period of time during which the trading price for our commonstock dropped below $1.00 and this may occur again in the future.  Due to extraordinary market conditions,NASDAQ suspended the bid price and market value of publicly held sharerequirements through April 19, 2009. NASDAQ may not extend the suspension. If enforcement of the rules resumes, our failure to meet theminimum bid price ($1.00) for 30 consecutive business days may result in theNASDAQ Stock Market initiating de-listing procedures for our stock. De-listingof our stock may have a dramatic effect on the liquidity of our stock and thevalue of our shares.

 

***Sales of large blocks of our stock mayresult in the reduction in the market price of our stock and make it moredifficult to raise funds 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 material weaknessesin our financial reporting or internal controls could adversely affect ourbusiness and the price of our common stock.***

 

Because our common stock ispublicly 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 recently issued new requirements and regulations and are currentlydeveloping additional regulations and requirements in response to recent lawsenacted by Congress, most notably the Sarbanes-Oxley Act of 2002.  Our compliance with certain of these rules,such as Section 404 of the Sarbanes-Oxley Act, is likely to require thecommitment of significant managerial resources. In addition, establishment ofeffective internal controls is further complicated because we are now a globalcompany with multiple locations and IT systems.

 

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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 ourstock.  Moreover, effective internalcontrols are necessary to produce reliable financial reports and to preventfraud.  If we have material weaknesses inour internal 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, oursenior debt and subordinated notes prohibit us from declaring dividends to ourcommon stockholders during the term of the notes. Accordingly, we do not anticipatepaying cash dividends on our common stock in the foreseeable future.

 

***Certain provisions of our charterdocuments, employment arrangements and Delaware law may discourage, delay orprevent an acquisition of us, even if an acquisition would be beneficial to ourstockholders, and may prevent attempts by our stockholders to replace or removeour 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:

 

·                  authorizing our board of directors to issueup to 2,000,000 shares of preferred stock and to determine the price, rights,preferences and privileges of those shares without any further vote or actionby our stockholders;

 

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

 

·                  we have a staggered board with each member ofthe Board of Directors serving for three years; in any given year, only aportion 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 are subjectto 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 paymentof a premium price to our stockholders. Notwithstanding the foregoing, thethree year moratorium imposed on business combinations by Section 203 willnot apply to the Singer Group because, prior to the date on which the SingerGroup became 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 agreementexpires on September 30, 2009.

 

Our executiveofficers have entered into management change in control agreements with us.Each agreement generally provides for acceleration on vesting of options, 50%upon a change in control (as defined in such agreements) if the executiveremains employed with the new entity, or 100% in the event such executive’semployment is terminated. The acceleration of vesting of options upon a changein control may be viewed as an anti-takeover measure and may have the effect ofdiscouraging a merger proposal, tender offer or other attempt to gain controlof us.

 

Our Amended and Restated StockOption Plan provides for acceleration of vesting under certain circumstances.Upon certain changes in control of us, vesting on some options awarded todirectors may be accelerated. In addition, the successor corporation may assumeoutstanding stock awards or substitute equivalent stock awards. If thesuccessor corporation refuses to do so, such stock awards

 

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will become fully vested and exercisable fora period of 15 days after notice from us but the option will terminate if notexercised during that period. As noted above, the acceleration on vesting ofoptions upon a change in control may be viewed as an anti-takeover measure.

 

***General economic factors, domestically and internationally, that impactthe communications industry, could negatively affect our revenues and operatingresults***

 

Unsettled financial markets,higher interest rates, inflation, levels of unemployment and other economicfactors 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 adversely affect revenueand gross margin;

 

·                  lengthening sales cycles and slowingdeployments;

 

·                  increased competition for fewer projects andsales opportunities;

 

·                  increased risk of charges relating to writeoff of goodwill and other intangible assets;

 

·                  customer and reseller financial difficultyand greater difficulty collecting accounts receivable.

 

We are unable to predict howlong the economic downturn will last and the magnitude of its effect on ourbusiness and results of operations.  Ifthese conditions continue, or further weaken, our business and results ofoperations could be materially adversely affected.

 

**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**

 

Welease office space at various locations which are shown below.

 

| **Location**                       | ** ** | **Square  Footage** | ** ** | **Lease  Expiration** | ** ** |
|------------------------------------|------------|---------------------|------------|-----------------------|------------|
| Englewood, Colorado (Headquarters) |       | 24,305              |       | 10/31/12              |       |
| Bath, England                      |       | 5,100               |       | 9/26/10               |       |
| London, England                    |       | 7,765               |       | 3/24/10               |       |
| Windsor, England                   |       | 118                 |       | 12/31/09              |       |
| Bangalore, India                   |       | 1,411               |       | 1/31/09               |       |
| Bangalore, India                   |       | 4,404               |       | 11/7/09               |       |
| Bangalore, India                   |       | 776                 |       | 11/7/09               |       |
| Bangalore, India                   |       | 776                 |       | 11/7/09               |       |
| Bangalore, India                   |       | 1,410               |       | 11/7/09               |       |
| Bangalore, India                   |       | 776                 |       | 1/31/09               |       |
| Bangalore, India                   |       | 3,116               |       | 11/15/09              |       |
| Munich, Germany                    |       | 732                 |       | Month-to-month        |       |
| Kuala Lumpur, Malaysia             |       | 1,042               |       | 7/14/09               |       |

 

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**ITEM 3.****                            ****LEGAL PROCEEDINGS**

 

During the fourth quarter of 2006, a previous software vendor filed acomplaint in the Superior Court of New Jersey against us asserting we breachedcertain provisions of a license agreement. While the outcome of this matter is uncertain, we believe we have paidall fees due under our license agreement and will continue to vigorously defendthis claim.

 

We are involved in various other legal matters arising in the normalcourse of business.  We do not believethat any such matters will have a material impact on our results of operationsand financial position.

 

**ITEM 4.****                            ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

None.

 

**PART II**

 

**ITEM 5.****                            ****MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES**

 

Our common stock began trading publicly through the Nasdaq NationalMarket under the symbol “EVOL” on May 12, 1998. Prior to that date, therewas no public market for our common stock. We transferred from the NasdaqNational Market to the Nasdaq SmallCap Market (now known as the Nasdaq CapitalMarket) on August 28, 2002. The closing price of our common stock asreported on the Nasdaq Capital Market as of March 9, 2009 was $0.92 pershare. The following table sets forth for the periods indicated the high andlow closing sale quotations and may not be based on actual transactions for ourcommon stock as reported on the Nasdaq Capital Market. The prices reported donot include retail mark-ups, markdowns or commissions.

 

| ** **     | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------|------------|---------------------------------------------------------------|------------|
| ** **     | ** ** | **2008**                                                      | ** ** | **2007** | ** ** |
| ** **     | ** ** | **High**                                                      | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                                                             | 2.62       |   | $ | 1.96 |   | $ | 2.10 |   | $ | 1.20 |   |
| Second Quarter |       | $                                                             | 2.38       |   | $ | 1.96 |   | $ | 2.44 |   | $ | 1.70 |   |
| Third Quarter  |       | $                                                             | 2.25       |   | $ | 1.50 |   | $ | 2.29 |   | $ | 1.66 |   |
| Fourth Quarter |       | $                                                             | 1.53       |   | $ | 0.78 |   | $ | 3.07 |   | $ | 1.70 |   |

 

As of March 9, 2009, there were approximately 136 holders ofrecord of our common stock.

 

We have not declared or paid a cash dividend on our common stock. Inaddition, the notes issued in connection with the Evolving Systems U.K.acquisition prohibit us from declaring dividends to our common stockholdersduring the term of the notes. We currently intend to retain future earnings, ifany, to finance the growth and development of our business and, therefore, donot anticipate paying cash dividends in the foreseeable future.

 

The following graph compares the cumulative 5-year total returnprovided to shareholders on Evolving Systems, Inc.’s common stock relativeto the cumulative total returns of the NASDAQ Composite index, the DJ WilshireMicroCap Software index, and the RDG Software Composite index. An investment of$100 (with reinvestment of all dividends) is assumed to have been made in ourcommon stock and in each index on 12/31/2003 and its relative performance istracked through 12/31/2008.

 

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**COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN***

Among Evolving Systems, Inc., The NASDAQ Composite Index,

The RDG Software Composite Index And The DJ Wilshire MicroCap SoftwareIndex

 

 

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*$100 invested on 12/31/03 in stock &index-including reinvestment of dividends.

Fiscal year ending December 31.

 

**ITEM 6.****                            ****SELECTED FINANCIAL DATA**

 

The selected financial data set forth below for each of the years inthe five-year period ended December 31, 2008, has been derived from ourconsolidated financial statements. The following selected financial data shouldbe read in conjunction with “Item 7 - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”, the consolidated financialstatements and the notes thereto and other financial information includedelsewhere in this Annual Report on Form 10-K.  Results for 2004 include amounts related tothe acquisition of Evolving Systems U.K. from the purchase date of November 2,2004 to December 31, 2004 and amounts related to the acquisition of TSEfrom the purchase date of October 15, 2004 to December 31, 2004.

 

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| ** **                                                                                                | ** ** | **For the Years Ended December 31,**         | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                | ** ** | **(in thousands, except per share amounts)** | ** ** |
|                                                                                                      |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Revenue                                                                                                   |       | $                                                                     | 37,821     |   | $ | 35,953 |   | $ | 33,833 |   | $ | 39,452 |   | $ | 26,342 |   |
| Costs of Revenue and Operating Expenses:                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Cost of revenue, excluding depreciation and  Amortization                                                 |       | 13,919                                                                |       | 14,260 |   | 13,036 |   | 16,070 |   | 12,936 |   |
| Sales and marketing                                                                                       |       | 8,500                                                                 |       | 8,557 |   | 8,962 |   | 9,643 |   | 4,412 |   |
| General and administrative                                                                                |       | 5,676                                                                 |       | 5,862 |   | 5,138 |   | 6,818 |   | 5,085 |   |
| Product development (1)                                                                                   |       | 3,607                                                                 |       | 2,376 |   | 3,072 |   | 1,921 |   | 1,066 |   |
| Depreciation                                                                                              |       | 847                                                                   |       | 899 |   | 1,169 |   | 1,443 |   | 1,152 |   |
| Amortization                                                                                              |       | 1,363                                                                 |       | 1,565 |   | 2,511 |   | 5,215 |   | 1,667 |   |
| Impairment of goodwill and intangible  assets (2)                                                    |       | —                                                                |       | — |   | 16,516 |   | — |   | — |   |
| Restructuring and other expense                                                                           |       | —                                                                |       | (4 | ) | (21 | ) | (49 | ) | (15 | ) |
| Income (loss) from operations                                                                             |       | 3,909                                                                 |       | 2,438 |   | (16,550 | ) | (1,609 | ) | 39 |   |
| Interest and other, net                                                                                   |       | (420                                                                  | )          | (1,284 | ) | (1,837 | ) | (1,692 | ) | 87 |   |
| Income tax expense (benefit)                                                                              |       | 560                                                                   |       | 556 |   | (1,604 | ) | (396 | ) | (298 | ) |
| Net income (loss)                                                                                         |       | 2,929                                                                 |       | 598 |   | (16,783 | ) | (2,905 | ) | 424 |   |
| Deemed dividend for beneficial conversion  feature of Series B convertible redeemable preferred stock (3) |       | —                                                                |       | — |   | — |   | — |   | 3,306 |   |
| Net income (loss) available to common and  preferred stockholders                                         |       | $                                                                     | 2,929      |   | $ | 598 |   | $ | (16,783 | ) | $ | (2,905 | ) | $ | (2,882 | ) |
|                                                                                                      |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic income (loss) per share                                                                             |       | $                                                                     | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) | $ | (0.16 | ) | $ | (0.18 | ) |
| Diluted income (loss) per share                                                                           |       | $                                                                     | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) | $ | (0.16 | ) | $ | (0.18 | ) |
| Weighted average basic shares outstanding                                                                 |       | 19,389                                                                |       | 19,198 |   | 19,100 |   | 18,695 |   | 16,307 |   |
| Weighted average diluted shares outstanding                                                               |       | 19,756                                                                |       | 19,576 |   | 19,100 |   | 18,695 |   | 16,307 |   |
|                                                                                                      |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Working capital (deficiency) (4)                                                                          |       | $                                                                     | 1,802      |   | $ | 1,395 |   | $ | 803 |   | $ | 447 |   | $ | (3,343 | ) |
| Total assets (5)                                                                                          |       | 45,411                                                                |       | 53,727 |   | 51,338 |   | 67,398 |   | 86,601 |   |
| Long-term debt, net of current portion                                                                    |       | 4,883                                                                 |       | 8,686 |   | 11,370 |   | 14,373 |   | 11,959 |   |
| Series B convertible redeemable  preferred stock (7) (8)                                   |       | —                                                                |       | 5,587 |   | 11,281 |   | 11,281 |   | 11,281 |   |
| Stockholders’ equity (6)                                                                             |       | $                                                                     | 19,942     |   | $ | 17,928 |   | $ | 10,158 |   | $ | 22,124 |   | $ | 29,314 |   |

 

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(1)        In 2004, we expensed $90,000 of in-process research and developmentassociated with the acquisitions of Evolving Systems U.K. and CMS.

 

(2)        In 2006, we recognized an impairment of $16.5 million on goodwill andamortizable intangible assets related to our license fees and servicesoperating segment.

 

(3)        In November 2004, we issued 966,666 shares of Series BPreferred Stock as part of our acquisition of Evolving Systems U.K.  Based upon the various features of the Series BPreferred Stock, the fair valueof this security was estimated to approximate the stated redemption price.Since the conversion price of the Series B Preferred Stock was fixed inthe purchase agreement to equal $3.50 per common share, a beneficial conversionfeature existed on the acquisition date equal to the difference between thevalue of our common stock on the acquisition date, or $4.64, and the conversionprice stated in the purchase agreement. The beneficial conversion feature was recognized as a reduction in netincome available to common stockholders of $3.3 million on the acquisition datesince the Series B Preferred Stock was immediately convertible to commonstock.

 

(4)        The decrease in working capital during 2004 was a result of ouracquisition of two companies, TSE and Evolving Systems U.K., during the fourthquarter of 2004.  In those transactionswe paid cash of $1.5 million and $11.0 million for TSE and Evolving SystemsU.K., respectively. The TSE transaction also included a short-term note payableof approximately $889,000. The acquisition of Evolving Systems U.K. alsoincluded the issuance of seller-financed notes of approximately $15.9 million,including a short-term note of $4.0 million and a long-term note ofapproximately $11.9 million. The purchase price related to these two acquisitions,including estimated transaction costs of $2.0 million, reduced our workingcapital by approximately $19.4 million.

 

(5)        The decrease in total assets from 2004 to 2005 and 2005 to 2006 isprimarily due to impairment of intangible assets, amortization of intangibleassets, 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 ofthe acquisitions of TSE and Evolving Systems U.K.

 

(6)        The decrease in stockholders’ equity from 2005 to 2006 is primarily aresult of the impairment of goodwill and intangible assets recorded during2006.

 

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(7)        The decrease in Series B convertible redeemable preferred stockand the increase in stockholders’ equity from 2006 to 2007 is primarily theresult of holders of 487,916 shares of Series B Preferred Stock, with anaggregate carrying value of $5.7 million, converting their shares of preferredstock into 1,463,748 shares of our common stock in accordance with theconversion provisions of the Series B Preferred Stock, during 2007.

 

(8)        On February 25, 2008, holders of 461,758 shares of Series BPreferred Stock with a carrying value of $5.4 million, or approximately 96% ofthe outstanding preferred stock, converted their shares of preferred stock into1,385,274 shares of our common stock in accordance with the conversionprovisions of the Series B Preferred Stock.  On March 19, 2008, a holder of 16,992shares of Series B Preferred Stock with a carrying value of $0.2 million,which represented the remainder of the outstanding preferred stock, convertedhis shares of preferred stock into 50,976 shares of our common stock inaccordance with the conversion provisions of the Series B PreferredStock.  As we previously included the Series BConvertible Preferred Stock as a participating security for basic EPS purposes,these conversions did not change our basic or diluted EPS calculations.

 

**ITEM 7.****                            ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

*This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements that have been made pursuant to the provisions of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements arebased on current expectations, estimates, and projections about EvolvingSystems’ industry, management’s beliefs, and certain assumptions made bymanagement. Forward-looking statements include our expectations regardingproduct, services, and customer support revenue; our expectations associatedwith Evolving India and Evolving Systems U.K., and short- and long-term cashneeds. In some cases, words such as “anticipates”, “expects”, “intends”, “plans”,“believes”, “estimates”, variations of these words, and similar expressions areintended to identify forward-looking statements. The following discussionshould be read in conjunction with, and is qualified in its entirety by, theconsolidated financial statements and the notes thereto included elsewhere inthis Annual Report on Form 10-K. Our actual results could differmaterially from those anticipated in these forward-looking statements as aresult of certain factors, including those set forth in this section and in “Item1A - Risk Factors.”*

 

**OVERVIEW**

 

EvolvingSystems, Inc. is a leading provider of software solutions and services tothe wireless, wireline and cable markets. We maintain long-standingrelationships with many of the largest wireline, wireless and cable companiesworldwide. Our customers rely on us to develop, deploy, enhance, maintain andintegrate complex, reliable software solutions for a range of OperationsSupport Systems (“OSS”).  Our activationsolution is the leading packaged solution for activation in the wirelessindustry.

 

Werecognize revenue in accordance with the prescribed accounting standards forsoftware revenue recognition under generally accepted accountingprinciples.  As a result, our licensefees and services revenues fluctuate from period to period as a result of thetiming of revenue recognition on existing projects.

