**UNITED STATES**

**SECURITIES ANDEXCHANGE 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, 2007**                                                                                                             |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **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.**

(Exactname of registrant as specified in its charter)

 

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

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

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

** **

**(303) 802-1000**

(Registrant’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**

 

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

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act.                Yes o  No x

 

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

 

Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, 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 companyx |
|--------------------------------|--------------------------|-----------------------------------------------|----------------------------|
|                           |                     | (Do not check if a smaller reporting company) |                       |

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).          Yes o  No x

 

The approximate aggregate market value of the CommonStock held by non-affiliates of the registrant, based upon the last sale priceof the Common Stock reported on the Nasdaq Capital Market, was approximately$37.5 million as of June 30, 2007.

 

The number of shares of Common Stock outstanding was19,310,944 as of March 5, 2008.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

The information required by Part III (Items 10, 11,12, 13 and 14) is incorporated by reference to portions of the registrant’sdefinitive proxy statement for the 2008 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission within 120 daysafter the close of the 2007 year.

** **

 

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**EVOLVING SYSTEMS, INC.**

**Annual Report onForm 10-K**

**For the yearended December 31, 2007**

**Table ofContents**

 
| ** ** | ** **                                                                                                         | **Page**   |
|------------|--------------------------------------------------------------------------------------------------------------------|------------|
|       |                                                                                                               |       |
| ** ** | **PART I**                                                                                                    | ** ** |
| Item 1     | Business                                                                                                           | 1          |
| Item 1A    | Risk Factors                                                                                                       | 7          |
| Item 1B    | Unresolved Staff  Comments                                                                                         | 15         |
| Item 2     | Properties                                                                                                         | 16         |
| Item 3     | Legal Proceedings                                                                                                  | 16         |
| Item 4     | Submission of Matters to a Vote of Security  Holders                                                               | 16         |
| ** ** | **PART II**                                                                                                   | ** ** |
| Item 5     | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities | 16         |
| 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                                                        | 30         |
| 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                              | 58         |
| Item 9A    | Controls and Procedures                                                                                            | 58         |
| Item 9B    | Other Information                                                                                                  | 58         |
| ** ** | **PART III**                                                                                                  | ** ** |
| Item 10    | Directors, Executive Officers and  Corporate Governance                                                            | 58         |
| Item 11    | Executive Compensation                                                                                             | 59         |
| Item 12    | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                    | 59         |
| Item 13    | Certain Relationships and Related  Transactions, and Director Independence                                         | 59         |
| Item 14    | Principal Accounting Fees and Services                                                                             | 59         |
| ** ** | **PART IV**                                                                                                   | ** ** |
| Item 15    | Exhibits, Financial Statement Schedules                                                                            | 59         |
|       | Signatures                                                                                                         | 61         |

 

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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 providerof software solutions and services to the wireless, wireline and IP carriermarket. We maintain long-standing relationships with many of the largestwireline, wireless and IP communications carriers worldwide. Our customers relyon us to develop, deploy, enhance, maintain and integrate complex, highlyreliable software solutions for a range of Operations Support Systems (“OSS”).Included among our more than 50 global customers is the largest wirelinecarrier, the largest wireless carrier and the largest cable company in NorthAmerica, as well as two of the world’s largest wireless carriers headquartered outsideof North America. We offer software products and solutions in three core areas:

 

·                  service activation solutions used to activate complex bundles of voice, videoand data services for traditional and next generation wireless and wirelinenetworks;

 

·                  numbering solutions products used by carriers to manage theirtelephone number inventory and number assignment processes and products thatcomply with government-mandated requirements regarding local number portabilityin North America; and

 

·                  mediation solutions supporting data collection for both serviceassurance and billing applications.

 

Historically, our products have been used to support traditionalwireless and wireline network telephony capabilities; however, as a result ofour on-going investment in and improvement of our products, we now offerproducts to carriers to support both their convergent offerings over InternetProtocol (“IP”) and advanced broadband networks.

 

We report the operations of our business as two operating segments basedon revenue type:  license fees/servicesrevenue and customer support revenue.  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 ourConsolidated Financial 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 a limited number of largetelecommunications companies in the United States. In 1996, concurrent with thepassage of the Telecommunications Act of 1996 (“the Telecom Act”), we made astrategic decision to add software products to our established professionalservices offerings. The outcome of that decision was the creation of acomprehensive product portfolio, of which we are best known for our LocalNumber Portability and Number Management solutions.

 

In 2003 and 2004, we significantly expanded our portfolio of products asa 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 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 communicationcarriers throughout Europe, the Middle East, Africa and Asia. With thisacquisition we expanded our markets beyond North America and added anactivation solution, *TertioTM,*and amediation solution, *EvidentTM*, toour product portfolio. The consequence of these acquisitions is a significantlyexpanded product and service 

 

 

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capabilityto address a larger portion of our customers’ OSS application needs with abalanced mix of products and product enhancements, as well as services.

 

In2005, with our growing product portfolio and geographic reach, we enhanced oursales model to include both direct and indirect channels.  We formed new relationships with networkequipment providers and system integrators to extend our reach to newgeographical regions as well as help us further penetrate our existingterritories.   In 2006 and 2007, we addedmore regional partners to help with both local selling and deployments inemerging markets.

 

**RECENT DEVELOPMENTS**

 

**DynamicSIM Allocation***TM*

 

In 2007, weannounced our *Dynamic SIM Allocation*TM solutionthat offers carriers a new way to provision wireless services by dynamicallyactivating a wireless device when it is first used. In countries around theworld, the wireless Subscriber Identity Module (SIM) card is central to theprovision of wireless access and services. Typically, SIM cards are eitherpre-provisioned before they are distributed to the retail environment or areprovisioned at the point-of-sale. Pre-provisioning SIM cards means that phonenumbers are allocated a long time before the SIM card is available for sale,leading to poor utilization of numbers, increased network costs, and a pooruser experience since users cannot choose their phone number. Provisioning SIMcards at the point-of-sale overcomes some 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*TMsolution 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:

 

—        For wireless carriers that have a high proportion ofSIM cards that are never activated, the solution improves the utilization ofmobile phone numbers, reducing the cost of acquiring and owning number rangeswhile making sure new numbers are always available to meet demand.

 

—        Prepaid subscribers have traditionally been unable tochoose their mobile phone number easily and from a wide range of availablenumbers. With this solution, prepaid subscribers can choose their number usingjust their mobile phone, and carriers can monetize their valuable stock ofvanity or golden numbers.

 

—        Wireless carriers that have regional number allocationcan overcome SIM card supply chain inflexibility to reduce SIM card logisticaland capacity costs.

 

**INDUSTRY DYNAMICS**

 

Historically, telecommunications carriers have operated in a highlyregulated environment. Deregulation in many countries has stimulatedcompetition which has led to an increase in the number of telecommunicationscarriers that operate in a given market. This increase in competition coupled with the emergence of new telecommunicationstechnologies, such as fiber optics, packet-data networks, digital and wirelesstelephony as well as Internet-based services, has created an industry that isin the midst of significant change. Traditional wireline customers are migrating with an increasingfrequency to broadband and wireless services, requiring network operators tomake large capital expenditures in the areas of broadband and wirelessinfrastructure, as well as new product offerings to differentiatethemselves.  In response to these marketchanges, we have broadened our product portfolio through internal R&D,customer-funded initiatives and the acquisition of key new products andtechnologies.  The competitive landscapeis continually changing as the communications industry consolidates in almostevery geographic market.

 

**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 and activation aswell as inventory systems.  Orderingsystems collect customer information, retrieve current service information,capture and validate new service requests, verify the availability of selectedservices and transmit 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 network service and turn services off and on fornew customers, as well as change or add services for existing customers.  Service assurance systems allow carriers toperform the testing, monitoring and reporting necessary to maintain appropriatenetwork availability and feed operational data to other business systems.Service assurance systems also allow carriers to track and report on serviceconditions or outages in order to dispatch the carrier’s large work force fornecessary repairs. Carriers use billing systems to collate, manage and reportusage information for partner and customer billing. OSS systems typicallyoperate in a 24x7 environment to 

 

 

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supportthe real-time communication networks that are the backbone of the carriers’service offerings.

 

                Traditionally, as carriers haveadded new services, such as wireless or Internet-based services, they haveeither developed their own in-house OSS systems or added new OSS systems fromproduct vendors. These additional OSS systems can be difficult to integrateinto the carriers’ operations.  Inaddition, these various OSS systems often utilize incompatible elements, makinginteroperability among the systems difficult. These OSS systems are furtherconstrained by the many incremental changes that have been made in order toaccommodate new computing and network technologies and new value-addedservices, such as call waiting, call forwarding and voice mail, broadband dataand video.  In addition, carriers havehad to adapt their OSS to comply with government or regulatory mandates that insome cases change how systems and processes are required to work.  Despite these difficulties, the carriers havebeen unable to completely replace existing OSS systems due to the largeinvestment and vast amounts of historical data contained in these systems. As aresult, carriers continue to make incremental modifications to these OSSsystems, thereby further increasing their complexity and making it moredifficult for the systems to interoperate successfully.  However, a trend over the past decade hasbeen the replacement of a portion of the carrier’s legacy OSS environment withOSS software packages designed to meet growing complex processes in the areasof service fulfillment, service assurance and billing.

 

**PRODUCT PORTFOLIO**

 

# ***Service Activation***

# *** ***

                Our service activation solution,*TertioTM*, is employed by carriers toactivate a new subscriber or to add a new service to an existingsubscriber.  Our Tertio product providesa flexible operating environment and can be used by carriers to manage theirvoice, data, and content service needs for both their traditional and broadbandIP networks.  Our solution is deployed asthe service activation engine for over 50 networks around the world includingtwo of the world’s largest wireless carriers.

 

Tertio is anintegrated solution comprised of the following components:

 

·                  Tertio Service Composer — a modeling tool thatsimplifies the creation of new services;

 

·                  Tertio Content Connector — a tool used for activationof next-generation services;

 

·                  Tertio Activation Designer — a tool that is designedto speed network feature activation;

 

·                  Tertio Service Activation — the platform that providesscalability and performance, flexibility and a graphical interface; and

 

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

 

·                  Tertio Process Management — a module that allowscarriers to manage long running transactions. Long running transactions can often occur when a carrier is implementinga converged activation solution that encompasses the activation of both awireless and fixed line (or IP) component.

 

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

 

***Numbering Solutions***

 

Evolving Systems’ Numbering Solutions product line includes our 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 comply withU.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. In addition, we developed the initial customsoftware used by all eight regional Number Portability Administration Centers(NPACs) in North 

 

 

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Americato control the porting process. This software receives ported telephone numberinformation from carriers as changes occur and distributes the data to allsubscribing carriers in the region. Our software was provided under contract toNeuStar, Inc., formerly a division of Lockheed Martin IMS. Over time, wehave expanded our number portability product features and developed othernumber portability related OSS software products for the wireline, wireless andcable markets.  Our full LNP and WNPproduct line comprises the following collection of products:

 

·                  *OrderPath®* order entry;

 

·                  *NumberManager®* networkprovisioning;

 

·                  *LNPDataServerTM* data warehousing;

 

·                  *VeriPortTM* NPAC testing;

 

·                  *VeriCommTM* Inter-carrierCommunications Processor testing; and

 

·                  *VerifyTM* product suite formonitoring carriers’ applicationcommunications for optimum service assurance,

 

                                                ***NumberManagement***

 

                We developed our *NumeriTrack®* solution in response to the FCC mandated numberconservation and number pooling regulations for both wireline and wirelesscarriers. These regulations, implemented in 2003, resulted from the FCC’sconcern that the U.S. was running out of 10-digit telephone numbers. As aresult, the FCC designed regulations to extend the life of the 10-digit numberingplan well into the 21st century by changing the way phone numbers areallocated to carriers and specifying rules regarding the assignment andclassification of those numbers.  Theregulations also require regular utilization reporting by carriers andarticulation of circumstances under which previously underutilized telephonenumbers must be returned to the “pool” to be reallocated to other carriers. Our*NumeriTrack®* solution, which has beenlicensed to seven carriers, facilitates compliance with the FCC mandates forboth wireline and wireless carriers (and cable carriers providing telephonyservices).  Our solution providesinventory management of phone numbers and other assets such as SIM cards andsupports inventory assignments and integration with carriers’ existingback-office systems. The *NumeriTrack®*solution also contains features for the inventory of, and assignment logic for,numbers associated with IP addresses and is used by a large carrier in the U.S.for deployment of a Voice over Internet Protocol (“VoIP”) service offering. Asis the case with our LNP and WNP solutions, the implementation of our *NumeriTrack®* solution has far-reaching implications forintegration with carriers’ existing OSS environments and businessprocesses.  During 2006 and 2007, wemodified our *NumeriTrack®* Internationalapplication to address markets outside of North America.

 

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

 

***Mediation***

 

                Our mediation portfolio consistsof network data mediation products and billing mediation.  Our billing mediation product, *Evident**TM*, was acquired as part of the Evolving Systems U.K.acquisition.  Our network mediationproducts are Traffic Data Management System (“TDMS”) and *Mediation CentralTM*.

 

# ***                Billing Mediation***

# *** ***

                Billing mediation is the processof collecting network usage data and verifying that usage data is accurate, andis a required pre-condition for generating accurate bills for a carrier’scustomers. Billing mediation’s importance lies in its ability to provide asystematic point of reliability and assurance between network consumption andthe billing system input. Our Evident product supports convergent voice, data,and content services. Evident enables the accurate management of data, allowingreconciliation of data inputs and outputs. In addition, Evident provides support for compliance with relevantregulatory, accounting and data integrity requirements.  This product also provides service usage datafor business intelligence, revenue assurance, and next-generation billingsolutions. Our Evident solution can be used by wireline, broadband and wirelesscarriers and provides carrier-grade support in terms of reliability,performance, and scalability.

 

 

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

 

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

# *** ***

                A common challenge for telecommunications carriers isto create an integration layer between network element (“NE”) devices and theOSS applications that provision, monitor and control these devices. Deployingnew devices needed for extending service offerings into the network cantherefore be difficult, time consuming and expensive. Our mediation solutionsprovide a common framework for simplifying the collection and distribution ofcritical network data.  Our networkmediation product, Mediation Central, supports a broad array of technologiesthat carriers typically deploy in their network.  Mediation Central provides support forwireline, broadband, transport and wireless networks. Our Mediation Centralproduct supports both centralized and distributed configurations allowing, forexample, carriers to deploy a single solution for all their data collection anddistribution needs.  Our TDMS product isa legacy product that helps traditional wireline carriers collect usage datafrom their circuit switch networks.

 

**PROFESSIONAL AND INTEGRATION SERVICES**

 

                Our Professional and Integration Services teamprovides expert consulting services and advice for the design, customization,integration and deployment for our Service Activation, Numbering Solutions, andMediation product portfolios.  The Professional and Integration Servicesteam works closely with the Product Engineering and Development teams to ensurewe are up to date with the latest product developments.  These services cover all aspects of theproject lifecycle including system architecture and design, component design,development and customization, system integration and testing, deployment andproduction support, 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.