 

**2008 HIGHLIGHTS**

 

Consolidatedrevenues increased, for the second consecutive year, to $37.8 million from$36.0 million for the years ended December 31, 2008 and 2007,respectively, representing a 5% increase.  This growth is primarily theresult of increased revenue from our Dynamic SIM Allocation solution andexpansion into new emerging international markets for both activation andnumbering solutions.  Our investment in the emerging growth marketscontinues to increase our customer base. Five of our seven new customeraccounts in 2008 were from emerging markets as well as seven of ten newcustomer accounts during 2007.

 

As a result of the improvement in revenue, wereported net income of $2.9 million for the year ended December 31, 2008.This is the second consecutive year in which we have reported net income.  Our backlog increased to $20.6 million as of December 31,2008, from $19.7 million as of December 31, 2007.  This ending backlog of $20.6 million,represents our highest ending backlog for any year following our 2003 and 2004acquisitions of Tertio, TSE and CMS.

 

During 2008, we replaced our existing seniorterm note and senior revolving facility with a new 8.25%, $4.0 million seniorterm loan, a $2.5 million U.S. Revolving Facility and a $3.5 million U.K.Revolving Facility.  Both the U.S and U.KRevolving Facilities bear interest at Prime plus 0.5%. The interest rates onthe senior term note and the U.S. and U.K. Revolving Facilities are lower thanthe previous loans.

 

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We used proceeds from the $4.0 million seniorterm loan to pay down our existing senior term note balance of approximately$3.8 million.  The new $6.0 millionrevolving credit facility replaces the prior $4.5 million revolver. The newrevolver has no mandatory borrowings, which allows us to better manage interestexpense. Cash from our balance sheet was used to repay the outstanding revolverbalance of $2.0 million with an additional $1.0 million applied to earlyrepayment on the Company’s 14% subordinated notes.

 

We also had several significant improvementsto our balance sheet during 2008. Benefiting from our increased cash flow from operations during 2008,working capital grew to $1.8 million at December 31, 2008 from $1.4million at December 31, 2007 despite $3.0 million in existing cash used toretire our $2.0 million revolving debt facility and to retire $1.0 millionrelated to our subordinated notes, including accrued non-current interest.These debt payments were unscheduled and reduced balances classified aslong-term as of December 31, 2007.

 

During 2008, holders of 478,750 shares of Series BPreferred Stock, which represented the total outstanding shares, with anaggregate carrying value of $5.6 million, converted their shares of preferredstock into 1,436,250 shares of our common stock in accordance with theconversion provisions of the Series B Preferred Stock.  This conversion plus the net income earnedduring 2008 contributed to the increased total stockholders’ equity ofapproximately $2.0 million or 11% from the beginning of the year totalstockholders’ equity balance

 

During the fourth quarter of 2008, the U.S.Dollar strengthened against many other currencies, including the British PoundSterling and the Euro. As a result, the Company’s revenue, when converted toU.S. Dollars, is reduced.  At the sametime, with more than 50% of the Company’s operating expenses originatingoverseas, the strengthening dollar conversely lowers expenses outside of theU.S. The net effect on our results for the year ended December 31, 2008were $0.3 million decrease in revenue and a $1.1 million decrease in netexpenses versus the year ended December 31, 2007.

 

**RESULTS OF OPERATIONS**

 

Thefollowing table presents our consolidated statements of operations incomparative format.

 
| ** **                                                                   | ** ** | **For the Years Ended  December 31,** | ** ** | **For the Years Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                                  | ** ** | **2007**                                                  | ** ** | **Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** |
| **Revenue:**                                                                 |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| License fees and services                                                    |       | $                                                         | 20,324     |                                                      | $          | 17,895 |   | $ | 2,429 |   | $ | 17,895 |   | $ | 15,883 |   | $ | 2,012 |   |
| Customer support                                                             |       | 17,497                                                    |       | 18,058                                                    |       | (561 | ) | 18,058 |   | 17,950 |   | 108 |   |
| Total revenue                                                                |       | 37,821                                                    |       | 35,953                                                    |       | 1,868 |   | 35,953 |   | 33,833 |   | 2,120 |   |
|                                                                         |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| **Costs of revenue and operating expenses:**                                 |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Costs of license fees and services, excluding  depreciation and amortization |       | 7,816                                                     |       | 8,023                                                     |       | (207 | ) | 8,023 |   | 7,342 |   | 681 |   |
| Costs of customer support, excluding depreciation  and amortization          |       | 6,103                                                     |       | 6,237                                                     |       | (134 | ) | 6,237 |   | 5,694 |   | 543 |   |
| Sales and marketing                                                          |       | 8,500                                                     |       | 8,557                                                     |       | (57 | ) | 8,557 |   | 8,962 |   | (405 | ) |
| General and administrative                                                   |       | 5,676                                                     |       | 5,862                                                     |       | (186 | ) | 5,862 |   | 5,138 |   | 724 |   |
| Product development                                                          |       | 3,607                                                     |       | 2,376                                                     |       | 1,231 |   | 2,376 |   | 3,072 |   | (696 | ) |
| Depreciation                                                                 |       | 847                                                       |       | 899                                                       |       | (52 | ) | 899 |   | 1,169 |   | (270 | ) |
| Amortization                                                                 |       | 1,363                                                     |       | 1,565                                                     |       | (202 | ) | 1,565 |   | 2,511 |   | (946 | ) |
| Impairment of goodwill and intangible  assets                                |       | —                                                    |       | —                                                    |       | — |   | — |   | 16,516 |   | (16,516 | ) |
| Restructuring and other expenses (recovery)                                  |       | —                                                    |       | (4                                                        | )          | 4 |   | (4 | ) | (21 | ) | 17 |   |
| Total costs of revenue and operating  expenses                               |       | 33,912                                                    |       | 33,515                                                    |       | 397 |   | 33,515 |   | 50,383 |   | (16,868 | ) |
| Income (loss) from operations                                                |       | 3,909                                                     |       | 2,438                                                     |       | 1,471 |   | 2,438 |   | (16,550 | ) | 18,988 |   |
|                                                                         |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Interest income                                                              |       | 161                                                       |       | 304                                                       |       | (143 | ) | 304 |   | 160 |   | 144 |   |
| Interest expense                                                             |       | (1,171                                                    | )          | (1,747                                                    | )          | 576 |   | (1,747 | ) | (1,992 | ) | 245 |   |
| Other income                                                                 |       | 57                                                        |       | —                                                    |       | 57 |   | — |   | — |   | — |   |
| Gain (loss) on extinguishment of debt                                        |       | (290                                                      | )          | 42                                                        |       | (332 | ) | 42 |   | — |   | 42 |   |
| Foreign currency exchange gain                                               |       | 823                                                       |       | 117                                                       |       | 706 |   | 117 |   | (5 | ) | 122 |   |
| Other expense, net                                                           |       | (420                                                      | )          | (1,284                                                    | )          | 864 |   | (1,284 | ) | (1,837 | ) | 553 |   |
|                                                                         |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes                                            |       | 3,489                                                     |       | 1,154                                                     |       | 2,335 |   | 1,154 |   | (18,387 | ) | 19,541 |   |
| Income tax expense (benefit)                                                 |       | 560                                                       |       | 556                                                       |       | 4 |   | 556 |   | (1,604 | ) | 2,160 |   |
| Net income (loss)                                                            |       | $                                                         | 2,929      |                                                      | $          | 598 |   | $ | 2,331 |   | $ | 598 |   | $ | (16,783 | ) | $ | 17,381 |   |

 

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***Revenue***

 

Revenue is comprised of license fees and services and customersupport.  License fees and servicesrevenue represent the fees we receive from the licensing of our softwareproducts and those services directly related to the delivery of the licensedproduct as well as integration services and time and materials work.  Customer support revenue 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,** | ** ** |
|---------------------|------------|---------------------------------------------------------------|------------|
| ** **          | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenue**         |       |                                                          |       |   |   |   |   |   |   |   |
| Activation          |       | $                                                             | 20,639     |   | $ | 19,533 |   | $ | 16,717 |   |
| Numbering solutions |       | 13,270                                                        |       | 11,919 |   | 12,006 |   |
| Mediation           |       | 3,912                                                         |       | 4,501 |   | 5,110 |   |
| Total revenues      |       | $                                                             | 37,821     |   | $ | 35,953 |   | $ | 33,833 |   |

 

***License Fees and Services***

 

License fees and services revenue increased14%, or $2.4 million, to $20.3 million for the year ended December 31,2008 compared to $17.9 million 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 from ourDynamic SIM Allocation and our expansion into new international markets forboth activation and numbering solutions (NumeriTrack), partially offset by slightly lower revenue from ourexisting mediation account base and the effects of the weakened British PoundSterling during the fourth quarter of 2008.

 

License fees and services revenue increased13%, or $2.0 million, to $17.9 million for the year ended December 31,2007 compared to $15.9 million for the year ended December 31, 2006.  The increase was a result of an increase of$2.3 million in revenue from our activation products and an increase of $0.5million in revenue from our numbering solutions products, partially offset by a$0.8 million decrease in revenue from our mediation products.  This growth is due to our expansion into newinternational markets for both activation and numbering solutions (NumeriTrack®) and follow on sales from our existing activationaccount base, partially offset by lower revenue from our existing mediationaccount base.

 

***Customer Support***

 

Customer support revenues decreased 3%, or$0.6 million, to $17.5 million for the year ended December 31, 2008 from$18.1 million for the year ended December 31, 2007.  The decrease in customer support revenue wasa result of the expiration of a mediation customer support contract.

 

Customer support revenues increased 1%, or$0.1 million, to $18.1 million for the year ended December 31, 2007 from$18.0 million for the year ended December 31, 2006.  The increase in customer support revenue wasa result of an increase of $0.5 million in revenue from our activation productsand an increase of $0.2 million in revenue from our mediation products,partially offset by $0.6 million in revenues from our numbering solutionsproducts.  The increase in activationcustomer support revenue was a result of our increased installed base.  The decrease in numbering solutions customersupport revenue was due to one of our products reaching its end of life.

 

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

 

Costs of revenue consist primarily of personnel costs, facilitiescosts, the costs of third-party software and all other direct costs associatedwith these personnel.  Costs of revenue,excluding depreciation and amortization were $13.9 million, $14.3 million and$13.0 

 

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millionfor the years ended December 31, 2008, 2007 and 2006, respectively.

 

***Costs of License Fees and Services,excluding depreciation and amortization***

 

Costs of revenue for license fees andservices decreased 3%, or $0.2 million, to $7.8 million for the year ended December 31,2008 from $8.0 million 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 revenue for license fees andservices increased 9%, or $0.7 million, to $8.0 million for the year ended December 31,2007 from $7.3 million for the year ended December 31, 2006.  The increase in costs is attributed toincreased labor necessary to support the increase in license fees and servicesrevenue.  As a percentage of license feesand services revenue, costs of license fees and services, excludingdepreciation and amortization, decreased to 45% for the year ended December 31,2007 from 46% for the year ended December 31, 2006.  This decrease was primarily due to reducedpartner commissions for the year ended December 31, 2007.

 

***Costs of Customer Support, excludingdepreciation and amortization***

 

Costs of revenue for customer supportdecreased 2%, or $0.1 million, to $6.1 million for the year ended December 31,2008 from $6.2 million for the year ended December 31, 2007.  The decrease was primarily due to the effectsof the weakened British Pound Sterling during the fourth quarter of 2008. As apercentage of customer support revenue, costs of customer support revenue,excluding depreciation and amortization, remained at 35% for the year ended December 31,2008.

 

Costs of revenue for customer supportincreased 10%, or $0.5 million, to $6.2 million for the year ended December 31,2007 from $5.7 million for the year ended December 31, 2006.  As a percentage of customer support revenue,costs of customer support revenue, excluding depreciation and amortization,increased to 35% for the year ended December 31, 2007 from 32% for the yearended December 31, 2006.  Theseincreases are due to higher support costs for our LNP products as a result ofthe increased porting volumes and supporting additional platforms.

 

***Sales and Marketing***

 

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

 

Sales and marketing expenses primarily consist of compensation costsincluding incentive compensation and commissions, other employee related costs,travel expenses, advertising and occupancy expenses.  Sales and marketing expenses decreased 5%, or$0.4 million, to $8.6 million for the year ended December 31, 2007 from$9.0 million for the year ended December 31, 2006.  As a percentage of total revenue, sales andmarketing expenses for the year ended December 31, 2007 decreased to 24%from 26% for the year ended December 31, 2006. These decreases are theresult of decreased headcount.

 

***General and Administrative***

 

General and administrative expenses consist principally of employeerelated costs, professional fees and occupancy costs for the followingdepartments: facilities, finance, legal, human resources and executivemanagement.  General and administrativeexpenses decreased 3%, or $0.2 million, to $5.7 million for the year ended December 31,2008 from $5.9 million for the year ended December 31, 2007.  As a percentage of total revenue, general andadministrative expenses for the year ended December 31, 2008 decreased to15% from 16% for the year ended December 31, 2007. These decreases are theresult of lower professional fees, as well as lower landlord costs related toour headquarters facility lease, partially offset by higher bonus expense relatedto improved results from operations and increased bad debt expense.

 

General and administrative expenses increased 14%, or $0.8 million, to$5.9 million for the year ended December 31, 2007 from

 

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$5.1million for the year ended December 31, 2006.  As a percentage of total revenue, general andadministrative expenses for the year ended December 31, 2007 and 2006,increased to 16% from 15%, respectively. These increases are the result of higher professional and legal fees, aswell as higher incentive compensation earned due to the improved results fromoperations.

 

***Product Development***

 

Product development expenses consist primarily of employee-relatedcosts for product development.  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 are the result of increasedinvestments made in our Dynamic SIM Allocation product, Tertio product portfolioand our LNP core products.

 

Product development expenses decreased 23%, or $0.7 million, to $2.4million for the year ended December 31, 2007 from $3.1 million for theyear ended December 31, 2006.  As apercentage of total revenue, product development expenses decreased to 7% in2007 from 9% in 2006.  These decreaseswere due to the completion of certain LNP product release enhancements as wellas the completion of the “internationalization” of our NumeriTrackproduct, which were under production during2006.

 

***Depreciation***

 

Depreciation expense consists of depreciation of long-lived propertyand equipment.  Depreciation expensesdecreased 6%, to $0.8 million for the year ended December 31, 2008 from$0.9 million for the year ended December 31, 2007.  This decrease is a result of certain assets becomingfully depreciated.

 

Depreciation expenses decreased 23%, or $0.3 million, to $0.9 millionfor the year ended December 31, 2007 from $1.2 million for the year ended December 31,2006.  This decrease is a result ofcertain assets becoming fully depreciated.

 

***Amortization***

 

Amortizationexpense consists of amortization of identifiable intangibles related to ouracquisitions of CMS, TSE and Evolving Systems U.K.  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.  This decrease was attributable to certainintangible assets becoming fully amortized.

 

Amortizationexpenses decreased 38%, or $0.9 million, to $1.6 million for the year ended December 31,2007 from $2.5 million for the year ended December 31, 2006.  This decrease was attributable to certainintangible assets becoming fully amortized as well as the impairment of certainintangible assets during 2006.

 

***Impairment of Goodwill and Intangible Assets***

 

During 2008 and 2007, we conducted our annualgoodwill impairment tests and it was determined that goodwill was not impaired.The annual goodwill impairment test is conducted as of July 31, annually.We have the following reporting units:

 

·                  License andservices – U.S.

·                  License andservices – U.K.

·                  Customer support –U.S.

·                  Customer support –U.K.

 

These reporting units were determined by how wecurrently operate our business. We calculate the fair value of the reportingunits based on the combination of the discounted cash flows of each unit andthe market value of the equity, which is based on revenue and EBITDA multiplesof the Company, based on industry comparables. During the fourth quarter of2008, we did not perform another impairment analysis but management evaluatedand concluded there was not a triggering event subsequent to our annualimpairment test, as defined by Statement of Financial Accounting Standards No. 142 (“SFAS 142”), which would more likely than not reduce thefair value of a reporting unit below its carrying amount.

 

During2006, we recorded a goodwill impairment of $10.9 million related to impairmentof our License Fees and Services operating segment.  Continuedpricing pressures and consolidation in the telecommunications industrynegatively impacted our achievement of forecasted revenues associated with theacquisitions of CMS in November 2003, TSE in October 2004 andEvolving Systems U.K. in November 2004. The market price of our common stock declined.  Based upon these events, we determined that atriggering event had occurred and we conducted a goodwill impairment analysisas of June 30, 2006.  This goodwillimpairment analysis resulted in the $10.9 million goodwill impairmentcharge.  We estimated the fair value ofeach reporting unit using the expected present

 

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value of future cash flows and other market factors.

 

Asa result of the circumstances that led to a triggering event related to thegoodwill impairment, we first reviewed intangible assets in accordance withStatement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accountingfor the Impairment or Disposal of Long-Lived Assets.”  Our evaluation of product strategy anddevelopment plans resulted in the determination that the undiscounted cashflows associated with these assets would not be sufficient to recover thecarrying amounts of these assets.  This reviewindicated that $5.6 million of intangible assets related to our License Feesand Services and Customer Support operating segments were impaired.  The impaired intangible assets were purchasedsoftware, purchased licenses and customer relationships which were acquiredthrough our acquisitions of Evolving Systems U.K., CMS and TSE.  As a result of the impairment of intangibleassets, our future amortization expense will be lower than originally projectedby the amount of the $5.6 million impairment charge.

 

***Interest Income***

 

Interestincome includes interest income earned on cash and cash equivalents.  Interest income for the year ended December 31,2008 decreased $143,000 as compared to the year ended December 31, 2007 asa result of lower cash and cash equivalents balances resulting from additionalprincipal payments we paid on long-term debt during 2008 as well as lower ratesof return.

 

Interestincome for the year ended December 31, 2007 increased $144,000 as comparedto the year ended December 31, 2006 as a result of higher cash and cashequivalents balances.