 

**RESEARCHAND DEVELOPMENT**

 

                We expend amounts on research and development (“R&D”),particularly for new products and/or for enhancements of existing products. Asdiscussed in Note 1 in the notes to our Consolidated Financial Statementsincluded elsewhere in this Annual Report on Form 10-K, R&D is expensedas incurred.  For the years ended December 31,2007, 2006 and 2005, we expensed $2.4 million, $3.1 million and $1.9 million,respectively, in R&D costs.  Themajority of all new R&D investments in 2007 have gone into enhancing ourTertio activation solutions and internationalizing our *NumeriTrack®* inventory and assignment solution.

 

                We focus our product developmentefforts on identifying specific industry and customer business needs as well asmarket requirements and then developing solutions that leverage our existingproduct capabilities.  Based upon theidentified customer business needs, our research and development effortscomprise a combination of design and development of new products or features toenhance our existing products, and design and development of new productfunctionality as identified in our product “roadmaps.”  We build investment plans for our threeprincipal product areas and we make other investments in tools and productextensions to accelerate the development, implementation and integrationprocess for customer solutions.

 

**BUSINESS STRUCTURE AND STRATEGY FOR GROWTH**

 

**               **We have developed acombination product/solutions business model that leverages our products andstrong telecommunications domain expertise with a worldwide work force.  This business model combines our U.S. andUnited Kingdom presence with the cost effective offshore developmentcapabilities provided by our Indian subsidiary.

 

                Our strategy for growth revolvesaround Tertio, our wireless service activation product, our internationalversion of our *NumeriTrack®* product, and ourrecently released Dynamic SIM Allocation product.  We continue to make investments in theseproducts and will focus on both traditional and emerging markets as we buildplans to add significant new functionality to these products.  These plans include enhancing and extendingthe functionality of these platforms to provide a more complete and robustsolution set for the activation and number/SIM management for all markets.  These investments target growth in the marketaround wireless and wireline convergence of services on IP networks.

 

**SALES AND MARKETING**

 

                The primary objective of oursales and marketing efforts is to identify markets for our products, createappropriate sales collateral and direct our sales force to those carrierslikely to need our products and services. Our sales force builds relationships with target carriers and educatesboth existing and potential carriers about the depth and breadth of ourcapabilities, experience, product portfolio and the 

 

 

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businesscase for an implementation of our solutions. Our sales and marketing efforts also include a high-level of interactionwith existing customers and prospects, participation in relevant industrybodies and trade shows, a website presence, presentations at industryconferences and forums, new releases to the industry and other marketinginitiatives.  Many of our salesactivities are a result of responding to requests for proposals and competitivetenders.  The majority of our salesefforts are conducted by direct sales teams. We are increasingly engaging insales activities with channel and business partners or system integrators suchas Alcatel, Siemens and Accenture who have been selected by our customers forlarger solution implementations where our products represent a portion of theoverall solution. We plan to continue this approach of working with global andlocal partners and system integrators.

 

**COMPETITION**

 

                The market fortelecommunications OSS products is intensely competitive and is subject torapid technological change, changing industry standards, regulatorydevelopments and consolidation. We face increasing demand for improved productperformance, reduced prices and rapid integration capabilities, and pricingpressures. Our existing and potential competitors include many large domesticand international companies that often have substantially greater financial,technological, marketing, distribution and other resources, larger installedcustomer bases and longer-standing relationships with telecommunicationscustomers than we do. The market for telecommunications OSS software andservices is extremely large. That notwithstanding, we currently hold only asmall portion of total market share.  Ourincreased focus on numbering solutions and activation solutions has resulted inour achieving a measurable and reasonable market share in those two areas.

 

                Our principal competitors in activation are ComptelCorporation (“Comptel”), Oracle/Metasolv, Intec Telecom Systems PLC (“Intec”)and Synchronoss Technologies, Inc.  Our principal competitors in thenumbering solutions market include Telcordia Technologies, Inc., Neustar, Inc.and Syniverse Technologies. In mediation, wecompete with many different companies including Intec, Amdocs and Comptel.

 

                We believe that our ability tocompete successfully depends on a wide range of factors.  We compete by offering quality solutions at acompetitive price that are tailored specifically to the customer. Furthermore,once our customer has implemented one of our core software products, we are ina preferable position as the incumbent vendor. Many of our customer relationships span five years or more withsome extending beyond ten years.  Webelieve these long-term relationships give us a competitive advantage andrepresent a barrier to entry for our competitors.

 

**SIGNIFICANT CUSTOMERS**

 

                In 2007, approximately 35% ofour consolidated revenues came from two unrelated customers in thetelecommunications industry, each of which accounted for more than 10% of ourconsolidated revenues.  Of thesecustomers, one is located in the U.S. and the other is located in the U.K.   The loss of either of these customers wouldhave 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 andlicensing arrangements, to establish and protect our proprietary rights. Wepresently have U.S. and Canadian patents on elements of our principal LNP OSSproducts, *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 ordersthat are anticipated to be delivered and recognized in revenue over the nexttwelve months. As of December 31, 2007 and 2006, our backlog wasapproximately $19.7 million and $13.8 million, respectively.  Our backlog at December 31, 2007 iscomprised of license fees and services of $6.5 million and customer support of$13.2 million compared to license fees and services of $4.8 million andcustomer support of $9.0 million at December 31, 2006.

 

**EMPLOYEES**

 

                As of December 31, 2007, weemployed 226 people including 57 in the United States, 69 in the United Kingdomand 100 in Bangalore, India.  Of ourworldwide staff, 82% are involved in product delivery, development, support andprofessional services, 10% in sales and marketing, and 8% in generaladministration.

 

 

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**ACCELERATED FILER STATUS**

 

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

 

·                  Has a common equity public float of $75 millionor more as of the last business day of its most recently completed secondfiscal 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 annualreport pursuant 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.

 

As of the last businessday of our most recently completed second fiscal quarter, June 30, 2007,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, 2007 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, 2008. The SEC has proposed delaying the auditor’s attestation for anadditional year, which if adopted, will delay our requirement to provide anauditor’s report on internal control over financial reporting until our AnnualReport on Form 10-K for the year ended December 31, 2009.

 

**AVAILABLE INFORMATION**

 

                You can find out moreinformation about us at our Internet website located at www.evolving.com*.* Theinformation on our website is not incorporated into this Annual Report on Form 10-K.Our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q,and our Current Reports on Form 8-K and any amendments to those reportsare available free of charge on our Internet website as soon as reasonablypracticable after we electronically file such material with the SEC. Additionally, these reports are availableat the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C.20549 or on the SEC’s website at www.sec.gov. Information on the operation of the Public Reference Room can beobtained by calling the SEC at 1-800-SEC-0330.

 

**ITEM1A.    RISKFACTORS**

 

**RisksRelated to Our Business**

 

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

 

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

 

·                  the size of new contracts and when we areable to recognize the related revenue;

·                  our rate of progress under our contracts;

·                  consolidation inthe communications market;

·                  the timing of customer and marketacceptance of our products and service offerings;

·                  our ability toeffectively manage offshore software development and control costs and turnoverin India;

·                  budgeting cycles of our customers;

·                  changes in the terms and rates related tothe renewal of support agreements;

·                  actual or anticipated changes in U.S. orforeign laws and regulations related to the telecommunications market;

·                  judicial or administrative actions aboutthese laws or regulations;

·                  product lifecycles;

·                  the mix of products and services sold;

·                  changes in demand for our products andservices;

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

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

 

 

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·                  competition by existing and emerging competitorsin the communications software markets;

·                  our success in developing and selling newproducts, controlling costs, attracting and retaining qualified personnel andexpanding our sales and customer focused programs;

·                  software defects and other productquality problems;

·                  changes in our strategy;

·                  foreign exchange fluctuations; and

·                  general economic conditions.

 

Personnel costs are asignificant component of our budgeted expense levels and, therefore, ourexpenses are, to a degree, variable based upon our expectations regardingfuture revenue. Our revenue is difficult to forecast because the market for ourproducts and services is rapidly changing, and our sales cycle and the size andtiming of significant contracts vary substantially among customers.Accordingly, we may be unable to adjust spending in a timely manner tocompensate for any unexpected shortfall in revenue. Any significant shortfallfrom anticipated levels of demand for our products and services could adverselyaffect our business, financial condition, results of operations and cash flows.

 

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

 

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

 

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

 

***The indebtedness incurred in connectionwith the Evolving Systems U.K. acquisition may limit our ability to grow andcould adversely affect our financial condition.***

 

In February 2008,we restructured the remaining debt associated with our 2004 acquisition ofEvolving Systems U.K.  We replaced ourexisting senior term note and senior revolving facility with a new $4.0 millionsenior term loan, a $1.0 million U.S. revolving credit facility and a $5.0million U.K. revolving credit facility. We used proceeds from the $4.0 million senior term loan to pay down ourexisting senior term note balance of approximately $3.8 million.  As part of this restructuring, we used $1.0million in existing cash to pay down approximately $0.2 million and $0.8million in principal and interest, respectively, on our subordinatednotes.  No borrowings have been madeunder either the U.S. or U.K. revolving credit facilities.  See Note 13, Subsequent Events, for furtherdetails related to 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.  This debt secured by a general lienon all of our assets.  If we are unable to pay the debt as it becomes due,the holders of the debt could foreclose on all of our assets.  The increased 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 inthe future, the related risks that we now face could intensify. Whether we areable to make required payments on our outstanding indebtedness and to satisfyany other future debt obligations will depend on our future operating performanceand our ability to obtain additional debt or equity financing.

 

***Certain provisionsof the senior debt and subordinated notes payable issued in conjunction withthe restructuring of our debt resulting from our acquisition of EvolvingSystems U.K. call for the acceleration of payments if certain covenants arebreached or cash balance thresholds are achieved.***

 

The outstanding senior debt, as well as the subordinated notes, containcertain affirmative and negative covenants that, if breached, could result insuch notes becoming immediately due and payable. The covenants include ouragreement to do the following:

 

 

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·                  maintain a specified ratio of debt toEBITDA, minimum EBITDA for the trailing twelve months, minimum liquidity, andratio of fixed 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 ouragreement not to do any of the following (except as specifically authorized):

 

·                  liquidate, dissolve or wind-up operations;

·      causeor permit a change in control;

·                  pay any dividends or make prepayments on anyindebtedness;

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

·                  sell or transfer a substantial portion of ourassets;

·                  incur additional indebtedness or permit any lienson our assets;

·                  make loans or enter into letters for credit orguarantees;

·                  enter into affiliate transactions;

·                  make negative pledges;

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

·                  change the nature of our business materially;

·                  make capital expenditures beyond establishedthresholds; or

·                  take certain other operational actions.

 

The covenants may limit our flexibility in planning for, or reacting tochanges in, our business. Failure to comply with the covenants, if not waived,could result in the acceleration of the debt. If we are required to pay thedebt on an accelerated basis, it would have a significant adverse impact on ourliquidity and financial condition and could cause us to incur additionalindebtedness.

 

Additionally, the unsecured notes issued to the Evolving Systems U.K.sellers require us to offer the note holders a prepayment on such notes at theend of any fiscal quarter if we achieve certain minimum cash thresholds. Such arequirement will restrict our liquidity and cash management flexibility. Untilthe notes are repaid, our ability to engage in transactions or to enter intoagreements requiring significant cash investments may be adversely affected.

 

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

 

In February 2004, weformed Evolving Systems India, a wholly owned subsidiary of Evolving Systems, Inc.  It is difficult managing development staffover multiple time zones. We are currently experiencing a high level ofturnover with our Indian development staff as a result of strong competitionfor technology-based personnel in India. In addition, salary levels in India are steadily increasing, reducingthe competitive advantages associated with offshore labor. If we are unable toeffectively manage the Evolving India development staff and/or we continue toexperience high levels of staff turnover, we may fail to provide qualitysoftware in a timely fashion, which could negatively affect our ability tosatisfy our customer contracts. Furthermore, political changes anduncertainties in India could negatively impact the business climate there.  As a result, we may be unable tosatisfactorily perform our customer contracts and our business, financialcondition and results of operations could be materially harmed.

 

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

 

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

 

·                   unexpected changes in regulatory requirements;

·                   tariffs and other barriers;

·                   political and economic instability;

·                   limited intellectual property protection;

·                   difficulties in staffing and managing foreignoperations; and

·                   potentially adverse tax consequences in connectionwith repatriating funds.

 

We may not be able tosustain or increase our international revenue or repatriate cash withoutincurring substantial risks involving floating currency exchange rates andincome tax expenses.  Any of theforegoing factors may have a material adverse impact on our internationaloperations and, therefore, our business, financial condition and results ofoperations.

 

***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 

 

 

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being permitted toprovide long distance services. Therefore, any changes to these regulations, orthe adoption of new regulations by federal or state regulatory authoritiesunder the Telecom Act, or any legal challenges to the Telecom Act, could hurtthe market for our products and services. For example, when the FCC delayedimplementation of the Telecom Act with respect to wireless carriers until November 2003,these delays impacted our revenue from our WNP products and services. Likewise,in mid-2001 when Verizon Wireless petitioned the FCC requesting forbearancefrom this requirement, we saw our wireless customers delay making decisions topurchase WNP products. WNP went into effect in November 2003.  Any invalidation, repeal or modification inthe requirements imposed by the Telecom Act or the FCC, could materially harmour business, financial condition and results of operations. In addition,customers may require, or we may find it necessary or advisable, to modify ourproducts or services to address actual or anticipated changes in regulationsaffecting our customers. This could also materially harm our business,financial condition, results of operations, and cash flows.  Additionally, with our acquisition ofEvolving Systems U.K., we are now subject to numerous regulatory requirementsof foreign jurisdictions.  Any compliancefailures or changes in such regulations could also materially harm ourbusiness, financial condition, results of operations and cash flows.

 

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

 

The communicationsindustry has experienced and continues to experience significant consolidation,both in the United States and internationally. These consolidations are causing our existing and potential customers tore-evaluate their OSS solutions and their capital expenditures.  These consolidations have caused us to losecustomers and may result in fewer potential customers requiring OSS solutionsin the future.  In addition, combiningcompanies may choose a competitive OSS solution used by one of the combiningcompanies.  As our customers becomelarger, they generally have stronger purchasing power, which can result inreduced prices for our products, lower margins on our products and longer salescycles.  Because of the uncertaintyresulting from these consolidations and the variations in our quarterlyoperating results, it is extremely difficult for us to forecast our quarterlyand annual revenue and we have discontinued providing revenue guidance.  All of these factors can have a negativeimpact on our financial performance, particularly in any fiscal quarter.  This negative impact, in turn, could resultin noncompliance with certain financial covenants governing our 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 becomingimmediately due and payable.  We can giveno assurance that we would be successful in amending the agreements orobtaining a waiver of any covenant violation.

 

***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, andcurrently, we earn a significant portion of our revenue from a small number ofcustomers in the communications industry. This has been mitigated somewhat bythe expansion of our customer base in recent years, but, as noted above, consolidationin the industry continues. The loss of any significant customer, delays indelivery or acceptance of any of our products by a customer, delays in theperformance of services for a customer, or delays in collection of customerreceivables 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.

 

The majority of ourexisting contracts provide for acceptance testing by the customer, which can bea lengthy process. Unanticipated difficulties or delays in the customeracceptance process could result in higher costs, delayed payments, and deferralof revenue recognition. In addition, if our software contains defects or we otherwisefail to satisfy acceptance criteria within prescribed times, the customer maybe entitled 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 of oursale 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 large 

 

 

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contracts couldmaterially harm our business, financial condition, results of operations andcash flows and cause our operating results to vary significantly from quarterto quarter and year to year.

 

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

 

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

 

The revenue for most ofour contracts is accounted for on the percentage-of-completion method ofaccounting.  This method of accountingrequires us to calculate 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.

 

***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.

 

 

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***The communications industry is highly competitiveand if our products do not satisfy customer demand for performance or 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(as a 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.

 

We believe that ourability to compete successfully depends on numerous factors. For example, thefollowing factors affect our ability to compete successfully:

 

·                  how well we respond to our customers’needs;

·                  the quality and reliability of ourproducts and services and our competitors’ products and services;

·                  the price for our products and services,as well as the price for our competitors’ products and services;

·                  how well we manage our projects;

·                  our technical subject matter expertise;

·                  the quality of our customer service andsupport;

·                  the emergence of new industry standards;

·                  the development of technical innovations;

·                  our ability to attract and retainqualified personnel;

·                  regulatory changes; and

·                  general market and economic conditions.

 

Some of these factors arewithin our control, and others are not. A variety of potential actions by ourcompetitors, including a reduction of product prices or increased promotion,announcement or accelerated introduction of new or enhanced products, orcooperative relationships among competitors and their strategic partners, couldnegatively impact the sales of our products and we may have to reduce theprices we charge for our products. Revenue and operating margins may consequently decline. We may not beable to compete successfully with existing or new competitors or to properlyidentify and address the demands of new markets. This is particularly true innew markets where standards are not yet established. Our failure to adapt toemerging market demands, respond to regulatory and technological changes orcompete successfully with existing and new competitors would materially harmour business, financial condition, results of operations and cash flows.

 

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

 

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

 

***Our products are complex and may have errors that are not detecteduntil deployment, and litigation related to warranty and product liabilityclaims could be expensive and could negatively affect our reputation andprofitability.***

 

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

 

 

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personnel, either ofwhich could materially harm our business, financial condition and results ofoperations. In addition, our business reputation could be harmed by productliability claims, regardless of their merit or the eventual outcome of theseclaims.

 

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

 

Our success and abilityto compete are dependent to a significant degree on our proprietary technology.We rely on a combination of patent, copyright, trademark and trade secret laws,as well as confidentiality agreements and licensing arrangements, to establishand protect our proprietary rights. We have a U.S. patent pending on elementsof our Dynamic SIM Allocation product and we have U.S. and Canadian patents onelements of our LNP products, ***NumberManager®***and ***OrderPath®***, and U.S. patents onelements of some of our other products. In addition, we have registered orfiled for registration of certain of our trademarks. Despite these precautions,it may be possible for a third party to copy or otherwise obtain and use ourproducts or technology without authorization or to develop similar technologyindependently through reverse engineering or other means. In addition, the lawsof some foreign countries may not adequately protect our proprietary rights.Our means of protecting our proprietary rights in the U.S. or abroad may not beadequate or others may independently develop technologies that are similar orsuperior to our technology, duplicate our technology or design around any ofour patents.

 

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

 

It is also possible thatour business activities may infringe upon the proprietary rights of others, orthat other parties may assert infringement claims against us. If we becomeliable to any third party for infringing its intellectual property rights, we couldbe required 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 softwaredeveloped or used by Evolving Systems, as well as certain software acquired inour acquisitions of CMS, TSE or Evolving Systems U.K., may include or bederived from software that is made available under an open source softwarelicense.

 

·                  Such open source software may be made available undera license such as the GNU General Public License (“GPL”) or GNU Lesser GeneralPublic License (“LGPL”) which imposes certain obligations on us in the event wewere to distribute derivative works based on the open source software.  These obligations may require us to makesource code for these derivative works available to the public or license thederivative works under a particular type of open source software license,rather than the license terms we customarily use to protect our software.

·                  There is little or no legal precedent for interpretingthe terms of certain of these open source licenses, including the termsaddressing the extent to which a derivative work based on open source softwaremay be subject to these licenses.  Webelieve we have complied with our obligations under the various applicable opensource licenses.  However, if the ownerof any open source software were to successfully establish that we had notcomplied with the terms of an open source license for a particular derivativework based on that open source software, we may be forced to release the sourcecode for that derivative work to the public or cease distribution of that work.

·                  We generally prohibit the combination of ourproprietary software with open source software. Despite these restrictions, parties may combine our proprietary softwarewith open source software without our authorization, in which case such partiescould be forced to release to the public the source code of our proprietarysoftware.

 

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

 

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

 

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

 

Our internationalbusiness operations include projects in developing countries and countries tornby conflict.  To the extent we operateoutside the U.S., we are subject to the Foreign Corrupt Practices Act (FCPA), whichgenerally prohibits U.S. companies and their intermediaries from paying oroffering anything of value to foreign government officials for the purpose ofobtaining or 

 

 

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keeping business, orotherwise receiving discretionary favorable treatment of any kind.  In particular, we may be held liable foractions taken by our local partners and agents, even though such parties arenot always subject to our control.  Anydetermination that we have violated the FCPA (whether directly or through actsof others, intentionally or through inadvertence) could result in sanctionsthat could have a material adverse effect on our business.  While we have procedures and controls in placeto monitor compliance, situations outside of our control may arise that couldpotentially put us in violation of the FCPA inadvertently and thus negativelyimpact our business.

 

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

 

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

 

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

 

***Sales of large blocks of our stock 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. These factors also could make itmore difficult to raise funds through future offerings of common stock.

 

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

 

Because our common stockis publicly traded, we are subject to certain rules and regulations offederal, state and financial market exchange entities charged with theprotection of investors and the oversight of companies whose securities arepublicly traded.  These entities,including the Public Company Accounting Oversight Board, the SEC and Nasdaq,have 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.

 

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 future earnings,if any, for use in the operation of our business. In addition, our senior debtand subordinated notes prohibit us from declaring dividends to our commonstockholders 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:

 

 

14

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·                  authorizing our board of directors to issue up to2,000,000 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 designated 250,000 shares of Series AJunior Participating Preferred Stock that contain “poison pill” provisions;

 

·                  we have a staggered board with each member of theBoard of Directors serving for three years; in any given year, only a portionof our Board of Directors have terms that expire;

 

·                  our stockholders cannot take action by writtenconsent; and

 

·                  we have advance notice requirements for nominationsfor election to the Board of Directors or for proposing matters that can beacted upon at stockholder meetings.

 

In addition, we aresubject to the anti-takeover provisions of Section 203 of Delaware GeneralCorporation Law, which prohibit us from engaging in a “business combination”with an “interested stockholder” for a period of three years after thedate of the transaction in which the person became an interested stockholder,unless the business combination is approved in the prescribed manner. Theapplication of Section 203 and certain provisions of our restatedcertificate of incorporation, including a classified board of directors, mayhave the effect of delaying or preventing changes in control of our management,which could adversely affect the market price of our common stock bydiscouraging or preventing takeover attempts that might result in the 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.

 

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

 

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

 

**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.

 

 

15

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**ITEM 2.     PROPERTIES**

 

                We lease office space at variouslocations 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                 |       | 6/30/08               |       |
| Bangalore, India                    |       | 1,411               |       | 1/7/08                |       |
| Bangalore, India                    |       | 4,404               |       | 1/7/08                |       |
| Bangalore, India                    |       | 776                 |       | 1/7/08                |       |
| Bangalore, India                    |       | 776                 |       | 1/7/08                |       |
| Bangalore, India                    |       | 1,410               |       | 2/29/08               |       |
| Bangalore, India                    |       | 776                 |       | 2/29/08               |       |
| Bangalore, India                    |       | 1,575               |       | 1/14/08               |       |
| Munich, Germany                     |       | 732                 |       | Month-to-month        |       |
| Kuala Lumpur, Malaysia              |       | 1,042               |       | 7/14/09               |       |

 

**ITEM 3.    LEGAL PROCEEDINGS**

 

                During the fourth quarter of2006, a previous software vendor filed a complaint in the Superior Court of NewJersey against us asserting we breached certain provisions of a licenseagreement.  While the outcome of thismatter is uncertain, we believe we have paid all fees due under our licenseagreement and will vigorously defend this claim.

 

                We are involved in various otherlegal matters arising in the normal course of business.  We do not believe that any such matters areprobable of loss that would have a material impact on our results of operationsand financial position.

 

**ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

                None.

 

**PART II**

 

**ITEM 5.    MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES**

 

                Our common stock began tradingpublicly through the Nasdaq National Market under the symbol “EVOL” on May 12,1998. Prior to that date, there was no public market for our common stock. Wetransferred from the Nasdaq National Market to the Nasdaq SmallCap Market (nowknown as the Nasdaq Capital Market) on August 28, 2002. The closing priceof our common stock as reported on the Nasdaq Capital Market as of March 5,2008 was $2.35 per share. The following table sets forth for the periods indicatedthe high and low closing sale quotations and may not be based on actualtransactions for our common stock as reported on the Nasdaq Capital Market. Theprices reported do not include retail mark-ups, markdowns or commissions.

 

| ** **     | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
|           | ** ** | **High**                                  | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                                         | 2.10       |   | $ | 1.20 |   | $ | 2.96 |   | $ | 1.96 |   |
| Second Quarter |       | $                                         | 2.44       |   | $ | 1.70 |   | $ | 2.06 |   | $ | 1.25 |   |
| Third Quarter  |       | $                                         | 2.29       |   | $ | 1.66 |   | $ | 1.44 |   | $ | 0.92 |   |
| Fourth Quarter |       | $                                         | 3.07       |   | $ | 1.70 |   | $ | 1.38 |   | $ | 1.00 |   |

 

                As of March 5, 2008, therewere approximately 168 holders of record of our common stock.

 

                We have not declared or paid acash dividend on our common stock. In addition, the notes issued in connectionwith the Evolving Systems U.K. acquisition prohibit us from declaring dividendsto our common stockholders during the term of the notes. We currently 

 

 

16

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intendto retain future earnings, if any, to finance the growth and development of ourbusiness and, therefore, do not anticipate paying cash dividends in theforeseeable future.

 

The graph below matchesEvolving Systems, Inc.’s cumulative 5-year total shareholder return oncommon stock with the cumulative total returns of the NASDAQ Composite index,the RDG Software Composite index and the DJ Wilshire MicroCap Software Index.The graph tracks the performance of a $100 investment in our common stock andin each of the indices (with the reinvestment of all dividends) from December 31,2002 to December 31, 2007. 

 

 

17

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**ITEM 6.    SELECTED FINANCIAL DATA**

 

                The selected financial data setforth below for each of the years in the five-year period ended December 31,2007, has been derived from our consolidated financial statements. Thefollowing selected financial data should be read in conjunction with “Item 7 -Management’s Discussion and Analysis of Financial Condition and Results ofOperations”, the consolidated financial statements and the notes thereto andother financial information included elsewhere 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.  Results for 2003 include amounts related tothe acquisition of CMS from the purchase date of November 3, 2003 to December 31,2003.

 
| ** **                                                                                                     | ** ** | **For the Years Ended December 31,**    | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2007**                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                     | ** ** | **(in thousands, except per share amounts)** | ** ** |
|                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenue                                                                                                        |       | $                                            | 35,953     |   | $ | 33,833 |   | $ | 39,452 |   | $ | 26,342 |   | $ | 27,973 |   |
| Costs of Revenue and  Operating Expenses:                                                                      |       |                                         |       |   |   |   |   |   |   |   |   |
| Cost of revenue, excluding depreciation and amortization                                                       |       | 14,260                                       |       | 13,036 |   | 16,070 |   | 12,936 |   | 11,346 |   |
| Sales and marketing                                                                                            |       | 8,557                                        |       | 8,962 |   | 9,643 |   | 4,412 |   | 2,940 |   |
| General and administrative                                                                                     |       | 5,862                                        |       | 5,138 |   | 6,818 |   | 5,085 |   | 3,494 |   |
| Product development (1)                                                                                        |       | 2,376                                        |       | 3,072 |   | 1,921 |   | 1,066 |   | 2,043 |   |
| Depreciation                                                                                                   |       | 899                                          |       | 1,169 |   | 1,443 |   | 1,152 |   | 1,182 |   |
| Amortization (2)                                                                                               |       | 1,565                                        |       | 2,511 |   | 5,215 |   | 1,667 |   | 130 |   |
| Impairment of goodwill and intangible assets (3)                                                               |       | —                                       |       | 16,516 |   | — |   | — |   | — |   |
| Restructuring and other expense (4)                                                                            |       | (4                                           | )          | (21 | ) | (49 | ) | (15 | ) | (9 | ) |
|                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations                                                                                  |       | 2,438                                        |       | (16,550 | ) | (1,609 | ) | 39 |   | 6,847 |   |
| Interest and other, net                                                                                        |       | (1,284                                       | )          | (1,837 | ) | (1,692 | ) | 87 |   | 191 |   |
| Income tax expense (benefit)                                                                                   |       | 556                                          |       | (1,604 | ) | (396 | ) | (298 | ) | 167 |   |
| Net income (loss)                                                                                              |       | 598                                          |       | (16,783 | ) | (2,905 | ) | 424 |   | 6,871 |   |
| Deemed dividend for beneficial conversion feature of Series B  convertible redeemable preferred stock (4) |       | —                                       |       | — |   | — |   | 3,306 |   | — |   |
| Net income (loss) available to common and preferred stockholders                                               |       | $                                            | 598        |   | $ | (16,783 | ) | $ | (2,905 | ) | $ | (2,882 | ) | $ | 6,871 |   |
|                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Basic income (loss) available to common and preferred stockholders  per common share                           |       | $                                            | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) | $ | (0.18 | ) | $ | 0.48 |   |
| Diluted income (loss) available to common and preferred stockholders  per common share                         |       | $                                            | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) | $ | (0.18 | ) | $ | 0.43 |   |
| Weighted average basic  shares outstanding                                                                     |       | 19,198                                       |       | 19,100 |   | 18,695 |   | 16,307 |   | 14,205 |   |
| Weighted average diluted  shares outstanding                                                                   |       | 19,576                                       |       | 19,100 |   | 18,695 |   | 16,307 |   | 16,139 |   |
|                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Working capital  (deficiency) (5)                                                                              |       | $                                            | 1,395      |   | $ | 803 |   | $ | 447 |   | $ | (3,343 | ) | $ | 13,836 |   |
| Total assets (6)                                                                                               |       | 53,727                                       |       | 51,338 |   | 67,398 |   | 86,601 |   | 41,701 |   |
| Long-term debt, net of  current portion                                                                        |       | 8,686                                        |       | 11,370 |   | 14,373 |   | 11,959 |   | 183 |   |
| Series B convertible  redeemable preferred stock (8)                                                      |       | 5,587                                        |       | 11,281 |   | 11,281 |   | 11,281 |   | — |   |
| Stockholders’ equity  (7) (8)                                                                        |       | $                                            | 17,928     |   | $ | 10,158 |   | $ | 22,124 |   | $ | 29,314 |   | $ | 26,473 |   |

----

(1)                                  In 2004 and 2003, weexpensed $90,000 and $233,000, respectively, of in-process research anddevelopment associated with the acquisitions of Evolving Systems U.K. and CMS.