 

***Interest Expense***

 

Interestexpense includes interest expense on our long-term debt and capital leaseobligations as well as amortization of debt issuance costs.  Interest expense for the year ended December 31,2008 decreased 33% or $0.6 million to $1.2 million as compared to $1.7 millionfor the year ended December 31, 2007. This decrease was a result of the repayment of our outstanding revolverbalance of $2.0 million with an additional $1.0 million applied to earlyrepayment on the our 14% subordinated notes, as well as lower interest rates onour new senior term note.

 

Interestexpense for the year ended December 31, 2007 decreased $0.3 million to$1.7 million as compared to $2.0 million for the year ended December 31,2006.  This decrease was a result oflower outstanding debt balances as well as lower variable interest rates on oursenior debt obligations.

 

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

 

InFebruary 2008, we wrote-off the remaining debt issuance costs of $297,000related to our senior term note payable that was replaced during the threemonths ended March 31, 2008.  Thisloss related to the debt issuance cost write-off was partially offset by a$7,000 gain resulting from us paying $272,000 to retire $279,000 ofsubordinated debt and related accrued interest held by two of our subordinatednote holders.  The retirements includedprincipal of $217,000 and accrued interest of $62,000.

 

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

 

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

 

Gain (loss) on foreign exchange transactions consists primarily ofrealized foreign currency transaction gains and losses.  Foreign currency transaction gains and lossesresult from transactions denominated in a currency other than the functionalcurrency of the respective subsidiary. Foreign currency transaction gain increased $0.7 million to a foreigncurrency gain of $0.8 million for the year ended December 31, 2008compared to a $0.1 million foreign currency gain for the year ended December 31,2007.  These gains were primarilygenerated in the fourth quarter by Evolving Systems U.K. transactionsdenominated in currencies other than its functional currency.

 

Foreign currency transaction gain (loss) increased $122,000 to aforeign currency gain of $117,000 for the year ended December 31, 2007compared to a $5,000 foreign currency loss for the year ended December 31,2006.  These gains were primarilygenerated by Evolving Systems U.K. transactions denominated in currencies otherthan its functional currency.

 

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***Income Tax Expense (Benefit)***

 

We recorded net income tax expense (benefit) of $0.6 million, $0.6million and $(1.6) million during the years ended December 31, 2008, 2007and 2006, respectively.  In the U.S. wehave net operating loss carryforwards of $49.5 million which are used to offsetmost U.S. tax liabilities. Our tax expense or benefit primarily relates to ourforeign subsidiaries in the U.K. and Germany.

 

The net income tax expense for the year ended December 31, 2008 of$0.6 million consisted of current tax expense of $0.9 million, partially offsetby a deferred tax benefit of $0.3 million.

 

The net income tax expense for the year ended December 31, 2007 of$0.6 million consisted of current tax expense of $0.9 million, partially offsetby a deferred tax benefit of $0.3 million.

 

The net income tax benefit for the year ended December 31, 2006 of$1.6 million related primarily to our U.K.-based operations and consisted ofcurrent income tax expense of $0.3 million and a deferred tax benefit of $1.9million.  During 2006, we recorded a $224,000 current tax benefit for research anddevelopment expenses related to a change in estimate based on our as-filed 2005tax return for Evolving Systems U.K.  Thedeferred tax benefit of $1.9 million relates primarily to amortization expenseon intangible assets.

 

In conjunction with the acquisition of Evolving Systems U.K., werecorded certain identifiable intangible assets.  Since the amortization of these identifiableintangibles is not deductible for income tax purposes, we established along-term deferred tax liability of $4.6 million at the acquisition date forthe expected difference between what would be expensed for financial reportingpurposes and what would be deductible for income tax purposes.  As of December 31, 2008 and 2007, thisdeferred tax liability was $0.7 million and $1.2 million, respectively.  The deferred tax liability relates toEvolving Systems U.K. and has no impact on our ability to recover the U.S.based deferred tax assets.  This deferredtax liability will be recognized as the identifiable intangibles are amortized.

 

We recorded a full valuation allowance against our U.S. net deferredtax assets as of December 31, 2008 and 2007 as we determined that it wasmore likely than not that we will not realize our U.S. deferred taxassets.  Such assets primarily consist ofcertain net operating loss carryforwards. We made our assessment of therealizability of our domestic deferred tax assets using all available evidence.In particular, we considered both historical results and projections ofprofitability for only the reasonably foreseeable future periods and any taxplanning strategies.

 

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

 

On January 1, 2007, we recorded a FIN 48 transition adjustmentconsisting of a $0.4 million decrease in our deferred tax assets related toResearch and Development Tax Credits that was offset by a correspondingdecrease in our valuation allowance.  Asof December 31, 2007, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes to our unrecognized tax positions over the next twelvemonths.

 

**FINANCIAL CONDITION**

 

Ourworking capital position of $1.8 million at December 31, 2008 reflects anincrease of $0.4 million from our working capital position of $1.4 million at December 31,2007.  Our working capital positionincreased at December 31, 2008 despite $3.0 million in existing cash usedto retire our $2.0 million revolving debt facility and to retire $1.0 millionrelated to our subordinated notes, including accrued non-current interest.These debt payments were unscheduled and reduced balances classified aslong-term as of December 31, 2007. We were in compliance with all of our debt covenants as of December 31,2008 and 2007.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We have historically financed operations through cash flows fromoperations as well as debt and equity transactions.  At December 31, 2008, our principalsource of liquidity was $5.8 million in cash and cash equivalents and $6.0million of unused availability under our revolving lines of credit.  The revolving credit facility is availablethrough February 2011.

 

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Net cash provided by operating activities for the years ended December 31,2008, 2007 and 2006 was $5.5 million, $4.8 million and $3.4 million,respectively.  The primary contributionto the improvement in cash provided by operating activities for the year ended December 31,2008 is due primarily to net income of $2.9 million compared to net income of$0.6 million for the year ended December 31, 2007.  Additionally, the net change in operatingassets and liabilities decreased $1.5 million in 2008 versus 2007.

 

The primary contribution to the improvement in cash provided byoperating activities for the year ended December 31, 2007 is the result ofnet income of $0.6 million plus non-cash operating adjustments of $3.0 millioncompared to a net loss of $16.8 million plus non-cash operating adjustments of$19.4 million for the year ended December 31, 2006.  Additionally, changes in operating assets andliabilities reflected an increase of $0.5 million in cash from operatingactivities in 2007 from 2006.

 

Net cash used by investing activities was $0.9 million, $0.4 millionand $0.6 million for the years ended December 31, 2008, 2007 and 2006,respectively.  During 2008, we purchased$0.9 million in property and equipment to support operations. During 2007, wepurchased $0.5 million in property and equipment to support operations,partially offset by reductions in restricted cash of $0.2 million.  During 2006, we purchased $0.5 million inproperty and equipment to support operations and paid additional cashconsideration to the TSE sellers of approximately $0.2 million. Historically,capital expenditures have been financed by cash from operating activities.

 

Net cash used in financing activities was $4.6 million, $2.1 millionand $1.9 million for the years ended December 31, 2008, 2007 and 2006,respectively.  The net cash used infinancing activities during 2008 was primarily the result of $8.3 million ofprincipal payments on long-term debt, offset by borrowings on our new seniorterm loan of approximately $3.7 million, net of issuance costs. The net cashused in financing activities during 2007 is the result of $2.1 million inprincipal payments on our senior debt facility.  The net cash used during 2006 of $1.9 millionincluded $2.0 million in principal payments on our senior debt facility.

 

We believe that our current cash and cash equivalents, together withanticipated cash flow from operations will be sufficient to meet our workingcapital and capital expenditure requirements for at least the next twelvemonths. In making this assessment, we considered the following:

 

·                 Ourcash and cash equivalents balance at December 31, 2008 of$5.8 million;

 

·                 Theavailability under our revolving credit facility of $6.0 million at December 31,2008;

 

·                 Ourdemonstrated ability to generate positive operating cash flows;

 

·                 Ourbacklog of approximately $20.6 million, including $8.7 million in license feesand services and $11.9 million in customer support at December 31, 2008;and

 

·                 Ourplanned capital expenditures of approximately $0.5 million during 2009.

 

We are exposed to foreigncurrency rate risks which impact the carrying amount of our foreignsubsidiaries and our consolidated equity, as well as our consolidated cashposition due to translation adjustments. For the year ended December 31, 2008, the effect of exchange ratechanges resulted in a $1.5 million reduction to consolidated cash.  For the year ended December 31, 2007,the effect of exchange rate changes resulted in a $0.1 million reduction toconsolidated cash.    We do not currentlyhedge our foreign currency exposure, but are monitoring the rate changes andmay hedge our exposures in the future.

 

**Off-Balance Sheet Arrangements**

 

We have no off-balance sheetarrangements that have a material current effect, or that are reasonably likelyto have a material future effect, on our financial condition, changes infinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures, or capital resources.

 

**Contractual Obligations and Commercial Commitments**

 

The following summarizes our significant contractual obligations as of December 31,2008, which are comprised of a capital lease, operating leases and principaland interest payments on our long-term debt, assuming no prepayments are made(in thousands).

 
| ** **            | ** ** | **Payments due by period** | ** ** |
|-----------------------|------------|-------------------------------------------|------------|
| **Fiscal Years** | ** ** | **Total**                                 | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013 and  thereafter** | ** ** |
|                  |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Long-term debt        |       | $                                         | 6,883      |   | $ | 2,000 |   | $ | 333 |   | $ | 4,550 |   | $ | — |   | $ | — |   |
| Interest on debt (1)  |       | 3,551                                     |       | 109 |   | 2 |   | 3,440 |   | — |   | — |   |
| Capital lease         |       | 98                                        |       | 30 |   | 30 |   | 30 |   | 8 |   | — |   |
| Operating leases      |       | 2,678                                     |       | 1,088 |   | 654 |   | 506 |   | 430 |   | — |   |
| Total commitments     |       | $                                         | 13,210     |   | $ | 3,227 |   | $ | 1,019 |   | $ | 8,526 |   | $ | 438 |   | $ | — |   |

 

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(1)  Interest on debt represents cashinterest payment obligations assuming all indebtedness at December 31,2008 will be paid in accordance with its contractual terms and maturity andassumes interest rates on variable interest debt as of December 31, 2008will remain unchanged in future periods.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our significant accounting policies are disclosed in Note 1 of ourConsolidated Financial Statements 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 derive revenue from two primary sources: license fees and servicesand customer support.  We recognizerevenue in accordance with Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition,” as amended and interpreted by SOP 98-9, “Modification ofSOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.”In addition we have applied Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition,” which provides further interpretive guidance for public companieson the recognition, presentation and disclosure of revenue in financialstatements.

 

Themajority of our license fees and services revenue is generated from fixed-pricecontracts which provide for licenses to our software products andservices.   Generally, when the servicesare determined to be essential to the functionality of the delivered software,we recognize revenue using the percentage-of-completion method of accounting,in accordance with SOP 97-2 and SOP 81-1, “Accounting for Long-TermConstruction Type Contracts.”  Weestimate the percentage of completion for each contract based on the ratio ofdirect labor hours incurred to total estimated direct labor hours.  Since estimated direct labor hours andproject costs, and changes thereto, can have a significant impact on revenuerecognition, these estimates are critical and are reviewed by managementregularly.  We record amounts billed inadvance of services being performed as unearned revenue. Unbilledwork-in-progress represents revenue earned but not yet billable under the termsof the fixed-price contracts. All such amounts are expected to be billed andcollected within 12 months.

 

Wemay encounter budget and schedule overruns on fixed price contracts causedby increased labor, overhead or material costs. We make adjustments to costestimates in the periods in which the facts requiring such revisions becomeknown. We record estimated losses, if any, in the period in which currentestimates of total contract revenue and contract costs indicate a loss.

 

In arrangements where the services are not essential to thefunctionality of the delivered software, we recognize license revenue when alicense agreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is reasonably assured. Where applicable, weunbundle and record as revenue fees from multiple element arrangements as theelements are delivered to the extent that vendor specific objective evidence (“VSOE”)of fair 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 generally recognize services revenue provided under fixed-pricecontracts using the percentage of completion method described above. Wegenerally recognize revenue from professional services provided pursuant totime-and-materials contracts and training services as the services areperformed, as that is when our obligation to our customers under sucharrangements is fulfilled.

 

We generally recognize customer support and maintenance revenue ratablyover the service contract period. When maintenance or training services arebundled with the original license fee arrangement, their fair value, based uponVSOE, is deferred and recognized during the periods such services are provided.

 

***Allowance for Doubtful Accounts***

 

We make judgments related to our ability to collect outstandingaccounts receivable. We provide allowances for receivables when theircollection becomes doubtful by recording an expense. Generally, we determinethe allowance based on our assessment of the realization of receivables usinghistorical information and current economic trends, including assessing theprobability of collection from

 

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customers.If the financial condition of our customers were to deteriorate, resulting inan impairment 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***

 

We account for income taxes in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.”Significant judgment is required in determining our provision for income taxes.We assess the likelihood that our deferred tax asset will be recovered fromfuture taxable income, and to the extent we believe that recovery is notlikely, we establish a valuation allowance. We consider future taxable incomeprojections, historical results and ongoing tax planning strategies inassessing the recoverability of deferred tax assets. However, adjustments couldbe required in the future if we determine that the amount to be realized isless or greater than the amount that we recorded. Such adjustments, if any,could have a material impact on our results of our operations.

 

EffectiveJanuary 1, 2007, we adopted the provisions of FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes - an interpretation of FASBStatement No. 109” (“FIN 48”).  FIN48 prescribes 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 taxing authorities.  There was no material impact on the company’sconsolidated financial position and results of operations as a result of theadoption of the provisions of FIN 48.

 

OnJanuary 1, 2007, we recorded a FIN 48 transition adjustment consisting ofa $0.4 million decrease in our deferred tax assets related to Research andDevelopment Tax Credits that was offset by a corresponding decrease in ourvaluation allowance.  As of December 31,2008, 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.

 

***Goodwill***

 

Goodwill is the excess of acquisition cost of an acquired entity overthe fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested forimpairment annually or whenever indicators of impairment exist. Theseindicators may include a significant change in the business climate, legalfactors, operating performance indicators, competition, sale or disposition ofa significant portion of the business or other factors. For purposes of thegoodwill evaluation, we compare the fair value of each of our reporting unitsto its respective carrying amount. If the carrying value of a reporting unitwere to exceed its fair value, we would then compare the fair value of thereporting unit’s goodwill to its carrying amount, and any excess of thecarrying amount over the fair value would be charged to operations as animpairment loss.  During the year ended December 31,2006, we recorded an impairment of goodwill. See Note 2 to the Consolidated Financial Statements for further details.

 

***Intangible Assets***

 

We allocate the cost of an acquired company to the tangible andidentifiable intangible assets and liabilities acquired, with the remainingamount being recorded as goodwill.  Weamortize certain intangible assets over their estimated lives, while in-processresearch and development is recorded as a one-time charge to productdevelopment expense in the statements of operations on the acquisition date.

 

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

 

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

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

·                  Significant negative industry or economictrends;

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

·                  Our market capitalization relative to netbook value.

 

If we determine that the carrying value of intangibles and/orlong-lived assets may not be recoverable based on the existence of one or moreof the above indicators of impairment, we measure any impairment based on theestimated discounted cash flows expected to result from the use of the assetand its eventual disposition and compare that to the asset’s carrying amount.Any impairment loss recognized would represent the excess of the asset’scarrying value over its estimated fair value. Significant estimates andjudgments are required when estimating such fair values. If we determine thatthe intangibles are impaired, we will record an impairment charge and theamount could be material.  We recorded animpairment of intangible assets during the year ended December 31,2006.  See Note 2 to the ConsolidatedFinancial Statements for further details.

 

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***Capitalization of Internal Software DevelopmentCosts***

 

Weexpend amounts on research and development, particularly for new productsand/or for enhancements of existing products. For internal development ofsoftware products that are to be licensed by us, we follow Statement ofFinancial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costsof Computer Software to Be Sold, Leased, or Otherwise Marketed” (“SFAS 86”).SFAS 86 requires that the cost of developing software be expensed prior toestablishing technological feasibility and those costs be capitalized oncetechnological feasibility has been established. Capitalization ceases upongeneral release of the software. The determination of whether internal softwaredevelopment costs are subject to capitalization is, by its nature, highlysubjective and involves significant judgments. This decision couldsignificantly affect earnings during the development period.  Further,once capitalized, the software costs are generally amortized on a straight-linebasis over the estimated economic life of the product. The determination of theexpected useful life of a product is highly judgmental. Finally, capitalizedsoftware costs must be assessed for impairment if facts and circumstanceswarrant such a review.

 

Wedid not capitalize any internal software development costs during theyears ended December 31, 2008, 2007, or 2006. In addition, we did not haveany capitalized internal software development costs included in our December 31,2008 and 2007 Consolidated Balance Sheets. We believe that during these periodsno material internal software development costs were required to becapitalized. Our conclusion is primarily based on the fact that thefeature-rich, pre-integrated, and highly-scalable nature ofour products requires that our development efforts include complex design,coding and testing methodologies, which include next generation software languagesand development tools. Development projects of this nature carry a high degreeof development risk. Substantially all of our internal software developmentefforts are of this nature, and therefore, we believe the period betweenachieving technological feasibility and the general release of the software tooperations is so short that any costs incurred during this period are notmaterial.