 

(2)                                  With the acquisitionof Evolving Systems U.K. and TSE, intangible asset amortization has become asignificant expense and is now being shown separately on the statements ofoperations. Amortization expense for the year ended December 31, 2003 of$130,000 has been reclassified to conform to the current period’s presentation.

 

(3)                                  In 2006, werecognized an impairment of $16.5 million on goodwill and amortizableintangible assets related to our L&S operating segment.

 

18

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(4)                                  In November 2004,we issued 966,666 shares of Series B Preferred Stock as part of ouracquisition of Evolving Systems U.K.  Based uponthe various features of the Series B Preferred Stock, the fair value of this security wasestimated to approximate the stated redemption price. Since the conversionprice of the Series B Preferred Stock was fixed in the purchase agreementto equal $3.50 per common share, a beneficial conversion feature existed on theacquisition date equal to the difference between the value of our common stockon the acquisition date, or $4.64, and the conversion price stated in thepurchase agreement.  The beneficialconversion feature was recognized as a reduction in net income available tocommon stockholders of $3.3 million on the acquisition date since the Series BPreferred Stock was immediately convertible to common stock.

 

(5)                                  The decrease inworking capital during 2004 was a result of our acquisition of two companies,TSE and Evolving Systems U.K., during the fourth quarter of 2004.  In those transactions we paid cash of $1.5million and $11.0 million for TSE and Evolving Systems U.K., respectively. TheTSE transaction also included a short-term note payable of approximately$889,000. The acquisition of Evolving Systems U.K. also included the issuanceof seller-financed notes of approximately $15.9 million, including a short-termnote of $4.0 million and a long-term note of approximately $11.9 million. The purchase price related to these twoacquisitions, including estimated transaction costs of $2.0 million, reducedour working capital by approximately $19.4 million.

 

(6)                                  The decrease intotal assets from 2004 to 2005 and 2005 to 2006 is primarily due to impairmentof intangible assets, amortization of intangible assets, goodwill impairment,adjustments to goodwill related to the acquisitions of TSE and Evolving SystemsU.K., foreign currency translation adjustments and use of cash to payshort-term obligations owed as a result of the acquisitions of TSE and EvolvingSystems U.K.

 

(7)                                  The decrease inequity from 2005 to 2006 is primarily a result of the impairment of goodwilland intangible assets recorded during 2006.

 

(8)                                  The decrease in Series Bconvertible redeemable preferred stock and the increase in stockholders’ equityfrom 2006 to 2007 is primarily the result of holders of 487,916 shares of Series B PreferredStock, with an aggregate carrying value of $5.7 million, converting theirshares of preferred stock into 1,463,748 shares of our common stock inaccordance with the conversion provisions of the Series B Preferred Stock,during 2007.  See also Note 13,Subsequent Events, for changes to our stockholders’ equity.

 

 

19

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** **

**ITEM 7.    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

*This Management’s Discussion and Analysis of FinancialCondition and Results of Operations contains forward-looking statements thathave been made pursuant to the provisions of the Private Securities LitigationReform Act of 1995. These forward-looking statements are based on currentexpectations, estimates, and projections about Evolving Systems’ industry,management’s beliefs, and certain assumptions made by management.Forward-looking statements include our expectations regarding product,services, and customer support revenue; our expectations associated withEvolving India and Evolving Systems U.K., and short- and long-term cash needs.In some cases, words such as “anticipates”, “expects”, “intends”, “plans”, “believes”,“estimates”, variations of these words, and similar expressions are intended toidentify forward-looking statements. The following discussion should be read inconjunction with, and is qualified in its entirety by, the consolidatedfinancial statements and the notes thereto included elsewhere in this AnnualReport on Form 10-K. Our actual results could differ materially from thoseanticipated in these forward-looking statements as a result of certain factors,including those set forth in this section and in “Item 1A - Risk Factors.”*

 

**OVERVIEW**

 

We are a provider of software solutions and services to thewireless, wireline and IP carrier market. We maintain long-standingrelationships with many of the largest wireline, wireless and IP communicationscarriers worldwide. Our customers rely on us to develop, deploy, enhance,maintain and integrate complex, highly reliable software solutions for a rangeof Operations Support Systems (“OSS”). Our activation solution is the leading packaged solution for activationin the wireless industry.

 

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.

 

**2007 HIGHLIGHTS**

 

Consolidated revenues increased to $36.0million from $33.8 million, for the years ended December 31, 2007 and2006, respectively, representing a 6% increase. This growth is primarily the result of expansion into new internationalmarkets for both activation and numbering solutions (NumeriTrack®) andfollow on sales fromour existing activation account base. Our investment in the emerging growth markets netted us ten new customeraccounts during 2007, up from three in 2006. In addition, we sold our NumeriTrack® product outside of the UnitedStates three times during 2007, rewarding us for investments made in 2006 forthis product.

 

Our DynamicSIM AllocationTM solution was introduced in 2007.  This solution utilizes our *TertioTM* and NumeriTrack®technology to offer carriers a new way to provision wireless services bydynamically activating a wireless device when it is first switched on. Incountries around the world, the wireless Subscriber Identity Module (SIM) cardis central to the provision of wireless access and services.  Our Dynamic SIM AllocationTM solutionsimplifies SIM management and inventory for wireless carriers allowing carriersto provide enhanced customer features.

 

As a result of the improvement in revenue, we reported net income forthe year ended December 31, 2007 for the first time since the year ended December 31,2003.  Our backlog increased to $19.7million as of December 31, 2007, from $13.8 million as of December 31,2006.  This ending backlog of $19.7million represents our highest ending backlog for any year following our 2003and 2004 acquisitions of Tertio Telecoms Ltd., Telecom Software Enterprises,LLC and CMS Communications, Inc.

 

We also had several significant improvements to our balance sheet during2007.  Benefiting from our increased cashflows from operations during 2007, we grew cash 43% while at the same timereducing our total debt.  Working capitalgrew to $1.4 million at December 31, 2007 from $0.8 million at December 31,2006.  During 2007, holders of 487,916 shares of Series BPreferred Stock, or approximately 50% of the outstanding preferred stock as of December 31,2006, 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.  This conversion plus the net income earnedduring 2007 contributed to the increasedtotal stockholders’ equity of approximately $7.8 million or 76% from thebeginning of the year total stockholders’ equity balance.  Additionally, subsequent to December 31,2007, holders of 461,758 shares of Series B Preferred Stock, with anaggregate carrying value of $5.4 million, converted their shares of preferredstock into 1,385,274 shares of common stock in accordance with the provisionsof the Series B Preferred Stock.

 

 

20

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**RESULTSOF OPERATIONS**

 

Thefollowing table presents our consolidated statements of operations incomparative format.

 
| ** **                                                                           | ** ** | **For the Year Ended December 31,** | ** ** | ** ** | ** ** | **For the Year Ended December 31,** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------|------------|------------------------------------------|------------|------------|------------|
| ** **                                                                           | ** ** | **2007**                                 | ** ** | **2006**   | ** ** | **Change**                               | ** ** | **2006**   | ** ** | **2005** | ** ** | **Change** | ** ** |
| **Revenue:**                                                                         | ** ** | ** **                               | ** ** | ** ** | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                            |       | $                                        | 17,895     |       | $          | 15,883                                   |       | $          | 2,012      |   | $ | 15,883 |   | $ | 19,779 |   | $ | (3,896 | ) |
| Customer support                                                                     |       | 18,058                                   |       | 17,950     |       | 108                                      |       | 17,950     |       | 19,673 |   | (1,723 | ) |
| Total revenue                                                                        |       | 35,953                                   |       | 33,833     |       | 2,120                                    |       | 33,833     |       | 39,452 |   | (5,619 | ) |
|                                                                                 |       |                                     |       |       |       |                                     |       |       |       |   |   |   |   |
| **Costs of revenue and operating  expenses:**                                        | ** ** | ** **                               | ** ** | ** ** | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Costs of license fees and related services, excluding depreciation  and amortization |       | 8,023                                    |       | 7,342      |       | 681                                      |       | 7,342      |       | 9,491 |   | (2,149 | ) |
| Costs of customer support, excluding depreciation and amortization                   |       | 6,237                                    |       | 5,694      |       | 543                                      |       | 5,694      |       | 6,579 |   | (885 | ) |
| Sales and marketing                                                                  |       | 8,557                                    |       | 8,962      |       | (405                                     | )          | 8,962      |       | 9,643 |   | (681 | ) |
| General and administrative                                                           |       | 5,862                                    |       | 5,138      |       | 724                                      |       | 5,138      |       | 6,818 |   | (1,680 | ) |
| Product development                                                                  |       | 2,376                                    |       | 3,072      |       | (696                                     | )          | 3,072      |       | 1,921 |   | 1,151 |   |
| Depreciation                                                                         |       | 899                                      |       | 1,169      |       | (270                                     | )          | 1,169      |       | 1,443 |   | (274 | ) |
| Amortization                                                                         |       | 1,565                                    |       | 2,511      |       | (946                                     | )          | 2,511      |       | 5,215 |   | (2,704 | ) |
| Impairment of goodwill and intangible assets                                         |       | —                                   |       | 16,516     |       | (16,516                                  | )          | 16,516     |       | — |   | 16,516 |   |
| Restructuring and other expense (recovery)                                           |       | (4                                       | )          | (21        | )          | 17                                       |       | (21        | )          | (49 | ) | 28 |   |
| Total costs of revenue and  operating expenses                                       |       | 33,515                                   |       | 50,383     |       | (16,868                                  | )          | 50,383     |       | 41,061 |   | 9,322 |   |
| Income (loss) from operations                                                        |       | 2,438                                    |       | (16,550    | )          | 18,988                                   |       | (16,550    | )          | (1,609 | ) | (14,941 | ) |
| Interest income                                                                      |       | 304                                      |       | 160        |       | 144                                      |       | 160        |       | 116 |   | 44 |   |
| Interest expense                                                                     |       | (1,747                                   | )          | (1,992     | )          | 245                                      |       | (1,992     | )          | (1,636 | ) | (356 | ) |
| Gain on extinguishment of debt                                                       |       | 42                                       |       | —     |       | 42                                       |       | —     |       | — |   | — |   |
| Gain (loss) on foreign exchange transactions                                         |       | 117                                      |       | (5         | )          | 122                                      |       | (5         | )          | (172 | ) | 167 |   |
| Income (loss) before  income taxes                                                   |       | 1,154                                    |       | (18,387    | )          | 19,541                                   |       | (18,387    | )          | (3,301 | ) | (15,086 | ) |
| Income tax expense (benefit)                                                         |       | 556                                      |       | (1,604     | )          | 2,160                                    |       | (1,604     | )          | (396 | ) | (1,208 | ) |
| Net income (loss)                                                                    |       | $                                        | 598        |       | $          | (16,783                                  | )          | $          | 17,381     |   | $ | (16,783 | ) | $ | (2,905 | ) | $ | (13,878 | ) |

 

***Revenue***

 

                Revenue is comprised of licensefees and services and customer support. License fees and services revenue represent the fees we receive from thelicensing of our software products and those services directly related to thedelivery of the licensed product as well as integration services and time andmaterials work.  Customer support revenueincludes annual support fees, recurring maintenance fees, minor productupgrades and warranty fees.  Warrantyfees are typically bundled with a license sale and the related revenue, basedon vendor specific objective evidence (“VSOE”), is deferred and recognizedratably over the warranty period.  Thefollowing table presents our revenue by product line (in thousands).

 

| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| ** **          | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Activation          |       | $                                         | 19,533     |   | $ | 16,717 |   | $ | 18,868 |   |
| Numbering solutions |       | 11,919                                    |       | 12,006 |   | 15,336 |   |
| Mediation           |       | 4,501                                     |       | 5,110 |   | 5,248 |   |
|                |       | $                                         | 35,953     |   | $ | 33,833 |   | $ | 39,452 |   |

 

 

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***        LicenseFees and Services***

 

                License fees andservices revenue increased 13%, or $2.0 million, to $17.9 million for the yearended December 31, 2007 compared to $15.9 million for the year ended December 31,2006.  The increase was a result of anincrease of $2.3 million in revenue from our activation products and anincrease of $0.5 million in revenue from our numbering solutions products, partiallyoffset 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®) andfollow on sales fromour existing activation account base, partially offset by lower revenue fromour existing mediation account base.

 

                License fees andservices revenue decreased 20%, or $3.9 million, to $15.9 million for the yearended December 31, 2006 compared to $19.8 million for the year ended December 31,2005.  The decline was a result of adecrease of $1.8 million in revenue from our activation products and a decreaseof $2.1 million in revenue from our numbering solutions products.  The decline in activation products revenuewas due to fewer license sales resulting from industry consolidation,competitive pressures and longer customer purchasing cycles.  The decline in numbering solutions licensefees and services revenue was due to the maturity of the narrowband numberingsolutions market in the U.S.

 

***        CustomerSupport***

 

                Customer supportrevenues 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 was a resultof an increase of $0.5 million in revenue from our activation products and anincrease of $0.2 million in revenue from our mediation products, partiallyoffset by $0.6 million in revenues from our numbering solutions products.  The increase in activation customer supportrevenue 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.

 

                Customer supportrevenues decreased 9%, or $1.7 million, to $18.0 million for the year ended December 31,2006 from $19.7 million for the year ended December 31, 2005.  The decrease in customer support revenue included adecrease of $0.3 million in our activation products, a decrease of $1.2 millionfrom our numbering solutions products and a decrease of $0.2 million in ourmediation products.  The decrease inactivation revenue is a result of pricingpressures on support contract renewals. The decrease in the numbering solutions revenue was due to industryconsolidation and smaller overall license sales, which is reflective of thematurity of the narrowband numbering solutions market in the U.S.  The decline in mediation revenue isconsistent with our focus on our activation and numbering solutions products.

 

***Costsof Revenue, excluding depreciation and amortization***

 

                Costs of revenue consistprimarily of personnel costs, facilities costs, the costs of third-partysoftware and all other direct costs associated with these personnel.  Costs of revenue, excluding depreciation andamortization were $14.3 million, $13.0 million and $16.1 million for the yearsended December 31, 2007, 2006 and 2005, respectively.

 

***        Costsof License Fees and Services, excluding depreciation and amortization***

 

                Costs of revenuefor license fees and services increased 9%, or $0.7 million, to $8.0 millionfor the year ended December 31, 2007 from $7.3 million for the year ended December 31,2006.  The increase in costs is attributed to increased labornecessary to support the increase in license fees and services revenue.  As a percentage of license fees and servicesrevenue, costs of license fees and services, excluding depreciation andamortization, decreased to 45% for the year ended December 31, 2007 from46% for the year ended December 31, 2006. This decrease was due to reducedpartner commissions for the year ended December 31, 2007.