 

***Stock-based Compensation***

 

We adopted SFAS No. 123(Revised), “Share-Based Payment” (“SFAS123R”) effective January 1, 2006. This statement replaced SFAS No. 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”) and superseded APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Underthe modified prospective method of adoption, we are required to apply afair-value-based measurement method in accounting for share-based paymenttransactions with employees and record compensation cost for all stock awardsgranted after January 1, 2006 and awards modified, repurchased, orcancelled after that date. In addition, we are required to record compensationcosts associated with the vesting of unvested options outstanding at January 1,2006 using the guidance under SFAS 123. From January 1, 2006, we accounted for stock option grants andemployee stock purchase plan purchases under SFAS 123R.  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**

 

InDecember 2007, the SEC issued Staff Accounting Bulletin 110, *Share-Based Payment* (“SAB 110”), which amends StaffAccounting Bulleting 107 (“SAB 107”), *Share-Based Payment*,to permit public companies, under certain circumstances, to use the simplifiedmethod of SAB 107 for employee option grants after December 31, 2007.  Use of the simplified method after December 31,2007 is permitted only for companies whose historical data about theiremployees’ exercise behavior does not provide a reasonable basis for estimatingthe expected term of the options.  Wecurrently use the simplified method to estimate expected term for employeeoption grants as adequate historical experience is not available to provide areasonable estimate.  SAB 110 iseffective for employee options granted after December 31, 2007.  We adopted SAB 110 effective January 1,2008 and continue applying the simplified method until adequate historicalexperience is readily available to provide a reasonable estimate of theexpected term for employee option grants.

 

InFebruary 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities - Including an Amendment of FASB Statement No. 115* (“SFAS 159”).  SFAS 159 permits entities to choose to measureeligible items at fair value at specific election dates (the ‘‘fair valueoption’’). Unrealized gains and losses on items for which the fair value optionhas been elected shall be reported in earnings at each subsequent reportingperiod. This accounting standard was effective for us beginning January 1,2008.  We have elected not to apply thefair value option allowed under SFAS 159.

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair ValueMeasurements* (“SFAS 157”). SFAS 157 defines fair value, establishesa framework for measuring fair value under generally accepted accountingprinciples, and expands disclosures about fair value measurements. SFAS 157 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2007. In February 2008, the FASB issued Staff Position No. 157-2,which delays the effective date of SFAS 157 for

 

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non-financialassets and liabilities until financial statements issued for fiscal years andinterim periods beginning after November 15, 2008.  The adoption of SFAS 157 did not have amaterial effect on our consolidated financial statements.

 

**ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

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

 

Our cash balances are subject to interest rate fluctuations and as aresult, interest income amounts may fluctuate from current levels.  We are exposed to interest rate risk relatedto our new senior revolving credit 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 no borrowings 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 revenues 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:**   | ** ** | **2008**              | ** ** | **2007** | ** ** |
| British Pound Sterling |       | 0.69096               |       | 0.50092 |   |
| Indian rupee           |       | 49.21259              |       | 39.43218 |   |

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| **Average rates:** | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| British Pound Sterling  |       | 0.544853                                                      |       | 0.49992 |   | 0.543739 |   |
| Indian rupee            |       | 43.30325                                                      |       | 41.28177 |   | 45.15648 |   |

 

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.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

Board of Directors andStockholders

Evolving Systems, Inc.

 

We have audited the accompanying consolidated balance sheets ofEvolving Systems, Inc. (a Delaware corporation) and subsidiaries (collectively,the “Company”) as of December 31, 2008 and 2007, and the related statements ofoperations, changes in stockholders’ equity and comprehensive income (loss),and cash flows for each of the two years in the period ended December 31, 2008.These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion onthese financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform an audit of its internal controlover financial reporting. Our audits included consideration of internal controlover financial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of the Companyas of December 31, 2008 and 2007, and the results of its operations and itscash flows for each of the two years in the period ended December 31, 2008 inconformity with accounting principles generally accepted in the United Statesof America.

 

GRANT THORNTON LLP

 

Denver, Colorado

March 11, 2009

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

TheBoard of Directors and Stockholders

EvolvingSystems, Inc.:

 

Wehave audited the accompanying consolidated statements of operations,stockholders’ equity and comprehensive income (loss), and cash flows ofEvolving Systems, Inc. and subsidiaries for the year ended December 31,2006. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the results of operations and the cash flowsof Evolving Systems, Inc. and subsidiaries for the year ended December 31,2006, in conformity with U.S. generally accepted accounting principles.

 

**KPMG LLP**

 

Denver,Colorado

March 14,2007

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(in thousands except share data)**

 
| ** **                                                                                                                                                                                       | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                       | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                                                       |       |                  |       |                  |       |
| Current assets:                                                                                                                                                                                  |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                        |       | $                     | 5,783      |                  | $          | 7,271 |   |
| Contract receivables, net of allowance for  doubtful accounts of $534 and $66 at December 31, 2008 and 2007,  respectively                                                                  |       | 11,484                |       | 10,959                |       |
| Unbilled work-in-progress                                                                                                                                                                        |       | 1,910                 |       | 922                   |       |
| Deferred income taxes                                                                                                                                                                            |       | 5                     |       | 4                     |       |
| Prepaid and other current assets                                                                                                                                                                 |       | 1,304                 |       | 1,331                 |       |
| Total current assets                                                                                                                                                                             |       | 20,486                |       | 20,487                |       |
| Property and equipment, net                                                                                                                                                                      |       | 1,277                 |       | 1,677                 |       |
| Amortizable intangible assets, net                                                                                                                                                               |       | 2,374                 |       | 4,687                 |       |
| Goodwill                                                                                                                                                                                         |       | 20,811                |       | 26,417                |       |
| Long-term restricted cash                                                                                                                                                                        |       | 100                   |       | 100                   |       |
| Long-term deferred income taxes                                                                                                                                                                  |       | 56                    |       | —                |       |
| Other long-term assets                                                                                                                                                                           |       | 307                   |       | 359                   |       |
| Total assets                                                                                                                                                                                     |       | $                     | 45,411     |                  | $          | 53,727 |   |
|                                                                                                                                                                                             |       |                  |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   |       |                  |       |                  |       |
| Current liabilities:                                                                                                                                                                             |       |                  |       |                  |       |
| Current portion of capital lease obligations                                                                                                                                                     |       | $                     | 21         |                  | $          | 20 |   |
| Current portion of long-term debt                                                                                                                                                                |       | 2,000                 |       | 2,500                 |       |
| Accounts payable and accrued liabilities                                                                                                                                                         |       | 5,198                 |       | 5,903                 |       |
| Deferred income taxes                                                                                                                                                                            |       | 20                    |       | 34                    |       |
| Unearned revenue                                                                                                                                                                                 |       | 11,445                |       | 10,635                |       |
| Total current liabilities                                                                                                                                                                        |       | 18,684                |       | 19,092                |       |
| Long-term liabilities:                                                                                                                                                                           |       |                  |       |                  |       |
| Capital lease obligations, net of current  portion                                                                                                                                               |       | 59                    |       | 79                    |       |
| Other long-term obligations                                                                                                                                                                      |       | 1,402                 |       | 1,477                 |       |
| Long-term debt, net of current portion                                                                                                                                                           |       | 4,883                 |       | 8,686                 |       |
| Deferred income taxes                                                                                                                                                                            |       | 441                   |       | 878                   |       |
| Total liabilities                                                                                                                                                                                |       | 25,469                |       | 30,212                |       |
|                                                                                                                                                                                             |       |                  |       |                  |       |
| Commitments and contingencies (Note 10)                                                                                                                                                          |       |                  |       |                  |       |
|                                                                                                                                                                                             |       |                  |       |                  |       |
| Series B convertible redeemable  preferred stock                                                                                                                                            |       | —                |       | 5,587                 |       |
|                                                                                                                                                                                             |       |                  |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                       |       |                  |       |                  |       |
| Preferred stock, $0.001 par value;  2,000,000 shares authorized; 0 and 478,750 shares of Series B issued and  outstanding as of December 31, 2008 and 2007, respectively (shown above) |       | —                |       | —                |       |
| Common stock, $0.001 par value; 40,000,000  shares authorized; 19,506,786 and 17,914,770 shares issue and outstanding as  of December 31, 2008 and 2007, respectively                       |       | 20                    |       | 18                    |       |
| Additional paid-in capital                                                                                                                                                                       |       | 81,814                |       | 75,317                |       |
| Accumulated other comprehensive income  (loss)                                                                                                                                                   |       | (5,270                | )          | 2,144                 |       |
| Accumulated deficit                                                                                                                                                                              |       | (56,622               | )          | (59,551               | )          |
| Total stockholders’ equity                                                                                                                                                                  |       | 19,942                |       | 17,928                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                  |       | $                     | 45,411     |                  | $          | 53,727 |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
| ** **                                                                   | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                    |       | $                                                             | 20,324     |   | $ | 17,895 |   | $ | 15,883 |   |
| Customer support                                                             |       | 17,497                                                        |       | 18,058 |   | 17,950 |   |
| Total revenue                                                                |       | 37,821                                                        |       | 35,953 |   | 33,833 |   |
|                                                                         |       |                                                          |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                                          |       |   |   |   |   |
| Costs of license fees and services,  excluding depreciation and amortization |       | 7,816                                                         |       | 8,023 |   | 7,342 |   |
| Costs of customer support, excluding  depreciation and amortization          |       | 6,103                                                         |       | 6,237 |   | 5,694 |   |
| Sales and marketing                                                          |       | 8,500                                                         |       | 8,557 |   | 8,962 |   |
| General and administrative                                                   |       | 5,676                                                         |       | 5,862 |   | 5,138 |   |
| Product development                                                          |       | 3,607                                                         |       | 2,376 |   | 3,072 |   |
| Depreciation                                                                 |       | 847                                                           |       | 899 |   | 1,169 |   |
| Amortization                                                                 |       | 1,363                                                         |       | 1,565 |   | 2,511 |   |
| Impairment of goodwill and intangible  assets                                |       | —                                                        |       | — |   | 16,516 |   |
| Restructuring and other expenses (recovery)                                  |       | —                                                        |       | (4 | ) | (21 | ) |
| Total costs of revenue and operating  expenses                               |       | 33,912                                                        |       | 33,515 |   | 50,383 |   |
|                                                                         |       |                                                          |       |   |   |   |   |
| Income (loss) from operations                                                |       | 3,909                                                         |       | 2,438 |   | (16,550 | ) |
|                                                                         |       |                                                          |       |   |   |   |   |
| Other income (expense)                                                       |       |                                                          |       |   |   |   |   |
| Interest income                                                              |       | 161                                                           |       | 304 |   | 160 |   |
| Interest expense                                                             |       | (1,171                                                        | )          | (1,747 | ) | (1,992 | ) |
| Other income                                                                 |       | 57                                                            |       | — |   | — |   |
| Gain (loss) on extinguishment of debt                                        |       | (290                                                          | )          | 42 |   | — |   |
| Foreign currency exchange gain (loss)                                        |       | 823                                                           |       | 117 |   | (5 | ) |
| Other expense, net                                                           |       | (420                                                          | )          | (1,284 | ) | (1,837 | ) |
|                                                                         |       |                                                          |       |   |   |   |   |
| Income (loss) before income taxes                                            |       | 3,489                                                         |       | 1,154 |   | (18,387 | ) |
| Income tax expense (benefit)                                                 |       | 560                                                           |       | 556 |   | (1,604 | ) |
| Net income (loss)                                                            |       | $                                                             | 2,929      |   | $ | 598 |   | $ | (16,783 | ) |
|                                                                         |       |                                                          |       |   |   |   |   |
| Basic income (loss) per common and  preferred share                          |       | $                                                             | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) |
|                                                                         |       |                                                          |       |   |   |   |   |
| Diluted income (loss) per common and  preferred share                        |       | $                                                             | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) |
|                                                                         |       |                                                          |       |   |   |   |   |
| Weighted average basic shares outstanding                                    |       | 19,389                                                        |       | 19,198 |   | 19,100 |   |
| Weighted average diluted shares outstanding                                  |       | 19,756                                                        |       | 19,576 |   | 19,100 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial 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, 2005**                             | ** ** | **16,137,821**        | ** ** | **$**       | **16**     | ** **        | **$**      | **67,891**             | ** ** | **$**                  | **(2,417** | **)**      | **$**      | **(43,366** | **)** | **$** | **22,124** | ** ** |
| Stock option exercises                                            |       | 12,469                |       | —      |       | 14                |       | —                 |       | —                 |       | 14         |       |
| Common Stock issued pursuant to the Employee  Stock Purchase Plan |       | 83,356                |       | —      |       | 112               |       | —                 |       | —                 |       | 112        |       |
| Stock-based compensation expense                                  |       |                  |       |        |       | 808               |       | —                 |       | —                 |       | 808        |       |
| Comprehensive income (loss):                                      |       |                  |       |        |       |              |       |                   |       |                   |       |       |       |
| Net loss                                                          |       | —                |       | —      |       | —            |       | —                 |       | (16,783                | )          |       |       |
| Foreign currency translation adjustment                           |       | —                |       | —      |       | —            |       | 3,883                  |       | —                 |       |       |       |
| Comprehensive loss                                                |       |                  |       |        |       |              |       |                   |       |                   |       | (12,900    | )          |
| **Balance at December 31, 2006**                             | ** ** | **16,233,646**        | ** ** | **16**      | ** ** | **68,825**        | ** ** | **1,466**              | ** ** | **(60,149**            | **)**      | **10,158** | ** ** |
| Stock option exercises                                            |       | 19,688                |       | —      |       | 19                |       | —                 |       | —                 |       | 19         |       |
| Common Stock issued pursuant to the Employee  Stock Purchase Plan |       | 60,189                |       | —      |       | 70                |       | —                 |       | —                 |       | 70         |       |
| Stock-based compensation expense                                  |       |                  |       |        |       | 710               |       | —                 |       | —                 |       | 710        |       |
| Preferred stock conversion                                        |       | 1,463,747             |       | 1           |       | 5,693             |       | —                 |       | —                 |       | 5,694      |       |
| Restricted stock issuance                                         |       | 137,500               |       | 1           |       | —            |       | —                 |       | —                 |       | 1          |       |
| Comprehensive income (loss):                                      |       |                  |       |        |       |              |       |                   |       |                   |       |       |       |
| Net income                                                        |       | —                |       | —      |       | —            |       | —                 |       | 598                    |       |       |       |
| Foreign currency translation adjustment                           |       | —                |       | —      |       | —            |       | 678                    |       | —                 |       |       |       |
| Comprehensive income                                              |       |                  |       |        |       |              |       |                   |       |                   |       | 1,276      |       |
| **Balance at December 31, 2007**                             | ** ** | **17,914,770**        | ** ** | **18**      | ** ** | **75,317**        | ** ** | **2,144**              | ** ** | **(59,551**            | **)**      | **17,928** | ** ** |
| Stock option exercises                                            |       | 5,054                 |       | —      |       | 4                 |       | —                 |       | —                 |       | 4          |       |
| Common Stock issued pursuant to the Employee  Stock Purchase Plan |       | 45,712                |       | —      |       | 68                |       | —                 |       | —                 |       | 68         |       |
| Stock-based compensation expense                                  |       |                  |       |        |       | 839               |       | —                 |       | —                 |       | 839        |       |
| Preferred stock conversion                                        |       | 1,436,250             |       | 1           |       | 5,586             |       | —                 |       | —                 |       | 5,587      |       |
| Restricted stock issuance                                         |       | 105,000               |       | 1           |       | —            |       | —                 |       | —                 |       | 1          |       |
| Comprehensive income (loss):                                      |       |                  |       |        |       |              |       |                   |       |                   |       |       |       |
| Net income                                                        |       | —                |       | —      |       | —            |       | —                 |       | 2,929                  |       |       |       |
| Foreign currency translation adjustment                           |       | —                |       | —      |       | —            |       | (7,414                 | )          | —                 |       |       |       |
| Comprehensive loss                                                |       |                  |       |        |       |              |       |                   |       |                   |       | (4,485     | )          |
| **Balance at December 31, 2008**                             | ** ** | **19,506,786**        | ** ** | **$**       | **20**     | ** **        | **$**      | **81,814**             | ** ** | **$**                  | **(5,270** | **)**      | **$**      | **(56,622** | **)** | **$** | **19,942** | ** ** |

 

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,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                             |       |                                                          |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                                             | 2,929      |   | $ | 598 |   | $ | (16,783 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation                                                                              |       | 847                                                           |       | 899 |   | 1,169 |   |
| Amortization of intangible assets                                                         |       | 1,363                                                         |       | 1,565 |   | 2,511 |   |
| Amortization of debt issuance costs                                                       |       | 147                                                           |       | 235 |   | 273 |   |
| Stock based compensation                                                                  |       | 839                                                           |       | 710 |   | 808 |   |
| Impairment of goodwill and intangible  assets                                             |       | —                                                        |       | — |   | 16,516 |   |
| (Gain)/loss on disposal of property and  equipment                                        |       | —                                                        |       | (4 | ) | (18 | ) |
| (Gain) loss on extinguishment of debt                                                     |       | 290                                                           |       | (42 | ) | — |   |
| Unrealized foreign currency transaction  (gains) and losses, net                          |       | (823                                                          | )          | (117 | ) | 5 |   |
| Provision for (recovery of) bad debt                                                      |       | 512                                                           |       | (5 | ) | 28 |   |
| Benefit from foreign deferred income taxes                                                |       | (320                                                          | )          | (279 | ) | (1,891 | ) |
| Change in operating assets and liabilities:                                               |       |                                                          |       |   |   |   |   |
| Contract receivables                                                                      |       | (1,007                                                        | )          | (1,265 | ) | 1,983 |   |
| Unbilled work-in-progress                                                                 |       | (1,465                                                        | )          | 153 |   | 192 |   |
| Prepaid and other assets                                                                  |       | (291                                                          | )          | 327 |   | (171 | ) |
| Accounts payable and accrued liabilities                                                  |       | 607                                                           |       | 778 |   | (1,622 | ) |
| Unearned revenue                                                                          |       | 1,989                                                         |       | 492 |   | 20 |   |
| Other                                                                                     |       | (73                                                           | )          | 728 |   | 346 |   |
| Net cash provided by operating activities                                                 |       | 5,544                                                         |       | 4,773 |   | 3,366 |   |
|                                                                                      |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                 |       |                                                          |       |   |   |   |   |
| Purchase of property and equipment                                                        |       | (898                                                          | )          | (546 | ) | (477 | ) |
| Proceeds from sale of property and  equipment                                             |       | —                                                        |       | 4 |   | 20 |   |
| Business combinations and earnout payments                                                |       | —                                                        |       | (24 | ) | (153 | ) |
| Restricted cash                                                                           |       | —                                                        |       | 200 |   | — |   |
| Net cash used in investing activities                                                     |       | (898                                                          | )          | (366 | ) | (610 | ) |
|                                                                                      |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                 |       |                                                          |       |   |   |   |   |
| Capital lease payments                                                                    |       | (20                                                           | )          | (21 | ) | (34 | ) |
| Principal payments on long-term debt                                                      |       | (8,298                                                        | )          | (2,141 | ) | (2,025 | ) |
| Proceeds from issuance of long-term debt                                                  |       | 4,000                                                         |       | — |   | — |   |
| Payments for debt issuance costs                                                          |       | (347                                                          | )          | — |   | — |   |
| Proceeds from the issuance of stock                                                       |       | 72                                                            |       | 89 |   | 126 |   |
| Net cash used in financing activities                                                     |       | (4,593                                                        | )          | (2,073 | ) | (1,933 | ) |
|                                                                                      |       |                                                          |       |   |   |   |   |
| Effect of exchange rate changes on cash                                                   |       | (1,541                                                        | )          | (139 | ) | 370 |   |
|                                                                                      |       |                                                          |       |   |   |   |   |
| Net increase (decrease) in cash and cash  equivalents                                     |       | (1,488                                                        | )          | 2,195 |   | 1,193 |   |
| Cash and cash equivalents at beginning of  year                                           |       | 7,271                                                         |       | 5,076 |   | 3,883 |   |
| Cash and cash equivalents at end of year                                                  |       | $                                                             | 5,783      |   | $ | 7,271 |   | $ | 5,076 |   |
|                                                                                      |       |                                                          |       |   |   |   |   |
| Supplemental disclosure of other cash and  non-cash financing and investing transactions: |       |                                                          |       |   |   |   |   |
| Interest paid                                                                             |       | $                                                             | 1,096      |   | $ | 819 |   | $ | 1,065 |   |
| Income taxes paid                                                                         |       | 671                                                           |       | 180 |   | 740 |   |
| 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                        |       | 99                                                            |       | 792 |   | — |   |

 

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

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

**Organization –**Weare a provider of software solutions and services to the wireless, wireline andIP carrier 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.