 

                Costs of revenuefor license fees and services decreased 23%, or $2.1 million, to $7.3 millionfor the year ended December 31, 2006 from $9.5 million for the year ended December 31,2005.  The decrease was due to decreased revenue as well ascost savings from our 2005 cost saving initiatives.  As a percentage of license fees and servicesrevenue, costs of license fees and services, excluding depreciation and amortization,decreased to 46% for the year ended December 31, 2006 from 48% for theyear ended December 31, 2005.  Thisdecrease was due to cost savings as well assavings from the increased utilization of our offshore development subsidiaryin Bangalore, India.

 

 

 

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***        Costsof Customer Support, excluding depreciation and amortization***

 

                Costs of revenuefor customer support increased 10%, or $0.5 million, to $6.2 million for theyear ended December 31, 2007 from $5.7 million for the year ended December 31,2006.  As a percentage of customer support revenue, costs ofcustomer support revenue, excluding depreciation and amortization, increased to35% for the year ended December 31, 2007 from 32% for the year ended December 31,2006.  These increases are due to highersupport costs for our LNP products as a result of the increased porting volumesand supporting additional platforms.

 

                Costs of revenuefor customer support decreased 13%, or $0.9 million, to $5.7 million for theyear ended December 31, 2006 from $6.6 million for the year ended December 31,2005.  The decrease was due to reduced revenue as well ascost savings.  As a percentage ofcustomer support revenue, costs of customer support revenue, excluding depreciationand amortization, decreased to 32% for the year ended December 31, 2006from 33% for the year ended December 31, 2005.  This decrease was primarily due to costreductions as well as savings from theincreased utilization of our offshore development subsidiary in Bangalore,India.

 

***Salesand Marketing***

 

                Sales and marketing expensesprimarily consist of compensation costs including bonuses and commissions,other employee related costs, travel expenses, advertising and occupancyexpenses.  Sales and marketing expensesdecreased 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 and marketingexpenses for the year ended December 31,2007 decreased to 24% from 26% for the year ended December 31, 2006.  These decreases are the result of decreasedheadcount.

 

                Sales and marketing expensesdecreased 7%, or $0.7 million, to $9.0 million for the year ended December 31,2006 from $9.6 million for the year ended December 31, 2005.  Cost savingmeasures targeted at reducing the number of U.S. sales personnel were somewhatoffset by sales and marketing investments made in Asia and Central and LatinAmerica as well as stock-based compensation expenses recorded during the yearended December 31, 2006.  Asa percentage of total revenue, sales and marketing expenses for the year ended December 31, 2006 increasedto 26% from 24% for the year ended December 31, 2005.  This increase was a result of decreasedrevenue without proportional decreases in sales and marketing expenses duringthe year ended December 31, 2006as compared to the same period in 2005.

 

***Generaland Administrative***

 

                General and administrativeexpenses consist principally of employee related costs, professional fees andoccupancy costs for the following departments: facilities, finance, legal,human resources and executive management. General and administrative expenses increased 14%, or $0.8 million, to$5.9 million for the year ended December 31, 2007 from $5.1 million forthe year ended December 31, 2006.  As a percentage of total revenue, generaland administrative 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.

 

                General and administrativeexpenses decreased 25%, or $1.7 million, to $5.1 million for the year ended December 31,2006 from $6.8 million for the year ended December 31, 2005.  As a percentage of total revenue, general andadministrative expenses for the year ended December 31, 2006 and 2005,decreased to 15% from 17%, respectively. These decreases were primarily a result of cost saving measures andreductions in professional and legal fees which were offset by stock-basedcompensation costs recorded during the year ended December 31, 2006.  As part of the reduction in professionalfees, we did not incur any professional fees during 2006 for compliance effortsrelated to the Sarbanes-Oxley Act.

 

***Product Development***

 

                Product development expensesconsist primarily of employee-related costs for product development.  Product development expenses decreased 23%,or $0.7 million, to $2.4 million for the year ended December 31, 2007 from$3.1 million for the year ended December 31, 2006.  As a percentage of total revenue, productdevelopment expenses decreased to 7% in 2007 from 9% in 2006.  These decreases were due to the completion ofcertain LNP product release enhancements as well as the completion of the “internationalization”of our NumeriTrack®product, which wereunder production during 2006.

 

                Product development expensesincreased 60%, or $1.2 million, to $3.1 million for the year ended December 31,2006 from $1.9 million for the year ended December 31, 2005.  As a percentage of total revenue, productdevelopment expenses increased to 9% in 2006 

 

 

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from5% in 2005.  These increases were due tocosts incurred to “internationalize” our NumeriTrack®product as well as costs attributable to product enhancements during 2006.

 

***Depreciation***

 

                Depreciation expense consists ofdepreciation of long-lived property and equipment.  Depreciation expenses decreased 23%, or $0.3million, to $0.9 million for the year ended December 31, 2007 from $1.2million for the year ended December 31, 2006.  This decrease is a result of certain assetsbecoming fully depreciated.

 

                Depreciation expenses decreased19%, or $0.3 million, to $1.2 million for the year ended December 31, 2006from $1.4 million for the year ended December 31, 2005.  This decrease is a result of certain assetsbecoming fully depreciated.

 

***Amortization***

 

                Amortization expense consists of amortization ofidentifiable intangibles related to our acquisitions of CMS, TSE and EvolvingSystems U.K.  Amortization expensesdecreased 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.

 

                Amortization expenses decreased 52%, or $2.7 million,to $2.5 million for the year ended December 31, 2006 from $5.2 million forthe year ended December 31, 2005. This decrease was attributable to certain intangible assets becomingfully amortized as well as the impairment of certain intangible assets during2006.

 

***Impairmentof Goodwill and Intangible Assets***

 

                During2007, we conducted our annual goodwill impairment test and it was determinedthat goodwill was not impaired.

 

                During 2006, we recorded a goodwill impairment of$10.9 million related to impairment of our License Fees and Services operatingsegment.  Continued pricing pressures and consolidationin the telecommunications industry negatively impacted our achievement offorecasted revenues associated with the acquisitions of CMS in November 2003,TSE in October 2004 and Evolving Systems U.K. in November 2004.  The market price of our common stockdeclined.  Based upon these events, wedetermined that a triggering event had occurred and we conducted a goodwillimpairment analysis as of June 30, 2006. This goodwill impairment analysis resulted in the $10.9 million goodwillimpairment charge.  We estimated the fairvalue of each reporting unit using the expected present value of future cashflows and other market factors.

 

                As a result of the events that led to a triggeringevent related to the goodwill impairment, we first reviewed intangible assetsin accordance with Statement of Financial Accounting Standards No. 144 (“SFAS144”), “Accounting for the Impairment or Disposal of Long-Lived Assets”.  An 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.  Thisreview indicated that $5.6 million of intangible assets related to our LicenseFees and 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***

 

                Interest income includes interestincome earned on cash and cash equivalents. Interest income for the year ended December 31, 2007 increased$144,000 as compared to the year ended December 31, 2006 as a result ofhigher cash and cash equivalents balances.

 

                Interest income for the yearended December 31, 2006 increased $44,000 as compared to the year ended December 31,2005 as a result of higher cash and cash equivalents balances.

 

***Interest Expense***

 

                Interest expense includesinterest expense on our long-term debt and capital lease obligations as well asamortization of debt issuance costs. Interest expense for the year ended December 31, 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 of loweroutstanding debt balances as well as lower variable interest rates on oursenior debt obligations.

 

 

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                Interest expense for the yearended December 31, 2006 increased $0.4 million to $2.0 million as comparedto $1.6 million for the year ended December 31, 2005.  This increase was a result of higher variableinterest rates on our senior debt obligations and increased amortization ofdebt issuance costs.

 

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

 

                Gain (loss) on foreign exchange transactions consists primarily of realized foreign currencytransaction gains and losses.  Foreigncurrency transaction gains and losses result from transactions denominated in acurrency other than the functional currency of the respective subsidiary.  Foreign currency transaction gain (loss)increased $122,000 to a foreign currency gain of $117,000 for the year ended December 31,2007 compared 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.

 

                Foreign currency transactionloss decreased $0.2 million to $5,000 for the year ended December 31, 2006compared to $0.2 million the year ended December 31, 2005.  These losses were primarily generated byEvolving Systems U.K. transactions denominated in currencies other than itsfunctional currency.

 

***IncomeTax Expense (Benefit)***

 

                We recorded net income tax expense (benefit) of $0.6million, $(1.6) million and $(0.4) million during the years ended December 31,2007, 2006 and 2005, respectively.  TheU.S. has net operating loss carryforwards of $50.5 million which are used tooffset any U.S. tax liability. Our tax expense or benefit primarily relates toour U.K-based subsidiary.

 

                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 offset by 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 andconsisted of current income tax expense of $0.3 million and a deferred taxbenefit of $1.9 million.  During 2006, we recorded a$224,000 current tax benefit for research and development expenses related to achange in estimate based on our as-filed 2005 tax return for Evolving SystemsU.K.  The deferred tax benefit of $1.9million relates primarily to amortization expense on intangible assets.

 

                The net income tax benefit for the year ended December 31,2005 of $0.4 million related primarily to our U.K.-based operations andconsisted of current income tax expense of $0.8 million and a deferred taxbenefit of $1.2 million.

 

                In conjunction with the acquisition of EvolvingSystems U.K., certain identifiable intangible assets were recorded.  Since the amortization of these identifiableintangibles is not deductible for income tax purposes, a long-term deferred taxliability of $4.6 million was established at the acquisition date for theexpected difference between what would be expensed for financial reportingpurposes and what would be deductible for income tax purposes.  As of December 31, 2007 and 2006, thisdeferred tax liability was $1.2 million and $1.5 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.

 

                A full valuationallowance was recorded against our U.S. net deferred tax assets as of December 31,2007 and 2006 as we determined that it was more likely than not that we willnot realize our U.S. deferred tax assets. Such assets primarily consist of certain net operating losscarryforwards. Our assessment of the realizability of our domestic deferred taxassets was made using all available evidence. In particular, we considered bothhistorical results and projections of profitability for only the reasonablyforeseeable future periods and any tax planning strategies.

 

                Effective January 1, 2007, the company adoptedthe provisions of Financial Accounting Standards Board (“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 not a material impact on thecompany’s consolidated financial position and results of operations as a resultof the adoption of the provisions of FIN 48.

 

                On January 1, 2007, we recorded a FIN 48transition adjustment consisting of a $0.4 million decrease in our deferred taxassets related to Research and Development Tax Credits that was offset by acorresponding decrease in our valuation allowance.  As of December 31, 2007, we had noliability for unrecognized tax benefits. We do not believe there will be any material changes our 

 

 

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unrecognized taxpositions over the next twelve months.

 

**FINANCIAL CONDITION**

 

                Our working capital position of$1.4 million at December 31, 2007 reflects an increase of $0.6 millionfrom our working capital position of $0.8 million at December 31,2006.  Our working capital positionincreased at December 31, 2007 despite $2.1 million in principal paymentson our senior note payable and a $0.5 million increase in the current portionof long-term debt, in accordance with the repayment schedule associated withour senior note payable.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

                We have historically financedoperations through a combination of cash flow from operations and equitytransactions.  At December 31, 2007,our principal source of liquidity was $7.3 million in cash and cashequivalents and $2.5 million of unused availability under a revolving creditfacility.  The revolving credit facility is availablethrough November 2010.

 

                Net cash provided by operatingactivities for the years ended December 31, 2007, 2006 and 2005 was $4.8million, $3.4 million and $0.4 million, respectively.  The primary contribution to the improvementin cash provided by operating activities for the year ended December 31,2007 is the result of net income of $0.6 million plus non-cash operatingadjustments of $3.0 million compared to a net loss of $16.8 million plusnon-cash operating adjustments of $19.4 million for the year ended December 31,2006.  Additionally, changes in operatingassets and liabilities reflected an increase of $0.5 million in cash fromoperating activities in 2007 from 2006. For the year ended December 31, 2006, net loss of $16.8 millionplus non-cash operating adjustments of $19.4 million compared to a net loss of$2.9 million plus non-cash operating adjustments of $7.0 million for the year endedDecember 31, 2005 resulted in a decrease in cash from operatingactivities.  However, changes inoperating assets and liabilities reflected a net increase in cash fromoperating activities in an increase of $4.4 million in 2006 from 2005.  These fluctuations were primarilyattributable to the timing of billings and collections for existing projectswhich vary based upon the specific billing schedules in each contract andaffect the reported amounts of contract receivables, unbilled work-in-processand unearned revenue.

 

                Net cash used by investingactivities was $0.4 million, $0.6 million and $1.3 million for the years ended December 31,2007, 2006 and 2005, respectively. During 2007, we purchased $0.5 million in property and equipment tosupport operations, partially offset by reductions in restricted cash of $0.2million.  During 2006, we purchased $0.5million in property and equipment to support operations and paid additionalcash consideration to the TSE sellers of approximately $0.2 million.  During 2005, we purchased $0.8 million inproperty and equipment to support operations, paid additional cashconsideration to the TSE sellers of approximately $0.8 million, including $0.3million which was accrued as of December 31, 2004, received $0.1 millionin settlement of pre-acquisition contingencies from the Evolving U.K.acquisition, which were partially offset by a reduction in restricted cash of$0.1 million.

 

                Net cash used in financingactivities was $2.1 million, $1.9 million and $6.0 million for the years ended December 31,2007, 2006 and 2005, respectively.  Thenet cash used in financing activities during 2007 is the result of $2.1 millionin principal 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.  During 2005, we paid $16 million towardreduction of our obligations incurred in connection with the TSE and EvolvingSystems U.K. acquisitions which included a debt restructuring prepayment of$8.5 million to the Evolving Systems U.K. sellers.  This prepayment was funded through proceeds obtained from an $8.5 millionsenior note payable that matures in November 2010.  We restructured the remaining$4.9 million in debt obligations to the Evolving Systems U.K. sellers.  The addition of the senior note payable andrestructuring of the Evolving Systems U.K. seller debt reduced our scheduledprincipal payments through December 31, 2007, from approximately $12.0million to $3.0 million.   In addition,we obtained a $4.5 million senior revolving credit facility in November 2005which required a minimum draw down of $2.0 million.

 

                Our capital expenditures over the last three yearsaveraged $0.6 million annually.  Afinancial covenant on our senior note payable prohibits capital expenditures inexcess of $1.4 million annually.  Overthe next twelve months, we expect our capital expenditure requirements willapproximate $1.0 million which will be used to support operations.

 

                We believe that our current cashand cash equivalents, together with anticipated cash flow from operations willbe sufficient to meet our working capital and capital expenditure requirementsfor at least the next twelve months. In making this assessment, we consideredthe following:

 

·                  Our cash and cash equivalentsbalance at December 31, 2007 of $7.3 million;

 

·                  The availability under ourrevolving credit facility of $2.5 million at December 31, 2007;

 

·                  Our demonstrated ability togenerate positive operating cash flows;

 

·                  Our backlog of approximately$19.7 million, including $6.5 million in license fees and services and $13.2million in 

 

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customer support at December 31,2007;

 

·                  Our planned capital expenditures;and

 

·                  Regardless of the long-term debtrestructuring, our cash forecast indicates that we will have sufficientliquidity to cover anticipated operating costs as well as debt servicepayments.

 

                On February 22, 2008, we replaced ourexisting senior term note and senior revolving facility with a new $4.0 millionsenior term loan, a $1.0 million U.S. revolving credit facility (“U.S.Revolving Facility”) and a $5.0 million U.K. revolving credit facility (“U.K.Revolving Facility”).  Upon execution ofthese new debt agreements, the entire $1.0 million and $5.0 million wasavailable for borrowing under the U.S. Revolving Facility and the U.K.Revolving Facility, respectively.  Thenew debt agreements improve our liquidity position by decreasing our averageinterest rates as well as providing additional borrowing capacity.  See Note 13, Subsequent Events, for furtherdetails on changes to our long-term debt.

 

                We are exposed toforeign currency 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, 2007, the effect of exchange ratechanges resulted in a $0.1 million reduction to consolidated cash.  For the year ended December 31, 2006,the effect of exchange rate changes resulted in a $0.4 million increase toconsolidated cash.  During the year endedDecember 31, 2005, the effect of exchange rate changes resulted in a $0.6million reduction to consolidated cash. We do not currently hedge our foreign currency exposure, but we intendto monitor the rate changes and may hedge our exposures if we see significantnegative trends in exchange rates.

 

**Off-Balance Sheet Arrangements**

 

                We have nooff-balance sheet arrangements that have a material current effect or that arereasonably likely to have a material future effect on our financial condition,changes in financial condition, revenues or expenses, results of operations,liquidity, capital expenditures, or capital resources.

 

**Contractual Obligations and Commercial Commitments**

 

                The following summarizes oursignificant contractual obligations as of December 31, 2007, which arecomprised of a capital lease, operating leases and principal and interestpayments on our long-term debt, assuming no prepayments are made (inthousands).

 
| ** **           | ** ** | **Payments due by period** | ** ** |
|----------------------|------------|----------------------------|------------|
| ** **           | ** ** | **Total**                  | ** ** | **2008** | ** ** | **2009-2010** | ** ** | **2011-2012** | ** ** | **2013 and thereafter** | ** ** |
| Long-term debt (1)   |       | $                          | 11,186     |   | $ | 2,500 |   | $ | 3,919 |   | $ | 4,767 |   | $ | — |   |
| Interest on debt (2) |       | 5,673                      |       | 472 |   | 407 |   | 4,794 |   | — |   |
| Capital lease        |       | 130                        |       | 30 |   | 60 |   | 40 |   | — |   |
| Operating leases     |       | 3,638                      |       | 984 |   | 1,718 |   | 936 |   | — |   |
| Total commitments    |       | $                          | 20,627     |   | $ | 3,986 |   | $ | 6,104 |   | $ | 10,537 |   | $ | — |   |

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(1)                                  See Note 13, Subsequent Events, for changes to our long-term debt.

 

(2)                                  Interest on debt represents cash interest payment obligations assumingall indebtedness at December 31, 2007 will be paid in accordance with itscontractual terms and maturity and assumes interest rates on variable interestdebt as of December 31, 2007 will remain unchanged in future periods.

 

**CRITICAL ACCOUNTING POLICIES**

 

                Our significant accountingpolicies are disclosed in Note 1 of our Consolidated Financial Statementsincluded 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.

 

***RevenueRecognition***

 

                We derive revenue from twoprimary sources: license fees/services and customer support.  We recognize revenue 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.” In addition we have appliedStaff Accounting Bulletin 

 

 

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(“SAB”)No. 104, “Revenue Recognition,” which provides further interpretiveguidance for public companies on the recognition, presentation and disclosureof revenue in financial statements.

 

                The majority of our license fees and services revenueis generated from fixed-price contracts which provide for licenses to oursoftware products and services.  Generally, when the services are determined to be essential to thefunctionality of the delivered software, we recognize revenue using thepercentage-of-completion method of accounting, in accordance with SOP 97-2 andSOP 81-1, “Accounting for Long-Term Construction Type Contracts.”  The percentage of completion for eachcontract is estimated based on the ratio of direct labor hours incurred tototal estimated direct labor hours. Since estimated direct labor hours and project costs, and changes thereto,can have a significant impact on revenue recognition, these estimates arecritical and are reviewed by management regularly.  Amounts billed in advance of services beingperformed are recorded as unearned revenue. Unbilled work-in-progressrepresents revenue earned but not yet billable under the terms of thefixed-price contracts. All such amounts are expected to be billed and collectedwithin 12 months.

 

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

 

                In arrangements where theservices are not essential to the functionality of the delivered software, werecognize license revenue when a license agreement has been signed, deliveryhas occurred, the fee is fixed or determinable and collectibility is reasonablyassured. Where applicable, fees from multiple element arrangements areunbundled and recorded as revenue as the elements are delivered to the extentthat vendor specific objective evidence (“VSOE”) of fair value of theundelivered elements exist. If VSOE for the undelivered elements does notexist, fees from such arrangements are deferred until the earlier of the datethat VSOE does exist on the undelivered elements or all of the elements havebeen delivered.

 

                Services revenue provided underfixed-price contracts is generally recognized using the percentage ofcompletion method described above. Revenue from professional services providedpursuant to time-and-materials contracts and training services are recognizedas the services are performed, as that is when our obligation to our customersunder such arrangements is fulfilled.

 

                Customer support and maintenancerevenue is generally recognized ratably over the service contract period. Whenmaintenance or training services are bundled with the original license fee arrangement,their fair value, based upon VSOE, is deferred and recognized during theperiods such services are provided.

 

***Allowancefor Doubtful Accounts***

 

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

 

***IncomeTaxes***

 

                We account for income taxes inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 109,“Accounting for Income Taxes.” Significant judgment is required in determiningour provision for income taxes. We assess the likelihood that our deferred taxasset will be recovered from future taxable income, and to the extent webelieve that recovery is not likely, we establish a valuation allowance. Weconsider future taxable income projections, historical results and ongoing taxplanning strategies in assessing the recoverability of deferred tax assets.However, adjustments could be required in the future if we determine that theamount to be realized is less or greater than the amount that we recorded. Suchadjustments, if any, could have a material impact on our results of ouroperations.

 

                Effective January 1, 2007, the company adoptedthe provisions of FASB Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes - an interpretation 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 not amaterial 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 48transition adjustment consisting of a $0.4 million decrease in our deferred tax

 

 

28

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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 our unrecognized tax positions over the next twelvemonths.

 

***Goodwill***

 

**               **Goodwill is the excess of acquisitioncost of an acquired entity over the fair value of the identifiable net assetsacquired.  Goodwill is not amortized, buttested for impairment annually or whenever indicators of impairment exist.These indicators may include a significant change in the business climate,legal factors, operating performance indicators, competition, sale ordisposition of a significant portion of the business or other factors. Forpurposes of the goodwill evaluation, we compare the fair value of each of ourreporting units to its respective carrying amount. If the carrying value of areporting unit were to exceed its fair value, we would then compare the fairvalue of the reporting unit’s goodwill to its carrying amount, and any excessof the carrying amount over the fair value would be charged to operations as animpairment loss.  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 costof an acquired company to the tangible and identifiable intangible assets andliabilities acquired, with the remaining amount being recorded as goodwill.  Certain intangible assets are amortized overtheir estimated lives, while in-process research and development is recorded asa one-time charge to product development expense in the statements ofoperations on the acquisition date.

 

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

 

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

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

·                  Significant negative industry oreconomic trends;

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

·                  Our market capitalizationrelative to net book value.

 

                If we determine that thecarrying value of intangibles and/or long-lived assets may not be recoverablebased on the existence of one or more of the above indicators of impairment, wemeasure any impairment based on the estimated discounted cash flows expected toresult from the use of the asset and its eventual disposition and compare thatto the asset’s carrying amount. Any impairment loss recognized would representthe excess of the asset’s carrying value over its estimated fair value.Significant estimates and judgments are required when estimating such fairvalues. If it is determined that the intangibles are impaired, an impairmentcharge would be recorded and the amount could be material.  We recorded an impairment of intangibleassets during the year ended December 31, 2006.  See Note 2 to the Consolidated FinancialStatements for further details.

 

***Capitalization of Internal Software DevelopmentCosts***

 

                We expend amounts on research and development,particularly for new products and/or for enhancements of existing products. Forinternal development of software products that are to be licensed by us, wefollow Statement of Financial Accounting Standards (“SFAS”) 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 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. We did not capitalize any internal software developmentcosts during the years ended December 31, 2007, 2006, or 2005. Inaddition, we did not have any capitalized internal software development costsincluded in our December 31, 2007 and 2006 Consolidated Balance Sheets. Webelieve that during these periods no material internal software development costswere required to be capitalized. Our conclusion is primarily based on the factthat the feature-rich, pre-integrated, and highly-scalablenature of our products requires that our development efforts include complexdesign, coding and testing methodologies, which include next generationsoftware languages and development tools. Development projects of this naturecarry a high degree of development risk. Substantially all of our internalsoftware development efforts are of this nature, and therefore, we believe theperiod between achieving technological feasibility and the general release ofthe software to operations is so short that any costs incurred during thisperiod are not material.

 

 

29

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***Stock-based Compensation***

 

We adopted SFAS No. 123(Revised),“Share-Based Payment” (“SFAS 123R”) effective January 1, 2006.  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 the modified prospective method of adoption, we are required toapply a fair-value-based measurement method in accounting for share-basedpayment transactions 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, stock option grants and employee stockpurchase plan purchases were accounted for 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**

 

In December 2007,the SEC issued Staff Accounting Bulletin 110, *Share-BasedPayment* (“SAB 110”), which amends Staff Accounting Bulleting 107 (“SAB107”), *Share-Based Payment*, to permit publiccompanies, under certain circumstances, to use the simplified method of SAB 107for 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 intend to adopt 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.

 

In February 2007,the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities - Including anAmendment of FASB Statement No. 115* (“SFAS 159”).  SFAS 159permits entities to choose to measure eligible items at fair value at specificelection dates (the ‘‘fair value option’’). Unrealized gains and losses onitems for which the fair value option has been elected shall be reported inearnings at each subsequent reporting period. This accounting standard iseffective for us beginning January 1, 2008.  We are currently assessing the impact of SFAS159.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value under generally accepted accounting principles, andexpands disclosures about fair value measurements. 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.  We are currently assessing theimpact of SFAS 157.

 

**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 borrowing under thesecredit facilities, but future borrowings will subject us to interest 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 

 

 

30

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results of foreignsubsidiaries and affiliates when their respective financial statements aretranslated into U.S. dollars for inclusion in our consolidated financialstatements. Cumulative translation adjustments are recorded in accumulatedother comprehensive income (loss) as a separate component of equity. As aresult of foreign currency risk, we may experience economic loss and a negativeimpact on earnings and equity with respect to our holdings solely as a resultof foreign currency exchange rate fluctuations.

 

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

 
| ** **          | ** ** | **December 31,** | ** ** |
|---------------------|------------|-----------------------|------------|
| **Spot rates:**     | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Great British pound |       | 0.50092               |       | 0.51069 |   |
| Indian rupee        |       | 39.43218              |       | 44.11116 |   |

 
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| **Average rates:**  | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Great British pound |       | 0.49992                                   |       | 0.543739 |   | 0.54989 |   |
| Indian rupee        |       | 41.28177                                  |       | 45.15648 |   | 44.14848 |   |

 

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

 

 

31

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**ITEM 8.    FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Boardof Directors and Shareholders

 

EvolvingSystems, Inc.

 

Wehave audited the accompanying consolidated balance sheet of Evolving Systems, Inc.(a Delaware corporation) and subsidiaries (collectively, the “Company”) as of December 31,2007, and the related consolidated statements of operations, statements ofchanges in stockholders’ equity and comprehensive income (loss), and cash flowsfor the year then ended. These financial statements are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).**Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement.**The Company is not required tohave, nor were we engaged to perform an audit of its internal control overfinancial reporting.**Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting.**Accordingly,we express no such opinion.**An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation.**We believethat our audit provides a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Evolving Systems, Inc.and subsidiaries as of December 31, 2007, and the results of theiroperations and their cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.

 

/s/GRANT THORNTON LLP

 

Denver,Colorado

March 13,2008

 

 

 

32

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

The Board of Directorsand StockholdersEvolving Systems, Inc.:

 

We haveaudited the accompanying consolidated balance sheet of Evolving Systems, Inc.and subsidiaries as of December 31, 2006, and the related consolidatedstatements of operations, changes in stockholders’ equity and comprehensiveincome (loss), and cash flows for each of the years in the two-year periodended December 31, 2006. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

Weconducted our audits 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 ouraudits provide a reasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Evolving Systems, Inc.and subsidiaries as of December 31, 2006, and the results of theiroperations and their cash flows for each of the years in the two-year periodended December 31, 2006, in conformity with U.S. generally acceptedaccounting principles.

 

Asdiscussed in note 7 to the accompanying consolidated financial statements,effective January 1, 2006, the Company adopted Statement of FinancialAccounting Standards No. 123(R), *Share-BasedPayment*.