 

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

 

**Use of Estimates –**The preparation of financial statements inconformity with accounting principles generally accepted in the U.S. requiresus to make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities, at thedate of the financial statements, as well as the reported amounts of revenueand expenses during the reporting period. We made estimates with respect torevenue recognition for estimated hours to complete projects accounted forusing the percentage of completion method, allowance for doubtful accounts,income tax valuation allowance, fair values of long-lived assets, valuation ofintangible assets and goodwill, useful lives for property, equipment andintangible assets, business combinations, capitalization of internal softwaredevelopment costs and fair value of stock-based compensation amounts.  Actual results could differ from theseestimates.

 

**Foreign Currency 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 unrealizedcumulative translation adjustment, net of applicable income taxes, is recordedas a component of accumulated other comprehensive income (loss) in stockholders’equity.  Realized and unrealizedtransaction gains and losses generated by transactions denominated in acurrency different from the functional currency of the applicable entity arerecorded in other income (loss) in the period in which they occur.

 

**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, 2008 were $4.6 million and$145,000, respectively and as of December 31, 2007 were $2.9 million and$217,000, respectively.

 

**Restricted Cash –**As of December 31, 2008 and 2007, we had $100,000 of restrictedcash, related to our headquarters lease. The restricted cash requirement wasreduced by $200,000 during 2007 as we negotiated a new lease with our existinglandlord.  The remainder of therestricted cash will become unrestricted within 60 days of the expiration ofour lease.

 

**Contract Receivables and Allowance for DoubtfulAccounts –**Contractreceivables are recorded at the invoiced amount and do not bear interest. Theallowance for doubtful accounts is our best estimate of the amount of probablecredit losses in accounts receivable. We determine the allowance based onhistorical 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 following table reflects the activity in the allowance for doubtfulaccounts:

 

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| ** ** | ** ** | ** **                       | ** ** | ** **          | ** ** | ** **        | ** ** | **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**          | ** ** |
| 2008       |       | Allowance  for doubtful accounts |       | $                   | 66         |              | $          | 512               |       | $                     | (28        | )                   | $          | (16 | ) | $ | 534 |   |
| 2007       |       | Allowance  for doubtful accounts |       | $                   | 70         |              | $          | (5                | )          | $                     | —     |                | $          | 1 |   | $ | 66 |   |
| 2006       |       | Allowance  for doubtful accounts |       | $                   | 48         |              | $          | 28                |       | $                     | —     |                | $          | (6 | ) | $ | 70 |   |

 

**Concentration of Credit Risk –**Financial instruments that potentiallysubject us to concentrations of credit risk consist primarily of contractreceivables and unbilled work-in-progress. We perform on-going evaluations ofcustomers’ financial condition and, generally, require no collateral fromcustomers.

 

A substantial portion of our revenue is from a limited number ofcustomers, all in the telecommunications industry.  The following tables depict the percentage ofrevenue and percentage of contract receivables generated from significantcustomers (defined as contributing at least 10%):

 
| ** **             | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|
| ** **             | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Customer A– U.S.  |       | 20                                                            | %          | 22 | % | 13 | % |
| Customer B – U.K. |       | 14                                                            | %          | 13 | % | 13 | % |
| Total % of Revenue     |       | 34                                                            | %          | 35 | % | 26 | % |

 
| ** **                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Customer A – U.S. (1)                                     |       | 45                    | %          | 38 | % |
| Total % of contract receivables and  unbilled work-in-progress |       | 45                    | %          | 38 | % |

 

----

(1)  In prior years this was presented as the customer’spercentage of contract receivables. In 2008, we are presenting the customer’spercentage of contract receivables and unbilled work-in-progress. Prior periodamounts have been adjusted to reflect the current presentation.

 

**Fair Value 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 31,2008, we estimated the fair value of our fixed rate senior term loan andsubordinated notes was $2.4 million and $6.0 million, respectively. As of December 31,2007, we believe that the carrying amounts of our variable rate long-term debtapproximated fair value due to the notes carrying a current market rate ofinterest.  We estimated that the fairvalue of our fixed rate long-term debt was approximately $5.4 million at December 31,2007.

 

**Revenue Recognition –**We recognize revenue from two primarysources: license fees and services, and customer support, in accordance withStatement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amendedand interpreted by SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions.”  Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition,” provides further interpretive guidance for publiccompanies on the recognition, presentation and disclosure of revenue infinancial statements.  In addition to thecriteria described below, we generally recognize revenue when an agreement issigned, the fee is fixed or determinable and collectability is reasonablyassured.

 

Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting, in accordance with SOP97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.”  We estimate the percentage of completion foreach contract based on the ratio of direct labor hours incurred to totalestimated direct labor hours.  Sinceestimated direct labor hours, and changes thereto, can have a significantimpact on revenue recognition, these estimates are critical and we review themregularly.  We record amounts billed inadvance of services being performed as unearned revenue. Unbilledwork-in-progress represents revenue earned but not yet billable under the termsof the fixed-price contracts. All such amounts are expected to be billed andcollected within 12 months.

 

Wemay encounter budget and schedule overruns on fixed price contracts causedby increased labor or overhead costs. We make adjustments to cost estimates inthe periods in which the facts requiring such revisions become known. We recordestimated losses, if any, in the period in which current estimates of total contractrevenue and contract costs indicate a loss.

 

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In arrangements where the services are not essential to the functionalityof the delivered software, we recognize license revenue when a licenseagreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is reasonably assured. Where applicable, weunbundle and record as revenue fees from multiple element arrangements as theelements are delivered to the extent that vendor specific objective evidence (“VSOE”)of fair 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.

 

Werecognize services revenue from fixed-price contracts using the proportionalperformance method of accounting, which is similar to the percentage ofcompletion method described above. We recognize revenue from professionalservices provided pursuant to time-and-materials based contracts and trainingservices as the services are performed, as that is when our obligation to ourcustomers under such arrangements is fulfilled.

 

Werecognize customer support, including maintenance revenue, ratably over theservice contract period. When maintenance is bundled with the original licensefee arrangement, its fair value, based upon VSOE, is deferred and recognizedduring the periods when services are provided.

 

**Sales, Use and Other Value Added Tax** – Revenue is recorded net of applicablestate, use and other value added taxes.

 

**Advertising and Promotion Costs –**All advertising and promotion costs areexpensed as incurred. Advertising costs totaled approximately $338,000,$322,000 and $287,000, for the years ended December 31, 2008, 2007 and2006, respectively.

 

**Stock-based Compensation –**We account for stock-based compensation under Statement of Financial AccountingStandards No. 123(Revised), “Share-Based Payment” (“SFAS 123R”).  This statement replaced SFAS No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”) and superseded APB Opinion No. 25,“Accounting for Stock Issued to Employees.” Under SFAS 123R, we apply a fair-value-based measurement method toaccount for share-based payment transactions with employees and directors andrecord compensation cost for all stock awards granted after January 1,2006 and awards modified, repurchased, or cancelled after that date. We recordcompensation costs associated with the vesting of unvested options on astraight-line basis over the vesting period using the guidance under SFAS123R.  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 recognize compensation cost for options ona straight-line basis over the vesting period using an estimated forfeiturerate.   Effective January 1, 2006,we accounted for stock option grants and employee stock purchase plan purchasesunder SFAS 123R.  We used theBlack-Scholes model to estimate the fair value of each option grant on the dateof grant.  This model requires the use ofestimates for expected term of the options and expected volatility of the priceof our common stock.

 

**Capitalization of Internal Software Development Costs –**We expend amounts on research anddevelopment, particularly for new products and/or for enhancements of existingproducts. For internal development of software products that are to be licensedby us, we follow Statement of Financial Accounting Standards No. 86, “Accountingfor the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” (“SFAS86”). SFAS 86 requires that the cost of developing software be expensed priorto establishing technological feasibility and those costs be capitalized oncetechnological feasibility has been established. Capitalization ceases upon generalrelease of the software. The determination of whether internal softwaredevelopment costs are subject to capitalization is, by its nature, highlysubjective and involves significant judgments. This decision couldsignificantly affect earnings during the development period. Further, oncecapitalized, the software costs are generally amortized on a straight-linebasis over the estimated economic life of the product. The determination of theexpected useful life of a product is highly judgmental. Finally, capitalizedsoftware costs must be assessed for realizability at the end of each reportingperiod. We did not capitalize any internal software developmentcosts during the years ended December 31, 2008, 2007 or 2006 due tothe high degree of development risk involved in each of our softwaredevelopment projects and the resulting short period of time between achievingtechnological feasibility and the general release of the software.  In addition, we did not have any capitalizedinternal software development costs included in our December 31, 2008 and2007 consolidated balance sheets.

 

**Property and Equipment and Long-Lived Assets –**Property and equipment are stated at cost orestimated fair value if acquired in an acquisition, less accumulateddepreciation, and are depreciated over their estimated useful lives, or thelease term, if shorter, using the straight-line method. Leasehold improvementsare stated at cost, less accumulated amortization, and are amortized over theshorter of the lease term or estimated useful life of the asset. Maintenanceand repair costs are expensed as incurred.

 

We review our long-lived assets, such as property and equipment andpurchased intangible assets subject to amortization for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset or asset group may not be recoverable. We evaluate the recoverability ofan asset or asset group by comparing its carrying amount to the estimatedundiscounted

 

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future cash flows expected to be generated by the asset or asset group.If the carrying amount of an asset or asset group exceeds its estimated futurecash flows, we recognize an impairment charge as the amount by which thecarrying amount of the asset exceeds 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.  During the year ended December 31, 2006,we recorded an impairment of goodwill. See Note 2 for further details.

 

**Intangible Assets –**Amortizable intangible assets consist primarily of purchased softwareand licenses, customer contracts and relationships, trademarks and tradenames,and business partnerships acquired in conjunction with our purchases of CMSCommunications, Inc. (“CMS”), Telecom Software Enterprises, LLC (“TSE”)and Evolving Systems U.K.  These definitelife assets are amortized using the straight-line method over their estimatedlives.

 

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

 

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

 

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

 

·                  Significant negative industry or economictrends; and/or

 

·                  Significant decline in our stock price for asustained period.

 

If, as a result of the existence of one or more of the above indicatorsof impairment, we determine that the carrying value of intangibles and/orlong-lived assets may not be recoverable, we compare the estimated undiscountedcash flows expected to result from the use of the asset and its eventualdisposition to the asset’s carrying amount. If an amortizable intangible orlong-lived asset is not deemed to be recoverable, we recognize an impairmentloss representing the excess of the asset’s carrying value over its estimatedfair value.  During the year ended December 31,2006, we recorded an impairment of amortizable intangible assets.  See Note 2 for further details.

 

**Income Taxes –**We account for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). We recorddeferred tax assets and liabilities for the estimated future tax effects oftemporary differences between the tax bases of assets and liabilities andamounts reported in the accompanying consolidated balance sheets, as well asoperating loss and tax credit carry-forwards. We measure deferred tax assetsand liabilities using enacted tax rates expected to be applied to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  We reduce deferredtax assets by a valuation allowance if, based on available evidence, it is morelikely than not that these benefits will not be realized.  We evaluate tax benefits recorded in ourconsolidated financial statements and record accruals for any amounts deemednot probable of being sustained.

 

EffectiveJanuary 1, 2007, we adopted the provisions of FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes - an interpretation of FASBStatement No. 109” (“FIN 48”).  FIN48 prescribes 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.  Forthose benefits to be recognized, a tax position must be more-likely-than-not tobe sustained upon examination by taxing authorities.  There was no material impact on the company’sconsolidated financial position and results of operations as a result of theadoption of the provisions of FIN 48.

 

OnJanuary 1, 2007, we recorded a FIN 48 transition adjustment consisting ofa $0.4 million decrease in our deferred tax assets related to Research andDevelopment Tax Credits that was offset by a corresponding decrease in ourvaluation allowance.  As of December 31,2008, 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.

 

**Recent Accounting Pronouncements –**InDecember 2007, the SEC issued Staff Accounting Bulletin 110, *Share-Based Payment* (“SAB 110”), which amends StaffAccounting Bulletin 107 (“SAB 107”), *Share-Based Payment*,to permit public companies, under certain circumstances, to use the simplifiedmethod of SAB 107 for employee option grants after December 31, 2007.  Use of the simplified method after December 31,2007 is permitted only for companies whose historical data about theiremployees’ exercise behavior does not provide a reasonable basis for estimatingthe expected term of the options.  Wecurrently use the simplified method

 

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to estimate expected term for employee option grantsas adequate historical experience is not available to provide a reasonableestimate.  SAB 110 is effective foremployee options granted after December 31, 2007.  We adopted SAB 110 effective January 1,2008 and continue applying the simplified method until adequate historicalexperience is readily available to provide a reasonable estimate of theexpected term for employee option grants.

 

InFebruary 2007, the FASB issued SFAS No. 159, The Fair Value Optionfor Financial Assets and Financial Liabilities - Including an Amendment of FASBStatement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure eligible items at fairvalue at specific election dates (the ‘‘fair value option’’). Unrealized gainsand losses on items for which the fair value option has been elected shall bereported in earnings at each subsequent reporting period. This accountingstandard was effective for us beginning January 1, 2008.  We have elected not to apply the fair valueoption allowed under SFAS 159.

 

InSeptember 2006, the FASB issued SFAS No. 157, Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value under generally accepted accounting principles, andexpands disclosures about fair value measurements. SFAS 157 is effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2007.  In February 2008,the FASB issued Staff Position No. 157-2, which delays the effective dateof SFAS 157 for non-financial assets and liabilities until financial statementsissued for fiscal years and interim periods beginning after November 15,2008.  The adoption of SFAS 157 did nothave a material effect on our consolidated financial statements.

 

**NOTE 2 – GOODWILL AND INTANGIBLE ASSETS**

 

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

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer  Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                             | ** ** | **US**                             | ** ** | **UK**                | ** ** | **US**    | ** ** | **UK** | ** ** | **Goodwill** | ** ** |
| Balance as of December 31, 2006                   |       | $                                  | —     |                  | $          | 8,944     |       | $ | 6,033 |   | $ | 11,050 |   | $ | 26,027 |   |
| Effects of changes in foreign Currency  exchange rates |       | —                             |       | 174                   |       | —    |       | 216 |   | 390 |   |
| 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 |   |

 

We conducted our annual goodwill impairmenttest as of July 31, 2008, and we determined that goodwill was not impairedas of the test date. From July 31, 2008 through December 31, 2008, noevents have occurred that we believe may have impaired goodwill.

 

During 2006, we recognized a goodwill impairmentcharge in our License and Services reporting units of $10.9 million.  Due to continued pricing pressures on servicesand consolidation in the telecommunications industry, revenues and cash flowshad been lower than expected and those lower operating results had a negativeimpact on the market price of our common stock. Based upon this trend, we reviewed our business plan during the secondquarter of 2006.  As a result of theseevents, we determined that a triggering event had occurred and conducted agoodwill impairment analysis.  This goodwillimpairment related to goodwill from our acquisitions of CMS in November 2003,TSE in October 2004 and Evolving Systems U.K. in November 2004.  The fair value of our reporting units wereestimated using the present value of expected future cash flows and thevaluation employed a combination of present value techniques to measure fairvalue.  We also considered marketfactors.

 

Identifiable intangible assets are amortizedon a straight-line basis over estimated lives ranging from one to seven yearsand include the cumulative effects of foreign currency exchange rates.  As of December 31, 2008 and 2007,identifiable intangibles were as follows (in thousands):

 

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| ** **                           | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** | **Weighted-**             | ** ** |
|--------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|---------------------------|------------|
| **Identifiable  intangible assets:** | ** ** | **(1)  Gross  Amount**          | ** ** | **Accumulated  Amortization**   | ** ** | **Net  Carrying  Amount** | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average  Amortization  Period** | ** ** |
| Purchased software                   |       | $                               | 1,583      |                            | $          | 902                       |       | $ | 681 |   | $ | 2,072 |   | $ | 700 |   | $ | 1,372 |   | 4.6 yrs |   |
| Purchased licenses                   |       | 227                             |       | 227                             |       | —                    |       | 227 |   | 146 |   | 81 |   | 2.3 yrs |   |
| Trademarks and tradenames            |       | 649                             |       | 232                             |       | 417                       |       | 896 |   | 192 |   | 704 |   | 7.0 yrs |   |
| Business partnerships                |       | 106                             |       | 53                              |       | 53                        |       | 146 |   | 44 |   | 102 |   | 5.0 yrs |   |
| Customer relationships               |       | 2,986                           |       | 1,763                           |       | 1,223                     |       | 3,707 |   | 1,279 |   | 2,428 |   | 5.3 yrs |   |
|                                 |       | $                               | 5,551      |                            | $          | 3,177                     |       | $ | 2,374 |   | $ | 7,048 |   | $ | 2,361 |   | $ | 4,687 |   | 5.2 yrs |   |

 

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

 

As a result of the events that led to the goodwill impairment during2006, we reviewed intangible assets for recoverability in accordance with SFAS144.  Our evaluation of product strategyand development plans resulted in our determination that the undiscounted cashflows associated with these assets would not be sufficient to recover thecarrying amounts of these assets.  As aresult of this review we recorded an intangible asset impairment of $5.6million at June 30, 2006.  This wascomprised of $4.2 million of purchased software and purchased licenseintangible assets in the License Fees and Services operating segment associatedwith the acquisitions of CMS and TSE as well as $1.4 million of customerrelationship and business partnership intangible assets in the Customer Supportoperating segment associated with the acquisition of Evolving U.K.  We estimated the fair values of our intangible assets using the present value ofexpected future cash flows.

 

Amortization expense of identifiable intangible assets was $1.4million, $1.6 million and $2.5 million for the years ended December 31,2008, 2007 and 2006, respectively.  AsEvolving Systems U.K. uses the British Pound Sterling as its functionalcurrency, the amount of future amortization actually recorded will be basedupon exchange rates in effect at that time. Expected future amortizationexpense related to identifiable intangibles based on our carrying amount as of December 31,2008 was as follows (in thousands):

 
| **Years ending** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2009                  |       | $          | 680        |   |
| 2010                  |       | 643        |       |
| 2011                  |       | 504        |       |
| 2012                  |       | 365        |       |
| 2013                  |       | 182        |       |
| Thereafter            |       | —     |       |
|                  |       | $          | 2,374      |   |

 

**NOTE 3 – BALANCE SHEET COMPONENTS**

 

The components of certain balance sheet line items are as follows (inthousands):

 
| ** **                                      | ** ** | **December 31,** | ** ** | **Estimated** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|---------------|------------|
| **Property and equipment:**           | ** ** | **2008**              | ** ** | **2007**      | ** ** | **Useful Life** | ** ** |
| Computer equipment and purchased software       |       | $                     | 25,769     |          | $          | 26,228 |   | 2-4 yrs |   |
| Furniture, fixtures and leasehold  improvements |       | 2,610                 |       | 2,691         |       | 5-7 yrs |   |
|                                            |       | 28,379                |       | 28,919        |       |   |   |
| Less accumulated depreciation                   |       | (27,102               | )          | (27,242       | )          |   |   |
|                                            |       | $                     | 1,277      |          | $          | 1,677 |   |   |   |

 
| **Assets acquired under capital lease:** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Original book value                                          |       | $        | 58         |     | $          | 58 |   |
| Accumulated amortization                                     |       | (24      | )          | (10      | )          |
| Net book value                                               |       | $        | 34         |     | $          | 48 |   |

 

Depreciationexpense was $0.8 million, $0.9 million and $1.2 million for the years ended December 31,2008, 2007 and 2006, respectively.

 

Includedin property and equipment at December 31, 2008 and 2007 are assets undercapital lease. Depreciation expense related to assets under capital leases was$14,000, $21,000 and $26,000 for the years ended December 31, 2008, 2007and 2006, respectively.

 

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| ** **                                                        | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|
| **Accounts payable and accrued liabilities:** | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Accounts payable                                                  |       | $                     | 760        |   | $ | 1,062 |   |
| Accrued compensation and related expenses                         |       | 2,101                 |       | 1,738 |   |
| Accrued liabilities                                               |       | 2,337                 |       | 3,103 |   |
|                                                              |       | $                     | 5,198      |   | $ | 5,903 |   |

 

**NOTE 4 –LONG-TERM DEBT**

 

Ournotes payable consist of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Senior term loan with financial institution, interest at a fixed rate  of 8.25%, principal installments and interest payments are due monthly with  final maturity on February 22, 2010. The loan is secured by  substantially all of our assets.                                                                                                                                 |       | $                     | 2,333      |   | $ | — |   |
|                                                                                                                                                                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Senior note payable to financial institution, interest at the  one-month London InterBank Offered Rate (“LIBOR”) plus a margin of 5.25% at  December 31, 2007; however, the LIBOR rate cannot be less than 3.75%,  interest rate was 10.25% at December 31, 2007. In February 2008,  this note payable was replaced by our new $4.0 million senior term loan. |       | —                |       | 4,419 |   |
|                                                                                                                                                                                                                                                                                                                                                                                   |       |                  |       |   |   |
| $4.5 million senior revolving credit facility payable to financial  institution, interest at one-month LIBOR plus 4.0%; however, the LIBOR rate  cannot be less than 3.75%; interest rate was 9.00% at December 31, 2007.  In February 2008, this revolver was replaced with our $6.0 million  senior revolving credit facilities.                                           |       | —                |       | 2,000 |   |
|                                                                                                                                                                                                                                                                                                                                                                                   |       |                  |       |   |   |
| Long-term unsecured subordinated notes payable, interest ranges from  11-14% with a weighted average rate of 12.60% and 12.82% at December 31,  2008 and December 31, 2007, respectively, accrued interest and principal  are due in full May 16, 2011.                                                                                                                 |       | 4,550                 |       | 4,767 |   |
| Total debt                                                                                                                                                                                                                                                                                                                                                                             |       | 6,883                 |       | 11,186 |   |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                   |       | (2,000                | )          | (2,500 | ) |
| Long-term debt, excluding current portion                                                                                                                                                                                                                                                                                                                                              |       | $                     | 4,883      |   | $ | 8,686 |   |

 

On February 22, 2008, we replaced our existingsenior term note and senior revolving facility with a new $4.0 million seniorterm loan, a $1.0 million U.S. revolving credit facility (“U.S. RevolvingFacility”) and a $5.0 million U.K. revolving credit facility (“U.K. RevolvingFacility”).  On December 18, 2008 wemodified our U.S. and U.K. Revolving Facilities. The U.S. Revolving Facility isnow a $2.5 million credit facility and the U.K. Revolving Facility is now a$3.5 million facility. All other terms and conditions remained the same. Therehave been no borrowings on either facility and therefore there are nooutstanding balances on either facility as of December 31, 2008.

 

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

 

Theremaining scheduled principal payments as of December 31, 2008 on our debtare as follows (in thousands):

 

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| **Years ending December 31,** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2009                                         |       | $          | 2,000      |   |
| 2010                                         |       | 333        |       |
| 2011                                         |       | 4,550      |       |
|                                         |       | $          | 6,883      |   |

 

Our $2.5 million U.S. Revolving Facility bearsinterest at Prime Rate plus 0.5%.  PrimeRate was 3.25% as of December 31, 2008. Borrowings under the senior revolving facilities are limited to a percentageof our eligible accounts receivable and cash. The U.S. Revolving Facility is secured by all assets of Evolving Systems, Inc.and is subject to the same covenants as the senior term loan.  All accrued interest on outstandingborrowings under the U.S. Revolving Facility is paid monthly, with anyoutstanding balance due with a final maturity of February 22, 2011.  As of December 31, 2008, we had $2.5million in availability, but no borrowing outstanding under this U.S. RevolvingFacility.

 

Our $3.5 million U.K. Revolving Facility bearsinterest at Prime Rate plus 0.5%.  PrimeRate was 3.25% as of December 31, 2008. Borrowings under the U.K. Revolving Facility are limited to a percentageof our eligible accounts receivable and cash. The U.K. Revolving Facility is secured by all assets of Evolving SystemsHoldings Ltd. and Evolving Systems Ltd. and is subject to the same covenants asthe Senior Term Loan.  All accruedinterest on outstanding borrowings under the Senior Revolving Facility is paidmonthly, with any outstanding balance due with a final maturity of February 22,2011.  As of December 31, 2008, wehad $3.5 million in availability, but no borrowing outstanding under this U.S.Revolving Facility.

 

In connection with the replacement of ourexisting senior term note and senior revolving facility with the new seniorterm loan and U.S. Revolving Facility and the U.K. Revolving Facility, werecorded a write-off of debt issuance costs associated with the retired seniordebt of approximately $0.3 million. Additionally, we capitalized debt issuance costs related to our newsenior debt of approximately $0.3 million. These newly capitalized debt issuance costs will be amortized over theterm of the new senior debt.

 

On February 22, 2008, we paid $272,000to retire $279,000 of subordinated debt and related accrued interest held bytwo of our subordinated note holders. The retirements included principal of $217,000 and accrued interest of$62,000.  The $7,000 gain onextinguishment of this debt is reflected within our other income (expense) onthe consolidated statements of operations. On February 22, 2008, we also paid $728,000 in accrued interest tothe remaining subordinated note holders.

 

InMarch 2007, we paid $77,000 to retire $119,000 of subordinated debt andrelated accrued interest held by one of our subordinated note holders.  The retirement included principal of $103,000and accrued interest of $16,000.  The$42,000 gain on extinguishment of this debt was reflected within our otherincome (expense) on the consolidated statement of operations.  The remaining long-term unsecuredsubordinated notes payable of $4.8 million, at December 31, 2007, bearinterest at 11% through December 31, 2007 and 14% thereafter.  Interest expense was recognized using aneffective rate of 12.82% at December 31, 2007 and 12.84% at December 31,2006.  The unsecured subordinated notesare subordinate to the senior note and senior revolving credit facility.  The unsecured subordinated notes payableagreements subject us to certain affirmative and negative covenants; however,certain covenants are not in effect until the senior note and senior revolvingcredit facility are paid in full. Outstanding amounts of the unsecured subordinated notes may beaccelerated upon the occurrence of an uncured event of default or if we achievecertain minimum cash thresholds.  Accruedinterest on the unsecured subordinated notes payable is separately reflected onthe balance sheet under “Other long-term obligations.”

 

Wewere in compliance with all of our debt covenants as of December 31, 2008and 2007.

 

**NOTE 5 – INCOME TAXES**

 

The pre-tax income (loss) on which theprovision for income taxes was computed is as follows (in thousands):

 
| ** ** | ** ** | **For the Years Ended December 31** | ** ** |
|------------|------------|--------------------------------------------------------------|------------|
| ** ** | ** ** | **2008**                                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| Domestic   |       | $                                                            | (115       | ) | $ | (2,398 | ) | $ | (7,113 | ) |
| Foreign    |       | 3,604                                                        |       | 3,552 |   | (11,274 | ) |
| Total      |       | $                                                            | 3,489      |   | $ | 1,154 |   | $ | (18,387 | ) |

 

The expense (benefit) for income taxes consists of the following (inthousands):

 

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| ** **     | ** ** | **For the Years Ended December 31** | ** ** |
|----------------|------------|--------------------------------------------------------------|------------|
| ** **     | ** ** | **2008**                                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| Current:       |       |                                                         |       |   |   |   |   |
| Federal        |       | $                                                            | 25         |   | $ | — |   | $ | — |   |
| Foreign        |       | 855                                                          |       | 835 |   | 287 |   |
| State          |       | —                                                       |       | — |   | — |   |
| Total current  |       | $                                                            | 880        |   | $ | 835 |   | $ | 287 |   |
| Deferred:      |       |                                                         |       |   |   |   |   |
| Federal        |       | $                                                            | —     |   | $ | — |   | $ | — |   |
| Foreign        |       | (320                                                         | )          | (279 | ) | (1,891 | ) |
| State          |       | —                                                       |       | — |   | — |   |
| Total deferred |       | (320                                                         | )          | (279 | ) | $ | (1,891 | ) |
|           |       |                                                         |       |   |   |   |   |
| Total          |       | $                                                            | 560        |   | $ | 556 |   | $ | (1,604 | ) |

 

As of December 31, 2008 and 2007, we had net operating losscarryforwards (“NOL”) of approximately $49.5 million and $50.5 million,respectively, related to U.S. federal and state jurisdictions.  The federal net operating loss expires atvarious times beginning in 2019 and ending in 2029.  In addition, we have research andexperimentation credit carryforwards of approximately $0.9 million which mayexpire at various times beginning in 2012. Of our $49.5 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. In 2008, we were subject toalternative minimum tax in the U.S. for $25,000.  A deferred tax asset in this amount has beenestablished with a full valuation allowance 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.

 

Deferredtax assets and liabilities reflect the net tax effects of temporary differencesbetween the carrying amount of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes.  Significant components of our deferred taxassets and liabilities were as follows (in thousands):

 
| ** **                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Deferred tax assets:                                      |       |                  |       |   |   |
| Net operating loss carryforwards                          |       | $                     | 18,493     |   | $ | 18,872 |   |
| Research & experimentation credit  carryforwards |       | 854                   |       | 854 |   |
| Equity compensation                                       |       | 422                   |       | 295 |   |
| AMT Credit                                                |       | 81                    |       | — |   |
| Depreciable assets                                        |       | 409                   |       | 512 |   |
| Acquired intangibles                                      |       | 673                   |       | 565 |   |
| Other                                                     |       | 136                   |       | 116 |   |
| Total deferred tax assets                                 |       | 21,068                |       | 21,214 |   |
| Deferred tax liabilities                                  |       |                  |       |   |   |
| Undistributed foreign earnings                            |       | (698                  | )          | (541 | ) |
| Acquired intangibles                                      |       | (691                  | )          | (1,151 | ) |
| Total deferred tax liability                              |       | (1,389                | )          | (1,692 | ) |
| Net deferred tax assets, before valuation  allowance      |       | 19,679                |       | 19,522 |   |
| Valuation allowance                                       |       | (20,079               | )          | (20,430 | ) |
| Net deferred tax liability                                |       | $                     | (400       | ) | $ | (908 | ) |
|                                                      |       |                  |       |   |   |
| ** **                                                | ** ** | **December 31,** | ** ** |
| ** **                                                | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Financial statement classification:                       |       |                  |       |   |   |
| Current deferred tax asset/liability                      |       | $                     | (15        | ) | $ | (30 | ) |
| Long-term deferred tax liability                          |       | (385                  | )          | (878 | ) |
| Net deferred tax liability                                |       | $                     | (400       | ) | $ | (908 | ) |

 

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In conjunction with the acquisition ofEvolving Systems U.K., we recorded certain identifiable intangible assets. Weestablished a deferred tax liability of $4.6 million at the acquisition datefor the expected difference between what would be expensed for financialreporting purposes and what would be deductible for income tax purposes. Thisdeferred tax liability related to Evolving Systems U.K. and has no impact onour ability to recover our U.S. based deferred tax assets. As of December 31,2008 and 2007, this deferred tax liability was $0.7 million and $1.2 million,respectively. This deferred tax liability will be recognized as theidentifiable intangibles are amortized.

 

Wecontinue to maintain a full valuation allowance on the domestic net deferredtax asset as we have determined it is more likely than not that we will notrealize our domestic deferred tax assets. Such assets primarily consist ofcertain net operating loss carryforwards. We assessed the realizability of ourdomestic deferred tax assets using all available evidence. In particular, weconsidered both historical results and projections of profitability for thereasonably foreseeable future periods. We are required to reassess ourconclusions regarding the realization of our deferred tax assets at eachfinancial reporting date. A future evaluation could result in a conclusion thatall or a portion of the valuation allowance is no longer necessary which couldhave a material impact on our results of operations and financial position.

 

Theincome tax benefit differs from the amount computed by applying the U.S.federal income tax rate of 34% to income (loss) before income taxes as follows(in thousands):

** **
| ** **                                                    | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                          |       |                                                          |       |   |   |   |   |
| U.S. federal income tax expense (benefit)  at statutory rates |       | $                                                             | 1,186      |   | $ | 393 |   | $ | (6,252 | ) |
| State income tax expense (benefit), net of  federal impact    |       | 28                                                            |       | (50 | ) | (163 | ) |
| Goodwill impairment                                           |       | —                                                        |       | — |   | 3,217 |   |
| Non-deductible meals                                          |       | 10                                                            |       | 13 |   | 12 |   |
| Foreign rate differential                                     |       | (61                                                           | )          | (4 | ) | 240 |   |
| Foreign deemed dividends                                      |       | 125                                                           |       | 63 |   | (77 | ) |
| Change in valuation allowance                                 |       | (351                                                          | )          | (47 | ) | 1,815 |   |
| Equity compensation                                           |       | 118                                                           |       | 79 |   | 121 |   |
| Research and development expenses                             |       | (564                                                          | )          | (312 | ) | (483 | ) |
| FIN 48 adjustment                                             |       | —                                                        |       | 433 |   | — |   |
| Foreign taxes                                                 |       | 84                                                            |       | 33 |   | — |   |
| Other, net                                                    |       | (15                                                           | )          | (45 | ) | (34 | ) |
| Income tax expense (benefit)                                  |       | $                                                             | 560        |   | $ | 556 |   | $ | (1,604 | ) |

 

Effective January 1, 2007, we adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes - aninterpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 prescribes a recognition threshold anda measurement attribute for the financial statement recognition and measurementof tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a taxposition must be more-likely-than-not to be sustained upon examination bytaxing authorities.  There was nomaterial impact on the company’s consolidated financial position and results ofoperations as a result of the adoption of the provisions of FIN 48.