 

**KPMG LLP**

 

Denver, ColoradoMarch 14, 2007

 

 

33

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(inthousands except share data)**

 
| ** **                                                                                                                                                                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                             | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **ASSETS**                                                                                                                                                                                             | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                        |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                                              |       | $                     | 7,271      |   | $ | 5,076 |   |
| Current portion of restricted cash                                                                                                                                                                     |       | —                |       | 300 |   |
| Contract receivables, net of allowance for doubtful accounts of $66  and $70 at December 31, 2007 and 2006, respectively                                                                          |       | 10,959                |       | 9,206 |   |
| Unbilled work-in-progress                                                                                                                                                                              |       | 922                   |       | 1,064 |   |
| Deferred income taxes                                                                                                                                                                                  |       | 4                     |       | 15 |   |
| Prepaid and other current assets                                                                                                                                                                       |       | 1,331                 |       | 1,686 |   |
| Total current assets                                                                                                                                                                                   |       | 20,487                |       | 17,347 |   |
| Property and equipment,  net                                                                                                                                                                           |       | 1,677                 |       | 1,349 |   |
| Amortizable intangible  assets, net                                                                                                                                                                    |       | 4,687                 |       | 6,155 |   |
| Goodwill                                                                                                                                                                                               |       | 26,417                |       | 26,027 |   |
| Long-term restricted cash                                                                                                                                                                              |       | 100                   |       | — |   |
| Other long-term assets                                                                                                                                                                                 |       | 359                   |       | 460 |   |
| Total assets                                                                                                                                                                                           |       | $                     | 53,727     |   | $ | 51,338 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                          | ** ** |
| Current liabilities:                                                                                                                                                                                   |       |                  |       |   |   |
| Current portion of capital lease obligations                                                                                                                                                           |       | $                     | 20         |   | $ | 37 |   |
| Current portion of long-term debt                                                                                                                                                                      |       | 2,500                 |       | 2,000 |   |
| Accounts payable and accrued liabilities                                                                                                                                                               |       | 5,903                 |       | 4,428 |   |
| Deferred income taxes                                                                                                                                                                                  |       | 34                    |       | — |   |
| Unearned revenue                                                                                                                                                                                       |       | 10,635                |       | 10,079 |   |
| Total current liabilities                                                                                                                                                                              |       | 19,092                |       | 16,544 |   |
| Long-term liabilities:                                                                                                                                                                                 |       |                  |       |   |   |
| Capital lease obligations, net of current portion                                                                                                                                                      |       | 79                    |       | 34 |   |
| Other long-term obligations                                                                                                                                                                            |       | 1,477                 |       | 749 |   |
| Long-term debt, net of current portion                                                                                                                                                                 |       | 8,686                 |       | 11,370 |   |
| Deferred income taxes                                                                                                                                                                                  |       | 878                   |       | 1,202 |   |
| Total liabilities                                                                                                                                                                                      |       | 30,212                |       | 29,899 |   |
| Commitments and  contingencies (Note 10)                                                                                                                                                               |       |                  |       |   |   |
| Series B convertible redeemable preferred stock                                                                                                                                                   |       | 5,587                 |       | 11,281 |   |
| Stockholders’ equity:                                                                                                                                                                             |       |                  |       |   |   |
| Preferred stock; $0.001 par value; 2,000,000 shares authorized; 478,750  and 966,666 shares of Series B issued and outstanding as of  December 31, 2007 and 2006, respectively (shown above) |       | —                |       | — |   |
| Common stock, $0.001 par value; 40,000,000 shares authorized; 17,914,770  and 16,233,646 shares issued and outstanding as of December 31, 2007 and  2006, respectively                            |       | 18                    |       | 16 |   |
| Additional paid-in capital                                                                                                                                                                             |       | 75,317                |       | 68,825 |   |
| Accumulated other comprehensive income                                                                                                                                                                 |       | 2,144                 |       | 1,466 |   |
| Accumulated deficit                                                                                                                                                                                    |       | (59,551               | )          | (60,149 | ) |
| Total stockholders’ equity                                                                                                                                                                        |       | 17,928                |       | 10,158 |   |
| Total liabilities and stockholders’ equity                                                                                                                                                        |       | $                     | 53,727     |   | $ | 51,338 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

 

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands except per share data)**

 
| ** **                                                                   | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                    |       | $                                         | 17,895     |   | $ | 15,883 |   | $ | 19,779 |   |
| Customer support                                                             |       | 18,058                                    |       | 17,950 |   | 19,673 |   |
| Total revenue                                                                |       | 35,953                                    |       | 33,833 |   | 39,452 |   |
|                                                                         |       |                                      |       |   |   |   |   |
| **COSTS OF REVENUE AND OPERATING  EXPENSES**                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Costs of license fees and services, excluding depreciation and  amortization |       | 8,023                                     |       | 7,342 |   | 9,491 |   |
| Costs of customer support, excluding depreciation and amortization           |       | 6,237                                     |       | 5,694 |   | 6,579 |   |
| Sales and marketing                                                          |       | 8,557                                     |       | 8,962 |   | 9,643 |   |
| General and administrative                                                   |       | 5,862                                     |       | 5,138 |   | 6,818 |   |
| Product development                                                          |       | 2,376                                     |       | 3,072 |   | 1,921 |   |
| Depreciation                                                                 |       | 899                                       |       | 1,169 |   | 1,443 |   |
| Amortization                                                                 |       | 1,565                                     |       | 2,511 |   | 5,215 |   |
| Impairment of goodwill and intangible assets                                 |       | —                                    |       | 16,516 |   | — |   |
| Restructuring and other expenses (recovery)                                  |       | (4                                        | )          | (21 | ) | (49 | ) |
| Total costs of revenue and  operating expenses                               |       | 33,515                                    |       | 50,383 |   | 41,061 |   |
| Income (loss) from  operations                                               |       | 2,438                                     |       | (16,550 | ) | (1,609 | ) |
| Interest and other:                                                          |       |                                      |       |   |   |   |   |
| Interest income                                                              |       | 304                                       |       | 160 |   | 116 |   |
| Interest expense                                                             |       | (1,747                                    | )          | (1,992 | ) | (1,636 | ) |
| Gain on extinguishment of debt                                               |       | 42                                        |       | — |   | — |   |
| Gain (loss) on foreign exchange transactions                                 |       | 117                                       |       | (5 | ) | (172 | ) |
| Interest and other income  (expense), net                                    |       | (1,284                                    | )          | (1,837 | ) | (1,692 | ) |
|                                                                         |       |                                      |       |   |   |   |   |
| Income (loss) before  income taxes                                           |       | 1,154                                     |       | (18,387 | ) | (3,301 | ) |
| Income tax expense (benefit)                                                 |       | 556                                       |       | (1,604 | ) | (396 | ) |
| Net income (loss)                                                            |       | $                                         | 598        |   | $ | (16,783 | ) | $ | (2,905 | ) |
|                                                                         |       |                                      |       |   |   |   |   |
| Basic income (loss) per  common and preferred share                          |       | $                                         | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) |
| Diluted income (loss) per  common and preferred share                        |       | $                                         | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) |
|                                                                         |       |                                      |       |   |   |   |   |
| Weighted average basic  shares outstanding                                   |       | 19,198                                    |       | 19,100 |   | 18,695 |   |
| Weighted average diluted  shares outstanding                                 |       | 19,576                                    |       | 19,100 |   | 18,695 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY**

**ANDCOMPREHENSIVE INCOME (LOSS)**

**(inthousands, except share data)**

 
| ** **                                                       | ** ** | ** ** | ** ** | **Additional Paid-in  Capital** | ** ** | **Accumulated Other Comprehensive Income (Loss)** | ** ** | **Accumulated Deficit** | ** ** | **Total Stockholders’ Equity** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|---------------------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|
| **Common Stock**                                                 |
| **Shares**                                                       | ** ** | **Amount** |
| ** **                                                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **                                        | ** ** | ** **              | ** ** | ** **                          | ** ** | ** ** | ** ** |
| **Balance at December 31,  2004**                           |       | 15,987,217 |       | $                               | 16         |                                              | $          | 67,765                  |       | $                                   | 1,994      |   | $ | (40,461 | ) | $ | 29,314 |   |
| Stock option exercises                                           |       | 132,488    |       | —                          |       | 71                                                |       | —                  |       | —                              |       | 71 |   |
| Common stock issued pursuant to the Employee Stock Purchase Plan |       | 18,116     |       | —                          |       | 55                                                |       | —                  |       | —                              |       | 55 |   |
| Comprehensive loss:                                              |       |       |       |                            |       |                                              |       |                    |       |                                |       |   |   |
|  Net loss                                                   |       | —     |       | —                          |       | —                                            |       | —                  |       | (2,905                              | )          |   |   |
|  Foreign currency translation  adjustment                   |       | —     |       | —                          |       | —                                            |       | (4,411                  | )          | —                              |       |   |   |
| Comprehensive loss                                               |       |       |       |                            |       |                                              |       |                    |       |                                |       | (7,316 | ) |
| **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 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:                                            |       |       |       |                            |       |                                              |       |                    |       |                                |       |   |   |
|  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 |   |

 

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

 

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

 
| ** **                                                                                | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                         | 598        |   | $ | (16,783 | ) | $ | (2,905 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                                      |       |   |   |   |   |
| Depreciation                                                                              |       | 899                                       |       | 1,169 |   | 1,443 |   |
| Amortization of intangible assets                                                         |       | 1,565                                     |       | 2,511 |   | 5,215 |   |
| Amortization of debt issuance costs                                                       |       | 235                                       |       | 273 |   | 105 |   |
| Stock-based compensation                                                                  |       | 710                                       |       | 808 |   | — |   |
| Impairment of goodwill and intangible assets                                              |       | —                                    |       | 16,516 |   | — |   |
| Interest expense added to debt principal                                                  |       | —                                    |       | — |   | 1,191 |   |
| Gain on disposal of property and equipment                                                |       | (4                                        | )          | (18 | ) | (8 | ) |
| Gain on extinguishment of debt                                                            |       | (42                                       | )          | — |   | — |   |
| Unrealized foreign currency transaction (gains) and losses, net                           |       | (117                                      | )          | 5 |   | 179 |   |
| Provision for (recovery of) bad debt                                                      |       | (5                                        | )          | 28 |   | 4 |   |
| Benefit from foreign deferred income taxes                                                |       | (279                                      | )          | (1,891 | ) | (1,177 | ) |
| Change in operating assets and liabilities:                                               |       |                                      |       |   |   |   |   |
| Contract receivables                                                                      |       | (1,265                                    | )          | 1,983 |   | (172 | ) |
| Unbilled work-in-progress                                                                 |       | 153                                       |       | 192 |   | 219 |   |
| Prepaid and other assets                                                                  |       | 327                                       |       | (171 | ) | 440 |   |
| Accounts payable and accrued liabilities                                                  |       | 778                                       |       | (1,622 | ) | (1,224 | ) |
| Unearned revenue                                                                          |       | 492                                       |       | 20 |   | (2,978 | ) |
| Other                                                                                     |       | 728                                       |       | 346 |   | 63 |   |
| Net cash provided by operating activities                                                 |       | 4,773                                     |       | 3,366 |   | 395 |   |
|                                                                                      |       |                                      |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                       |       | (546                                      | )          | (477 | ) | (758 | ) |
| Proceeds from sale of property and equipment                                              |       | 4                                         |       | 20 |   | 18 |   |
| Business combinations and earnout payments                                                |       | (24                                       | )          | (153 | ) | (652 | ) |
| Restricted cash                                                                           |       | 200                                       |       | — |   | 100 |   |
| Net cash used in investing activities                                                     |       | (366                                      | )          | (610 | ) | (1,292 | ) |
|                                                                                      |       |                                      |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital lease payments                                                                    |       | (21                                       | )          | (34 | ) | (31 | ) |
| Principal payments on long-term debt                                                      |       | (2,141                                    | )          | (2,025 | ) | (13,389 | ) |
| Proceeds from the issuance of long-term debt, net of issuance costs                       |       | —                                    |       | — |   | 9,898 |   |
| Payment of amounts to Evolving U.K. sellers                                               |       | —                                    |       | — |   | (2,617 | ) |
| Proceeds from the issuance of stock                                                       |       | 89                                        |       | 126 |   | 126 |   |
| Net cash used in financing activities                                                     |       | (2,073                                    | )          | (1,933 | ) | (6,013 | ) |
|                                                                                      |       |                                      |       |   |   |   |   |
| Effect of foreign exchange rate changes on cash                                           |       | (139                                      | )          | 370 |   | (593 | ) |
|                                                                                      |       |                                      |       |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                      |       | 2,195                                     |       | 1,193 |   | (7,503 | ) |
| Cash and cash equivalents at beginning of year                                            |       | 5,076                                     |       | 3,883 |   | 11,386 |   |
| Cash and cash equivalents at end of year                                                  |       | $                                         | 7,271      |   | $ | 5,076 |   | $ | 3,883 |   |
|                                                                                      |       |                                      |       |   |   |   |   |
| Supplemental disclosure of  other cash and non-cash items:                                |       |                                      |       |   |   |   |   |
| Interest paid                                                                             |       | $                                         | 819        |   | $ | 1,065 |   | $ | 211 |   |
| Income taxes paid                                                                         |       | $                                         | 180        |   | $ | 740 |   | $ | 389 |   |
| Conversion of preferred stock into common stock                                           |       | $                                         | 5,694      |   | $ | — |   | $ | — |   |
| Property and equipment acquired under capital lease agreements                            |       | $                                         | 84         |   | $ | — |   | $ | — |   |
| Property and equipment purchased and included in accounts payable                         |       | $                                         | 792        |   | $ | — |   | $ | — |   |

 

The accompanying notes arean integral part of these consolidated financial statements

 

37

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**EVOLVING SYSTEMS, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

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

 

**                Principles ofConsolidation -**The consolidated financial statements include theaccounts of Evolving Systems and subsidiaries, all of which are whollyowned.  All significant intercompanytransactions and balances have been eliminated in consolidation.

 

**                Use ofEstimates -**The preparation of financial statements in conformitywith accounting principles generally accepted in the U.S. requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities, at the date ofthe financial statements, as well as the reported amounts of revenue andexpenses during the reporting period. We made estimates with respect to revenuerecognition for estimated hours to complete projects accounted for using thepercentage of completion method, allowance for doubtful accounts, income taxvaluation allowance, fair values of long-lived assets, valuation of intangibleassets and goodwill, useful lives for property, equipment and intangibleassets, business combinations, capitalization of internal software developmentcosts and fair value of stock-based compensation amounts.  Actual results could differ from theseestimates.

 

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

 

**                Cash andCash Equivalents -**All highly liquid investments and investments witha maturity of three months or less when purchased are considered to be cashequivalents.  All cash equivalents arecarried at cost, which approximates fair value. We have cash investmentpolicies that limit investments to investment grade securities and certificatesof deposit.

 

**                Restricted Cash-**As of December 31, 2007 and 2006, we had $100,000and $300,000 of restricted cash, respectively, related to our headquarterslease. The restricted cash requirement was reduced by $200,000 during 2007 aswe negotiated a new lease with our existing landlord.  The remainder of the restricted cash willbecome unrestricted within 60 days of the expiration of our lease.

 

**                ContractReceivables and Allowance for Doubtful Accounts -**Contract receivables are recorded at theinvoiced amount and do not bear interest. The allowance for doubtful accountsis our best estimate of the amount of probable credit losses in accounts receivable.We determine the allowance based on historical write-off experience andinformation received during collection efforts. We review our allowance fordoubtful accounts monthly and past due balances over 90 days are reviewedindividually for collectibility. Account balances are charged against theallowance after all means of collection have been exhausted and the potentialfor recovery is considered remote. We do not have any off-balance-sheet creditexposure related to our customers.

 

                The following table reflects theactivity in the allowance for doubtful accounts:

 
| **Fiscal  Year** | ** ** | **Description**                  | ** ** | **Balance at  Beginning  of Period** | ** ** | **Bad Debt  Expense/  (Recovery)** | ** ** | **Write-  Offs Charged  to  Allowance** | ** ** | **Effects of  Foreign   Currency  Exchange  Rates** | ** ** | **Balance at  End of  Period** | ** ** |
|------------------|------------|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|
| 2007             |       | Allowance  for doubtful accounts |       | $                                    | 70         |                               | $          | (5                                      | )          | $                                                   | —     |                           | $          | 1 |   | $ | 66 |   |
| 2006             |       | Allowance  for doubtful accounts |       | $                                    | 48         |                               | $          | 28                                      |       | $                                                   | —     |                           | $          | (6 | ) | $ | 70 |   |
| 2005             |       | Allowance  for doubtful accounts |       | $                                    | 44         |                               | $          | 4                                       |       | $                                                   | —     |                           | $          | — |   | $ | 48 |   |

 

 

 

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**                Concentration of Credit Risk-**Financialinstruments that potentially subject us to concentrations of credit riskconsist primarily of contract receivables and unbilled work-in-progress. Weperform on-going evaluations of customers’ financial condition and, generally,require no collateral from customers.