 

On January 1, 2007, we recorded a FIN 48 transition adjustmentconsisting of a $0.4 million decrease in our deferred tax assets related toResearch and Development Tax Credits that was offset by a correspondingdecrease in our valuation allowance as we determined that it was not morelikely than not that our deferred tax assets will be realized.  As of December 31, 2007, we had noliability for unrecognized tax benefits. We do not believe there will be any material changes our unrecognizedtax positions over the next twelve months.

 

During 2006, we recorded a $224,000 tax benefit for research anddevelopment expenses related to a change in estimate based on our as filed 2005tax return for Evolving Systems U.K.

 

We conduct business globally and, as a result, Evolving Systems, Inc.or one or more of our subsidiaries file income tax returns in the U.S. federaljurisdiction and various state and foreign jurisdictions.  In the normal course of business, we aresubject to examination by taxing authorities throughout the world, namely theUnited Kingdom, Germany and India.  Withfew exceptions, we are no longer subject to U.S. federal, state and local, ornon-U.S. income tax examinations for years before 2003.

 

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During 2004, we formed Evolving Systems India, a wholly ownedsubsidiary of Evolving Systems, Inc. which is used for offshore productdevelopment.  We were granted a tax holiday by India whichextends through March 2009.  Underthe terms of the tax holiday, we are not liable for income taxes associated withour operations in India.

 

**NOTE 6 – STOCKHOLDERS’ EQUITY**

 

## ***(a)           Series B Convertible Redeemable Preferred Stock***

## *** ***

OnNovember 2, 2004, we issued 966,666 shares of Series B PreferredStock in connection with our acquisition of Evolving Systems U.K.  During 2007, holders of 487,916 shares of Series BPreferred Stock, or approximately 50% of the outstanding preferred stock as of January 1,2007, with an aggregate carrying value of $5.7 million, converted their sharesof preferred stock into 1,463,748 shares of our common stock in accordance withthe conversion provisions of the Series B Preferred Stock.

 

On February 25, 2008, holders of 461,758shares of Series B Preferred Stock with a carrying value of $5.4 million,or approximately 96% of the outstanding preferred stock, converted their sharesof preferred stock into 1,385,274 shares of our common stock in accordance withthe conversion provisions of the Series B Preferred Stock.  On March 19, 2008, a holder of 16,992shares of Series B Preferred Stock with a carrying value of $0.2 million,which represented the remainder of the outstanding preferred stock, convertedhis shares of preferred stock into 50,976 shares of our common stock inaccordance with the conversion provisions of the Series B Preferred Stock.  As we previously included the Series B Convertible Preferred Stockas a participating security for basic EPS purposes, these conversions did notchange our basic or diluted EPS calculations.

 

Basedon the specific features of the Series B Preferred Stock, the issuancedate fair value was estimated to be approximately the same as its value uponredemption, which is the same as its value upon liquidation. The Series BPreferred Stock was entitled to dividends on an as-converted basis with thecommon stock and was, therefore, considered a participating security and sharesissuable upon conversion are included in weighted average shares outstandingfor purposes of calculating basic earnings per share.  Upon the occurrence of certain materialevents (liquidation, merger, etc.), the holders of Series B PreferredStock were entitled to receive a preference payment that is senior to thecommon stock, but subordinate to our senior and unsecured subordinate debt,equal to the sum of the number of shares of common stock into which each shareof Series B Preferred Stock is convertible as of the date of such eventmultiplied by $3.89 per share (subject to adjustment for stock splits andcombinations), or $0 and $5.6 million at December 31, 2008 and 2007,respectively.

 

**(b)           Certain****Anti-Takeover Provisions**

 

Our restated certificate of incorporationallows the board of directors to issue up to 2,000,000 shares of preferredstock and to determine the price, rights, preferences and privileges of thoseshares without any further vote or action by our stockholders. The rights ofthe holders of our common stock will be subject to, and may be adverselyaffected by, the rights of the holders of any preferred stock that may beissued in the future. Issuance of preferred stock, while providing desiredflexibility in connection with possible acquisitions and other corporatepurposes, could make it more difficult for a third party to acquire a majorityof our outstanding voting stock. In 1999, our Board of Directors designated250,000 shares of Series A Junior Participating Preferred Stock thatcontain “poison pill” provisions. In connection with the Evolving Systems U.K.acquisition, we issued 966,666 shares of Series B Preferred Stock.  As of December 31, 2008 and 2007, 0 and478,750 shares of Series B Preferred Stock are outstanding, respectively.

 

In addition, we are subject to theanti-takeover provisions of Section 203 of Delaware General CorporationLaw which prohibit us from engaging in a “business combination” with an “interestedstockholder” for a period of three years after the date of the transactionin which the person became an interested stockholder, unless the businesscombination is approved in the prescribed manner. The application of Section 203and certain provisions of our restated certificate of incorporation, includinga classified board of directors, may have the effect of delaying or preventingchanges in control of our management, which could adversely affect the marketprice of our common stock by discouraging or preventing takeover attempts thatmight result in the payment of a premium price to our stockholders.

 

On February 25, 2008 we entered into a Standstill Agreement (the “StandstillAgreement”) with Karen Singer, Trustee of the Singer Children’s Management Trust(the “Singer Trust”) in which the Board of Directors agreed to appoint twoindependent members to the Board of Directors and to waive the provisions of Section 203of the Delaware General Corporation Law (“Section 203”), as it related tothe Singer Trust’s acquisition of our stock, provided that the Singer Trust andits affiliates 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

 

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proposeany matter to be voted on by stockholders of the Company and it would vote itsshares in favor of the Company’s nominees for directors.

 

**NOTE 7 – SHARE-BASED COMPENSATION**

 

Weadopted SFAS 123R effectiveJanuary 1, 2006 using the modified prospective method.  We previously applied theintrinsic-value-based method in accounting for the recognition of stock-basedcompensation arrangements and the fair value method only for disclosurepurposes.  Because we historicallygranted options with exercise prices equal to the fair market value of ourcommon stock at the grant date, the adoption of SFAS 123R on January 1,2006 did not result in a significant impact on our financial statements.  Further, as a result of the preceding, ourconsolidated statements of operations from January 1, 2006 forward includecharges for stock-based compensation. We recognized $0.8 million, $0.7 millionand $0.8 million of compensation expense in the consolidated statements ofoperations for the years ended December 31, 2008, 2007 and 2006,respectively, with respect to our stock-based compensation plans.  The following table summarizes stock-basedcompensation expenses recorded in the statement of operations (in thousands):

** **
| ** **                                                                 | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cost of license fee and services, excluding  depreciation and amortization |       | $                                                             | 62         |   | $ | 59 |   | $ | 57 |   |
| Cost of customer support, excluding depreciation  and amortization         |       | 7                                                             |       | 2 |   | 8 |   |
| Sales and marketing                                                        |       | 137                                                           |       | 151 |   | 183 |   |
| General and administrative                                                 |       | 551                                                           |       | 478 |   | 513 |   |
| Product development                                                        |       | 82                                                            |       | 20 |   | 47 |   |
|                                                                       |       | $                                                             | 839        |   | $ | 710 |   | $ | 808 |   |

 

**Stock Option/Incentive Plans**

 

In January 1996, ourstockholders approved “The Amended and Restated Stock Option Plan” (the “OptionPlan”).  Initially, 3,150,000 shares werereserved for issuance under the Option Plan. Subsequently, our stockholders approved an amendment to the Option Planto increase the number of shares available for issuance to 8,350,000. Optionsissued under the Option Plan were at the discretion of the Board of Directors,including the vesting provisions of each stock option granted. Options weregranted with an exercise price equal to the closing price of our common stockon the date of grant, generally vest over four years and expire no more than tenyears from the date of grant. The Option Plan terminated on January 18,2006; options granted before that date were not affected by the plantermination.

 

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

 

In June 2007, ourstockholders approved the “2007 Stock Incentive Plan” (the “2007 Stock Plan”).  A maximum of 2,000,000 shares may be issuedunder the 2007 Stock Plan.  Awardspermitted under the 2007 Stock Plan include: Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted StockUnits, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan areat the discretion of the Board of Directors. As applicable, awards are granted with an exercise price equal to theclosing price of our common stock on the date of grant, generally vest overfour years for employees and one year for board members and expire no more thanten years from the date of grant.

 

In December 2008 and2007, under the 2007 Stock Plan, we awarded a total of 105,000 and 137,500,respectively, shares of restricted stock to members of our board of directorsand senior management.  During the yearsended December 31, 2008 and 2007, 83,000 and 57,000 shares of restricted stock vested,respectively. There were no forfeitures of restricted stock during the yearsended December 31, 2008 and 2007.  Thefair market value for share-based compensation expensing is equal to theclosing price of our common stock on the date of grant.  The restrictions on the stock award arereleased generally over four years for senior management and over one year forboard members.

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesmodel.  The Black-Scholes model uses fourassumptions to calculate the fair value of each option grant.  The expected term of share options granted isderived using the simplified method as prescribed by the SEC Staff AccountingBulletin 107, “Share-Based Payment” as amended by SAB 110, which permits use ofthe simplified method after December 31, 2007.  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 the stock options.  The expected volatility is based uponhistorical volatility of our common stock over a period equal to the expectedterm of the stock options.  The expecteddividend yield is zero and is based upon historical and anticipated payment ofdividends.  The weighted-averageassumptions used in the fair value 

 

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calculations are as follows:

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected term (years)   |       | 6.1                                                           |       | 6.1 |   | 6.1 |   |
| Risk-free interest rate |       | 1.77                                                          | %          | 3.98 | % | 4.35 | % |
| Expected volatility     |       | 83.95                                                         | %          | 105.74 | % | 121.14 | % |
| Expected dividend yield |       | 0                                                             | %          | 0 | % | 0 | % |

 

The following is a summary of stock option activity under the plan forthe year ended December 31, 2008:

 
| ** **                                     | ** ** | ** **              | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **              | ** ** |
|------------------------------------------------|------------|-------------------------|------------|---------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                     | ** ** | ** **              | ** ** | ** **    | ** ** | **Average**     | ** ** | ** **              | ** ** |
| ** **                                     | ** ** | ** **              | ** ** | **Weighted-** | ** ** | **Remaining**   | ** ** | **Aggregate**           | ** ** |
| ** **                                     | ** ** | **Number of**      | ** ** | **Average**   | ** ** | **Contractual** | ** ** | **Intrinsic**           | ** ** |
| ** **                                     | ** ** | **Shares**              | ** ** | **Exercise**  | ** ** | **Term**        | ** ** | **Value**               | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** | **Price**     | ** ** | **(Years)**     | ** ** | **(in thousands)** | ** ** |
| Options outstanding at December 31,  2007 |       | 4,534                   |       | $             | 3.02       |            |       |                    | $          | 2,845 |   |
| Options granted                                |       | 483                     |       | $             | 1.00       |            |       |                    |       |   |
| Less options forfeited                         |       | (149                    | )          | $             | 2.85       |            |       |                    |       |   |
| Less options expired                           |       | (209                    | )          | $             | 3.39       |            |       |                    |       |   |
| Less options exercised                         |       | (5                      | )          | $             | 0.76       |            |       |                    |       |   |
| Options outstanding at December 31,  2008 |       | 4,654                   |       | $             | 2.81       |            | 5.70       |                    | $          | 78 |   |
|                                           |       |                    |       |          |       |            |       |                    |       |
| Options exercisable at December 31,  2008 |       | 3,609                   |       | $             | 3.15       |            | 4.77       |                    | $          | 70 |   |

 

The weighted-averagegrant-date fair value of stock options granted during the years ended December 31,2008, 2007 and 2006 was $1.00, $1.83 and $2.05 respectively.

 

As of December 31,2008, there were approximately $1.6 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 1.4 years.

 

The total intrinsic value ofstock option exercises for the years ended December 31, 2008, 2007 and2006 was $5,000, $23,000 and $15,000, respectively.  The total fair value of stock awards vestedduring the years ended December 31, 2008, 2007 and 2006 was $1.0 million,$0.7 million and $0.4 million, respectively.

 

The deferred income taxbenefits from stock options expense related to Evolving Systems U.K. totaledapproximately $58,000, $41,000 and $27,000 for the years ended December 31,2008, 2007 and 2006, respectively.

 

Cash received from stockoption exercises was $4,000, $19,000 and $14,000 for the years ended December 31,2008, 2007 and 2006, respectively.

 

Prior to the adoption of SFAS 123R on January 1,2006, we applied the intrinsic-value-based method in accounting for therecognition of employee stock-based compensation arrangements and the fairvalue method for disclosure purposes.

 

**Employee Stock Purchase Plan**

 

Under the Employee StockPurchase Plan (“ESPP”), we are authorized to issue up to 1,100,000 shares ofour common stock to full-time employees, nearly all of whom are eligible to participate.Under the terms of the ESPP, employees may elect to have up to 15% of theirgross salaries withheld through payroll deduction to purchase our common stock,capped at $25,000 annually. The purchase price of the stock is 85% of the lowerof the market price at the beginning or end of each three-month participationperiod.  As of December 31, 2008,there were 247,000 shares available for purchase.  For the years ended December 31, 2008,2007 and 2006, we recorded compensation expense of $21,000,  $22,000 and $46,000, respectively, associatedwith grants under the ESPP which includes the fair value of the look-backfeature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period based

 

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upon employee participation.

 

The fair value of each grantmade under our ESPP is estimated on the date of grant using the Black-Scholesmodel.  The Black-Scholes model uses fourvariables 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 uponhistorical volatility of our common stock. The expected dividend yield is based upon historical and anticipatedpayment of dividends.  The weightedaverage assumptions used in the fair value calculations are as follows:

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected term (years)   |       | 0.25                                                          |       | 0.25 |   | 0.25 |   |
| Risk-free interest rate |       | 0.86                                                          | %          | 4.58 | % | 5.02 | % |
| Expected volatility     |       | 66.81                                                         | %          | 67.52 | % | 78.18 | % |
| Expected dividend yield |       | 0                                                             | %          | 0 | % | 0 | % |

 

Cash received from employeestock plan purchases was $68,000, $70,000 and $112,000 for the years ended December 31,2008, 2007 and 2006, respectively.  Weissued shares related to the ESPP of 46,000, 60,000 and 83,000 for the yearsended December 31, 2008, 2007 and 2006, respectively.

 

**NOTE 8 – BENEFIT PLANS**

 

We have established a defined contributionretirement plan for our employees under section 401(k) of the InternalRevenue Code (the “401(k) Plan”) that is available to all U.S. employees21 years of age or older with a month of service. Employees may contributeup to 15% of gross compensation not to exceed the maximum statutorycontribution amount. We may make discretionary matching contributions. Allemployee contributions are fully vested immediately and employer contributionsvest over a period of three years.  Forthe years ended December 31, 2007 and 2006, we made discretionary matchingcontributions using funds available in the 401(k) Plan’s forfeitureaccount. For the year ended December 31, 2008, we will make a matchingcontribution using our cash balances. This contribution will be made during thefirst quarter of 2009.

 

Evolving Systems U.K. has established adefined contribution pension scheme that is available to all employees in theirfirst full month of employment. Employees may contribute a percentage of their earnings, the amount ofwhich is dependent upon the age of the employee, not to exceed the maximumstatutory contribution amount.  We match5% of employee contributions.  Allcontributions are immediately vested in their entirety.

 

During 2008, 2007 and 2006, we recorded aconsolidated expense of $486,000, $483,000 and $366,000, respectively, underthe aforementioned plans.

 

**NOTE 9 – EARNINGS PER SHARE**

 

Basic earnings per share (“EPS”) is computedby dividing net income or loss available to common stockholders by the weightedaverage number of shares of common stock outstanding during the period,including common stock issuable under participating securities, such as the Series BPreferred Stock. Diluted EPS is computed using the weighted average number ofshares of common stock outstanding, including participating securities, plusall potentially dilutive common stock equivalents using the treasury stockmethod. Common stock equivalents consist of stock options. The following is thereconciliation of the numerators and denominators of the basic and diluted EPScomputations (in thousands except per share data):

 
| ** **                                                        | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Basic income (loss) per common and  preferred share:              |       |                                                          |       |   |   |   |   |
| Net income (loss) available to common and  preferred shareholders |       | $                                                             | 2,929      |   | $ | 598 |   | $ | (16,783 | ) |
| Weighted average common shares outstanding                        |       | 19,265                                                        |       | 17,467 |   | 16,200 |   |
| Participating securities                                          |       | 124                                                           |       | 1,731 |   | 2,900 |   |
| Basic weighted average shares outstanding                         |       | 19,389                                                        |       | 19,198 |   | 19,100 |   |
| Basic income (loss) per common and  preferred share               |       | $                                                             | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) |
|                                                              |       |                                                          |       |   |   |   |   |
| Diluted income (loss) per common and  preferred share:            |       |                                                          |       |   |   |   |   |
| Net income (loss) available to common and  preferred shareholders |       | $                                                             | 2,929      |   | $ | 598 |   | $ | (16,783 | ) |
| Weighted average common shares outstanding                        |       | 19,265                                                        |       | 17,467 |   | 16,200 |   |
| Participating securities                                          |       | 124                                                           |       | 1,731 |   | 2,900 |   |
| Effect of dilutive securities – options                      |       | 367                                                           |       | 378 |   | — |   |
| Diluted weighted average shares outstanding                       |       | 19,756                                                        |       | 19,576 |   | 19,100 |   |
| Diluted income (loss) per common and  preferred share             |       | $                                                             | 0.15       |   | $ | 0.03 |   | $ | (0.88 | ) |

 

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Weighted average options to purchase 3.5million, 3.2 million and 3.3 million shares of common stock equivalents wereexcluded from the computation of diluted weighted average shares outstandingfor the years ended December 31, 2008, 2007 and 2006, respectively,because the effect would have been anti-dilutive since their exercise priceswere greater than the average market value of our common stock for the period.Weighted average options to purchase 0.9 million shares of common stock wereexcluded from the computation of diluted weighted average shares outstandingfor the year ended December 31, 2006, as their effect would have beenanti-dilutive as a result of the net loss for the period.

 

**NOTE 10 – COMMITMENTS AND CONTINGENCIES**

 

**(a)           LeaseCommitments**

 

We lease office and operating facilities andequipment under non-cancelable operating leases. Current facility leasesinclude our headquarters; the London and Bath, England and Munich, Germanyoffices which were assumed as part of the Evolving Systems U.K. acquisition;the Bangalore, India office; the Kuala Lumpur, Malaysia office and the Windsor,England office. Rent expense was $1.1 million, $1.4 million and $1.6 millionfor the years ended December 31, 2008, 2007 and 2006, respectively. Rentexpense is net of sublease rental income of $0, $117,000 and $142,000 for theyears ended December 31, 2008, 2007 and 2006, respectively.

 

Our headquarters facility lease contains aclause that adjusts the lease rate every year. The lease rate increasesannually as of November 1.  Weaccount for the effect of such escalating lease payments as if the lease ratewere consistent over the lease term.

 

Future minimum commitments undernon-cancelable operating leases and capital leases as of December 31, 2008are as follows (in thousands):

 
| ** **                                          | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
| 2009                                                |       | $                     | 1,088      |                | $          | 30 |   |
| 2010                                                |       | 654                   |       | 30                  |       |
| 2011                                                |       | 506                   |       | 30                  |       |
| 2012                                                |       | 430                   |       | 8                   |       |
| 2013                                                |       | —                |       | —              |       |
| Total minimum lease payments                        |       | $                     | 2,678      |                | 98         |   |
| Less: Amount representing interest                  |       |                  |       | (18                 | )          |
| Principal balance of capital lease  obligations     |       |                  |       | 80                  |       |
| Less: Current portion of capital lease  obligations |       |                  |       | (21                 | )          |
| Long-term portion of capital lease  obligations     |       |                  |       | $                   | 59         |   |

 

**(b)           OtherCommitments**

 

Aspermitted under Delaware law, we have agreements with officers and directorsunder which we agree to indemnify them for certain events or occurrences whilethe officer or director is, or was serving, at our request in this capacity.The term of the indemnification period is indefinite. There is no limit on theamount of future payments we could be required to make under theseindemnification agreements; however, we maintain Director and Officer insurancepolicies, as well as an Employment Practices Liability Insurance Policy, thatmay enable us to recover a portion of any amounts paid. As a result of ourinsurance policy coverage, we believe the estimated fair value of these indemnificationagreements is minimal. Accordingly, we did not record any liabilities for theseagreements as of December 31, 2008 and 2007.

 

Weenter into standard indemnification terms with customers and suppliers, asdiscussed below, in the ordinary course of business.  As we may subcontract the development ofdeliverables under customer contracts, we could be required to indemnifycustomers for work performed by subcontractors. Depending upon the nature ofthe customer indemnification, the potential amount of future payments we couldbe required to make under these indemnification agreements may be unlimited. Wemay be able to recover

 

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damagesfrom a subcontractor 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’failure to 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 31,2008 and 2007.

 

Ourstandard license agreements contain product warranties that the software willbe free of material defects and will operate in accordance with the statedrequirements for a limited period of time. The product warranty provisions require us to cure any defects throughany reasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, we did not record anyliabilities for these product warranty provisions as of December 31, 2008and 2007.

 

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

 

In relation to the acquisitions of EvolvingSystems U.K., Telecom Software Enterprises, LLC (TSE) and CMS Communications, Inc.(CMS), we agreed to indemnify certain parties from any losses, actions, claims,damages or liabilities (or actions in respect thereof) resulting from any claimraised by a third party.  We do notbelieve that there will be any claims related to these indemnifications.Accordingly, we did not record any liabilities for these agreements as of December 31,2008 and 2007.

 

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

 

During the fourth quarter of 2006, a previousvendor filed a complaint in the Superior Court of New Jersey against usasserting we breached certain provisions of a license agreement.  While the outcome of this matter isuncertain, we believe we have paid all fees due under our license agreement andwill continue to vigorously defend this claim.

 

We are involved in various other legalmatters 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.

 

**NOTE 11 – SEGMENT INFORMATION**

 

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

 

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

 

Revenue information by segments was asfollows (in thousands):

 
| ** **                                                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenue**                                                                 | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                   |       | $                                                             | 20,324     |   | $ | 17,895 |   | $ | 15,883 |   |
| Customer support                                                            |       | 17,497                                                        |       | 18,058 |   | 17,950 |   |
| Total revenue                                                               |       | 37,821                                                        |       | 35,953 |   | 33,833 |   |
|                                                                        |       |                                                          |       |   |   |   |   |
| **Revenue less costs of revenue, excluding depreciation  and amortization** |       |                                                          |       |   |   |   |   |
| License fees and services                                                   |       | 12,508                                                        |       | 9,872 |   | 8,541 |   |
| Customer support                                                            |       | 11,394                                                        |       | 11,821 |   | 12,256 |   |
|                                                                        |       | 23,902                                                        |       | 21,693 |   | 20,797 |   |
| **Unallocated Costs**                                                       |       |                                                          |       |   |   |   |   |
| Other operating expenses                                                    |       | 17,783                                                        |       | 16,795 |   | 17,172 |   |
| Depreciation and amortization                                               |       | 2,210                                                         |       | 2,464 |   | 3,680 |   |
| Impairment of goodwill and intangible  assets                               |       | —                                                        |       | — |   | 16,516 |   |
| Restructuring and other expenses (recovery)                                 |       | —                                                        |       | (4 | ) | (21 | ) |
| Interest income                                                             |       | (161                                                          | )          | (304 | ) | (160 | ) |
| Interest expense                                                            |       | 1,171                                                         |       | 1,747 |   | 1,992 |   |
| Other income                                                                |       | (57                                                           | )          | — |   | — |   |
| Gain (loss) on extinguishment of debt                                       |       | (290                                                          | )          | (42 | ) | — |   |
| Foreign currency exchange gain                                              |       | (823                                                          | )          | (117 | ) | 5 |   |
| **Income (loss) before income taxes**                                       |       | $                                                             | 3,489      |   | $ | 1,154 |   | $ | (18,387 | ) |

 

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***Geographic Regions***

 

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

 
|           |       |                                                                   |       |   |       |      |       |   |   |   |
|----------------|------------|------------------------------------------------------------------------|------------|--------|------------|-----------|------------|--------|--------|--------|
| ** **     | ** ** | **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 revenues |       | $                                                                      | 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 revenues |       | $                                                                      | 17,895     |   | $          | 18,058    |       | $      | 35,593 |   |
|           |       |                                                                   |       |   |       |      |       |
| ** **     | ** ** | **For the Year Ended December 31, 2006**                          | ** ** |
| ** **     | ** ** | **L&S**                                                            | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                                                   |       |   |       |      |       |
| United States  |       | $                                                                      | 2,863      |   | $          | 11,320    |       | $      | 14,183 |   |
| United Kingdom |       | 6,099                                                                  |       | 2,470  |       | 8,569     |       |
| Other          |       | 6,921                                                                  |       | 4,160  |       | 11,081    |       |
| Total revenues |       | $                                                                      | 15,883     |   | $          | 17,950    |       | $      | 33,833 |   |

 
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2008**              | ** ** | **2007** | ** ** |
| **Long-lived assets, net** |       |                  |       |   |   |
| United States              |       | $                     | 7,060      |   | $ | 7,814 |   |
| United Kingdom             |       | 17,327                |       | 24,883 |   |
| Other                      |       | 75                    |       | 84 |   |
|                       |       | $                     | 24,462     |   | $ | 32,781 |   |

 

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

** **
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|---------------------------------------------------------------|------------|
| ** **          | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenue**         |       |                                                          |       |   |   |   |   |   |   |   |
| Activation          |       | $                                                             | 20,639     |   | $ | 19,533 |   | $ | 16,717 |   |
| Numbering solutions |       | 13,270                                                        |       | 11,919 |   | 12,006 |   |
| Mediation           |       | 3,912                                                         |       | 4,501 |   | 5,110 |   |
| Total revenues      |       | $                                                             | 37,821     |   | $ | 35,953 |   | $ | 33,833 |   |

 

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

 

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

** **
| ** **                                         | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                         | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                               |       |        |       |        |       |        |       |        |       |
| **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                                              |       | $           | (0.01      | )           | $          | 0.04        |       | $           | 0.03       |   | $ | 0.09 |   |
| Diluted                                            |       | $           | (0.01      | )           | $          | 0.04        |       | $           | 0.03       |   | $ | 0.09 |   |
|                                               |       |        |       |        |       |        |       |        |       |
| **Year Ended December 31, 2007**              |       |        |       |        |       |        |       |        |       |
| Total revenue                                      |       | $           | 8,461      |        | $          | 9,122       |       | $           | 9,311      |   | $ | 9,059 |   |
| Less: cost of revenue and operating  expenses      |       | 8,231       |       | 8,493       |       | 8,232       |       | 8,559       |       |
| Income from operations                             |       | 230         |       | 629         |       | 1,079       |       | 500         |       |
| Income (loss) before income taxes                  |       | (186        | )          | 155         |       | 914         |       | 271         |       |
| Net income (loss)                                  |       | $           | (326       | )           | $          | 72          |       | $           | 569        |   | $ | 284 |   |
| Net income (loss) per common and preferred  share: |       |        |       |        |       |        |       |        |       |
| Basic                                              |       | $           | (0.02      | )           | $          | —      |       | $           | 0.03       |   | $ | 0.01 |   |
| Diluted                                            |       | $           | (0.02      | )           | $          | —      |       | $           | 0.03       |   | $ | 0.01 |   |

 

**NOTE 13 – RELATED PARTY TRANSACTIONS**

 

EffectiveJanuary 1, 2008, we entered into a one-year consulting agreement withStephen K. Gartside, Jr., our previous President and CEO and currentChairman of the Board.  Under theagreement, we paid Mr. Gartside a fee of $20,000 for consulting servicesprovided to us during 2008.  We had currentobligations in the consolidated balance sheets, under the agreement, of $5,000and $0 as of December 31, 2008 and 2007, respectively.  We recorded $20,000 of general andadministrative expense in the consolidated statements of operations, related tothis agreement, for the year ended December 31, 2008.

 

**NOTE 14 – SUBSEQUENT EVENTS**

 

On March 4,2009 our Board of Directors adopted a stockholder rights plan that is designedto strengthen the ability of the Board of Directors to protect Evolving Systems’stockholders.  The plan was not adopted in response to any unsolicitedoffer or takeover attempt. Under the Plan, each common stockholder of theCompany at the close of business on March 16, 2009 will receive a dividendof one right for each share of the Company’s common stock held of record onthat date.  Each right will entitle the holder to purchase from theCompany, in certain circumstances, one one-hundredth of a share ofnewly-created Series C junior participating preferred stock of the Companyfor an initial purchase price of $8.00 per share. The rights distribution willnot be taxable to stockholders and the distribution of rights under the planwill not interfere with the Company’s business plans or be dilutive to oraffect the Company’s reported per share results.

 

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**ITEM 9.****                      ****CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS 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.

 

Our management,with the participation of the Chief Executive Officer and Chief FinancialOfficer, has evaluated the effectiveness of our disclosure controls andprocedures 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 in evaluatingthe cost-benefit relationship of possible disclosure controls and procedures.The design of any disclosure controls and procedures also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.

 

*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, 2008.

 

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.

 

*Changesin internal control over financial reporting. *During thethree and twelve months ended December 31, 2008, 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.****             ****OTHER INFORMATION**

 

None.

 

**PART III**

 

**ITEM 10.****               ****DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE GOVERNANCE**

 

Incorporated by reference to the sections ofEvolving Systems, Inc. 2009 Proxy Statement, anticipated to be filedwithin 120 days of December 31, 2008, entitled “Proposal No. 1—Electionof Directors,” “Management” and “Information Regarding the Board and ItsCommittees.”

 

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**ITEM 11.****               ****EXECUTIVE COMPENSATION**

 

Incorporated by reference to the section ofEvolving Systems, Inc. 2009 Proxy Statement, anticipated to be filedwithin 120 days of December 31, 2008, entitled “Summary CompensationTable.”

 

**ITEM 12.****               ****SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Incorporated by reference to the section ofthe Evolving Systems, Inc. 2009 Proxy Statement, anticipated to be filedwithin 120 days of December 31, 2008, entitled “Information Regarding Beneficial Ownership ofPrincipal Stockholders, Directors, and Management.”

 

**ITEM 13.****               ****CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

Incorporated by reference to the sections of the Evolving Systems, Inc.2009 Proxy Statement, anticipated to be filed within 120 days of December 31,2008, entitled “Certain Relationships and Related Transactions” and “InformationRegarding the Board and Its Committees.”

 

**ITEM 14.****               ****PRINCIPAL ACCOUNTING FEESAND SERVICES**

 

Incorporated by reference to the section ofthe Evolving Systems, Inc. 2009 Proxy Statement, anticipated to be filed within120 days of December 31, 2008, entitled “Report of the AuditCommittee.”

 

**PART IV**

 

**ITEM 15.****               ****EXHIBITS AND FINANCIALSTATEMENT SCHEDULES**

 

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

 

Consolidated Financial Statements.

 

Consolidated Financial Statement Scheduleshave been omitted because the required information is not present, or notpresent in amounts sufficient to require submission of the schedules or becausethe required information is provided in the Consolidated Financial Statementsor 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.               |
| 3.2†            |       | 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.                                                                                                                                                                                    |
| 10.1† *         |       | Indemnification  Agreement, entered into by the Registrant and each of its directors and  executive officers, dated as of January 1, 1998.                                                                                                     |

 

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| 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.                                                                                                                            |
| 10.10†  |   | 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.                                                                                                                                                                                                                                                                                                |
| 23.1         |   | Consent  of Grant Thornton LLP, Independent Registered Public Accounting Firm related  to Registration Statements on Forms S-3 and S-8.                                                                                                                                                                                         |
| 23.2         |   | Consent  of KPMG LLP, Independent Registered Public Accounting Firm related to  Registration Statements on Forms S-3 and S-8.                                                                                                                                                                                                   |
| 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.                                                                                                                                                                                                                      |
| 31.2         |   | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                      |

 

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| 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. |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |

 

----

†                                          Incorporated by reference to the Registrant’sRegistration Statement on Form S-1 No. 333-43973.

*                                         Identifies each management contract orcompensatory plan or arrangement.

 

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**SIGNATURES**

 

**Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.**

 

**EVOLVING SYSTEMS, INC.**

 
| By:    /s/  THADDEUS DUPPER |   | Chief  Executive Officer, President and Director |   | March 11,  2009 |
|--------------------------------------------|--------|--------------------------------------------------|--------|----------------------|
| Thaddeus Dupper                            |   |                                             |   |                 |

 

**POWER OFATTORNEY**

 

KNOW ALL MEN BY THESE PRESENTS, that eachperson whose signature appears below constitutes and appoints Thaddeus Dupperand Anita T. Moseley, or any of them, his or her attorney-in-fact, each withthe power of substitution, for him or her in any and all capacities, to signany amendments to this Report, and to file the same, with exhibits thereto andother documents in connections therewith, with the Securities and ExchangeCommission, hereby ratifying and confirming all that each of saidattorneys-in-fact, or his or her substitute or substitutes, may do or cause tobe done by virtue hereof.

 

**Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons n behalf of the registrant and in the capacities and onthe dates indicated.**

 
| **Signature**                                                                                        | ** ** | **Title**                                          | ** ** | **Date**            |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------|
|                                                                                                 |       |                                               |       |                |
| By:    /s/  THADDEUS DUPPER                                                           |       | Chief  Executive Officer, President and Director   |       | March 11, 2009 |
| Thaddeus Dupper                                                                                      |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:          /s/  BRIAN R. ERVINE                       |       | Executive  Vice President, Chief Financial Officer |       | March 11, 2009 |
| Brian R. Ervine                                                                                      |       | (Principal  Financial and Accounting Officer)      |       |                |
|                                                                                                 |       |                                               |       |                |
| By:    /s/  STEPHEN K. GARTSIDE, JR.                                                  |       | Chairman  of the Board of Directors                |       | March 11, 2009 |
| Stephen K. Gartside, Jr.                                                                        |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:    /S/ GEORGE A. HALLENBECK                                                       |       | Director                                           |       | March 11, 2009 |
| George A. Hallenbeck                                                                                 |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:              /S/ DAVID J. NICOL |       | Director                                           |       | March 11, 2009 |
| David J. Nicol                                                                                       |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:          /s/  PHILIP M. NECHES                      |       | Director                                           |       | March 11, 2009 |
| Philip M. Neches                                                                                     |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:       /s/  STEVE B. WARNECKE                                       |       | Director                                           |       | March 11, 2009 |
| Steve B. Warnecke                                                                                    |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:     /s/  BRUCE W. ARMSTRONG                                                  |       | Director                                           |       | March 11, 2009 |
| Bruce W. Armstrong                                                                                   |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:       /S/ RICHARD R. RAMLALL                                       |       | Director                                           |       | March 11, 2009 |
| Richard R. Ramlall                                                                                   |       |                                               |       |                |
|                                                                                                 |       |                                               |       |                |
| By:             /s/ DAVID S. OROS        |       | Director                                           |       | March 11, 2009 |
| David S. Oros                                                                                        |       |                                               |       |                |

 

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