 

                A substantial portion of ourrevenue is from a limited number of customers, all in the telecommunicationsindustry.  The following tables depictthe percentage of revenue and percentage of contract receivables generated fromsignificant customers (defined as contributing at least 10%):

 
| ** **                   | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Customer A— U.S.        |       | 22                                        | %          | 13 | % | 14 | % |
| Customer B — Luxembourg |       | —                                    |       | — |   | 12 | % |
| Customer C — U.K.       |       | 13                                        | %          | 13 | % | 12 | % |
| Total % of Revenue           |       | 35                                        | %          | 26 | % | 38 | % |

 

 
|                            |   | **December 31,** |       |     |   |
|---------------------------------|--------|-----------------------|------------|----------|--------|
|                            |   | **2007**              | ** ** | **2006** |   |   |   |
| Customer A — U.S.          |   | 42                    | %          | 40       | %      |   |   |
| Customer B — Luxembourg    |   | —                |       | 11       | %      |   |   |
| Total % of Contract Receivables |   | 42                    | %          | 51       | %      |   |   |

 

**                FairValue of Financial Instruments -**The carrying amounts for certainfinancial instruments, including cash and cash equivalents, contractreceivables and accounts payable, approximate fair value due to their shortmaturities.  We estimate the fair valueof our debt based on currentrates offered to us for debt of the same remaining maturities, if available, orif not available, based on discounted future cash flows using current marketinterest rates.  As of December 31, 2007 and 2006, webelieve that the carrying amounts of our variable rate long-term debt approximatedfair value due to the notes carrying a current market rate of interest.  We estimated that the fair value of our fixedrate long-term debt was approximately $5.4 million and $4.6 million at December 31,2007 and 2006, respectively.

 

**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 collectibility is reasonablyassured.

 

The majority of ourlicense fees and services revenue is generated from fixed-price contracts,which provide for licenses to our software products and services to customizesuch software to meet our customers’ use.  When the services are determined to be essential to the functionality ofthe delivered software, we recognize revenue using the percentage-of-completionmethod of accounting, in accordance with SOP 97-2 and SOP 81-1, “Accounting forLong-Term Construction Type Contracts.” The percentage of completion for each contract is estimated based on theratio of direct labor hours incurred to total estimated direct laborhours.  Since estimated direct laborhours, and changes thereto, can have a significant impact on revenuerecognition, these estimates are critical and are reviewed regularly.  Amounts billed in advance of services beingperformed are recorded as unearned revenue.

 

Unbilled work-in-progressrepresents revenue earned but not yet billable under the terms of thefixed-price contracts. All such amounts are expected to be billed and collectedwithin 12 months.

 

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

 

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

 

Services revenue fromfixed-price contracts is recognized using the proportional performance methodof accounting, which is 

 

 

39

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similar to the percentageof completion method described above. Revenue from professional servicesprovided pursuant to time-and-materials based contracts and training servicesare recognized as the services are performed, as that is when our obligation toour customers under such arrangements is fulfilled.

 

                Customer support, including maintenance revenue, isrecognized ratably over the service contract period. When maintenance isbundled with the original license fee arrangement, its fair value, based uponVSOE, is deferred and recognized during the periods when services are provided.

 

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

 

**                Advertisingand Promotion Costs -**All advertising and promotioncosts are expensed as incurred. Advertising costs totaled approximately$322,000, $287,000 and $594,000, for the years ended December 31, 2007,2006 and 2005, 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.  Compensation cost for options is recognizedon a straight-line basis over the vesting period using an estimated forfeiturerate.   Effective January 1, 2006,stock option grants and employee stock purchase plan purchases were accountedfor under SFAS 123R.  We used theBlack-Scholes model to estimate the fair value of each option grant on the dateof grant.  This model requires the use ofestimates for expected term of the options and expected volatility of the priceof our common stock.

 

**                Capitalization ofInternal Software Development Costs -**We expend amounts on research and development,particularly for new products and/or for enhancements of existing products. Forinternal development of software products that are to be licensed by us, wefollow Statement of Financial Accounting Standards No. 86, “Accounting forthe 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 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, 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, 2007, 2006 or 2005 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, 2007 and2006 consolidated balance sheets.

 

**                Propertyand Equipment and Long-Lived Assets -**Property and equipment are statedat cost or estimated fair value if acquired in an acquisition, less accumulateddepreciation, and are depreciated over their estimated useful lives, generallytwo to four years or the lease term, if shorter, using the straight-linemethod. Leasehold improvements are stated at cost, less accumulatedamortization, and are amortized over the shorter of the lease term or estimateduseful life of the asset. Maintenance and repair costs are expensed asincurred.

 

                Our long-lived assets, such asproperty and equipment and purchased intangible assets subject to amortizationare reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset or asset group may not berecoverable. The recoverability of an asset or asset group is evaluated bycomparing its carrying amount to the estimated undiscounted future cash flowsexpected to be generated by the asset or asset group. If the carrying amount ofan asset or asset group exceeds its estimated future cash flows, an impairmentcharge is recognized as the amount by which the carrying amount of the assetexceeds the estimated fair value of the asset.

 

**                Goodwill -**Goodwill is the excess of acquisitioncost of an acquired entity over the fair value of the identifiable net assetsacquired.  Goodwill is not amortized, buttested for impairment annually or whenever indicators of impairment exist.These indicators may include a significant change in the business climate,legal factors, operating performance indicators, competition, sale ordisposition of a significant portion of the business or other factors. Forpurposes of the goodwill evaluation, we compare the fair value of each of ourreporting units to its respective carrying amount. If the carrying value of areporting unit were to exceed its fair value, 

 

 

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we would then compare thefair value of the reporting unit’s goodwill to its carrying amount, and anyexcess of the carrying amount over the fair value would be charged tooperations as an impairment loss.  Duringthe year ended December 31, 2006, we recorded an impairment ofgoodwill.  See Note 2 for furtherdetails.

 

**Intangible Assets -**Amortizable intangible assets consist primarily ofpurchased software and licenses, customer contracts and relationships,trademarks and tradenames, and business partnerships acquired in conjunctionwith our purchases of CMS, TSE and Evolving Systems U.K.  These definite life assets are amortizedusing the straight-line method over their estimated lives.

 

Weassess the impairment of identifiable intangibles if events or changes incircumstances indicate that the carrying value of the asset may not berecoverable. Factors that we consider significant which could trigger animpairment analysis include the following:

 

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

 

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

 

·                  Significant negative industry oreconomic trends; and/or

 

·                  Significant decline in our stockprice for a sustained period.

 

If,as a result of the existence of one or more of the above indicators ofimpairment, 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, an impairment loss isrecognized representing the excess of the asset’s carrying value over itsestimated fair 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 inaccordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”).Deferred tax assets and liabilities are recorded for the estimated future taxeffects of temporary differences between the tax bases of assets andliabilities and amounts reported in the accompanying consolidated balancesheets, as well as operating loss and tax credit carry-forwards. Deferred taxassets and liabilities are measured using enacted tax rates expected to beapplied to taxable income in the years in which those temporary differences areexpected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if, based onavailable evidence, it is more likely than not that these benefits will not berealized.  We evaluate tax benefits recorded in ourconsolidated financial statements and record accruals for any amounts deemednot probable of being sustained.

 

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

 

On January 1, 2007,we recorded a FIN 48 transition adjustment consisting of a $0.4 milliondecrease in our deferred tax assets related to Research and Development TaxCredits that was offset by a corresponding decrease in our valuationallowance.  As of December 31, 2007,we had no liability for unrecognized tax benefits.  We do not believe there will be any materialchanges our unrecognized tax positions over the next twelve months.

 

**Reclassifications -**Certain prior periodbalances have been reclassified to conform to the current year’s presentation.

 

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

 

In February 2007,the FASB issued SFAS No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities - Including anAmendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 permits entities to choose to measureeligible items at fair value at specific election dates (the ‘‘fair valueoption’’). Unrealized gains and losses on items for which the fair value optionhas been elected shall be reported in earnings at each subsequent reportingperiod. This accounting standard is effective for us 

 

 

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beginning January 1,2008.  We are currently assessing theimpact of SFAS 159.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value under generally accepted accounting principles, andexpands disclosures about fair value measurements. In February 2008, theFASB issued Staff Position No. 157-2, which delays the effective date ofSFAS 157 for non-financial assets and liabilities until financial statementsissued for fiscal years and interim periods beginning after November 15,2008. We are currently assessing the impact of SFAS 157.

 

**NOTE 2 - GOODWILL AND INTANGIBLE ASSETS**

 

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

 
| ** **                                            | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|----------------------|------------|-----------|------------|
| ** **                                            | ** ** | **U.S.**                 | ** ** | **U.K.**             | ** ** | **U.S.**  | ** ** | **U.K.** | ** ** | **Goodwill** | ** ** |
| Balance as of  December 31, 2005                 |       | $                        | 3,078      |                 | $          | 15,492    |       | $ | 6,008 |   | $ | 9,495 |   | $ | 34,073 |   |
| TSE earnout                                           |       | 2                        |       | —               |       | 25        |       | — |   | 27 |   |
| Goodwill impairment charge                            |       | (3,080                   | )          | (7,831               | )          | —    |       | — |   | (10,911 | ) |
| Effects of changes in foreign currency exchange rates |       | —                   |       | 1,283                |       | —    |       | 1,555 |   | 2,838 |   |
| 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 |   |

 

                Ourannual goodwill impairment test was conducted as of July 31, 2007, and itwas determined that goodwill was not impaired as of the test date. From July 31,2007 through December 31, 2007, no events have occurred that we believemay have impaired goodwill.

 

                During 2006, we recognized agoodwill impairment charge in our License and Services reporting units of $10.9million.  Due to continued pricing pressures on services and consolidation in thetelecommunications industry, revenues and cash flows had been lower thanexpected and those lower operating results had a negative impact on the marketprice of our common stock.  Based uponthis trend, we reviewed our business plan during the second quarter of 2006.  As a result of these events, we determinedthat a triggering event had occurred and conducted a goodwill impairmentanalysis.  This goodwill impairmentrelated to goodwill from our acquisitions of CMS in November 2003, TSE in October 2004and 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.

 

                Identifiableintangible assets are amortized on a straight-line basis over estimated livesranging from one to seven years and include the cumulative effects of foreigncurrency exchange rates.  As of December 31,2007 and 2006, identifiable intangibles were as follows (in thousands):

 
| **Identifiable intangible   assets:** | ** ** | **December 31, 2007**  | ** ** | **December 31, 2006**   | ** ** | ** **              | ** ** |
|---------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **(1)   Gross Amount** | ** ** | **Accumulated Amortization** | ** ** | **Net Carrying Amount** | ** ** | **(2)    Gross Amount** | ** ** | **(2)   Accumulated Amortization** | ** ** | **Net   Carrying Amount** | ** ** | **Weighted-Average Amortization Period** | ** ** |
| Purchased software                    |       | $                           | 2,072      |                         | $          | 700                     |       | $ | 1,372 |   | $ | 2,038 |   | $ | 237 |   | $ | 1,801 |   | 4.7  yrs |   |
| Purchased licenses                    |       | 227                         |       | 146                          |       | 81                      |       | 227 |   | 49 |   | 178 |   | 2.3  yrs |   |
| Trademarks and tradenames             |       | 896                         |       | 192                          |       | 704                     |       | 879 |   | 63 |   | 816 |   | 7.0  yrs |   |
| Business partnerships                 |       | 146                         |       | 44                           |       | 102                     |       | 143 |   | 14 |   | 129 |   | 5.0  yrs |   |
| Customer relationships                |       | 3,707                       |       | 1,279                        |       | 2,428                   |       | 3,657 |   | 426 |   | 3,231 |   | 5.6  yrs |   |
|                                  |       | $                           | 7,048      |                         | $          | 2,361                   |       | $ | 4,687 |   | $ | 6,944 |   | $ | 789 |   | $ | 6,155 |   | 5.4  yrs |   |

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(1)               Increases inintangible values as of December 31, 2007 compared to December 31,2006 are the direct result of changes in foreign currency exchange rates forthe years then ended.

 

(2)               In associationwith our impairment of intangible assets during the second quarter of 2006, weestablished a new cost basis for amortizable intangible assets at June 30,2006 and reduced the accumulated amortization to nil at June 30,2006.  We also re-evaluated estimatedremaining useful lives.

 

 

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                As a result of the events that led to the goodwillimpairment during 2006, we reviewed intangible assets for recoverability inaccordance with SFAS 144.  Our evaluationof product strategy and development plans resulted in our determination thatthe undiscounted cash flows associated with these assets would not besufficient to recover the carrying amounts of these assets.  As a result of this review we recorded anintangible asset impairment of $5.6 million at June 30, 2006.  This was comprised of $4.2 million ofpurchased software and purchased license intangible assets in the License Feesand Services operating segment associated with the acquisitions of CMS and TSEas well as $1.4 million of customer relationship and business partnershipintangible assets in the Customer Support operating segment associated with theacquisition of Evolving U.K.  The fair values of ourintangible assets were estimated using the present value of expected futurecash flows.

 

                Amortization expenseof identifiable intangible assets was $1.6 million, $2.5 million and $5.2million for the years ended December 31, 2007, 2006 and 2005,respectively.  As Evolving Systems U.K.uses the GreatBritish pound as its functional currency, the amount of future amortizationactually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related toidentifiable intangibles based on our carrying amount as of December 31,2007 was as follows (in thousands):

 
| **Years ending** | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| 2008             |       | $          | 1,427      |   |
| 2009             |       | 924        |       |
| 2010             |       | 888        |       |
| 2011             |       | 695        |       |
| 2012             |       | 503        |       |
| Thereafter       |       | 250        |       |
|             |       | $          | 4,687      |   |

 

**NOTE 3 - BALANCE SHEET COMPONENTS**

 

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

 
|                                            |   | **December 31,** |       | **Estimated** |   |
|-------------------------------------------------|--------|-----------------------|------------|---------------|--------|
| **Property and equipment:**                     |   | **2007**              | ** ** | **2006**      |   | **Useful Life** |   |
| Computer equipment and  purchased software      |   | $                     | 26,228     |          | $      | 26,132 |   | 2-4  yrs |   |
| Furniture, fixtures and  leasehold improvements |   | 2,691                 |       | 1,948         |   | 5-7  yrs |   |
|                                            |   | 28,919                |       | 28,080        |   |   |   |
| Less accumulated  depreciation                  |   | (27,242               | )          | (26,731       | )      |   |   |
|                                            |   | $                     | 1,677      |          | $      | 1,349 |   |   |   |

 
|                                      |   | **December 31,** |       |     |   |
|-------------------------------------------|--------|-----------------------|------------|----------|--------|
| **Assets acquired under capital  lease:** |   | **2007**              | ** ** | **2006** |   |   |   |
| Original book value                       |   | $                     | 58         |     | $      | 104 |   |   |   |
| Accumulated depreciation                  |   | (10                   | )          | (85      | )      |   |   |
| Net book value                            |   | $                     | 48         |     | $      | 19 |   |   |   |

 

 

                Depreciationexpense was $0.9 million, $1.2 million and $1.4 million for the years ended December 31,2007, 2006 and 2005, respectively.

 

                Included inproperty and equipment at December 31, 2007 and 2006 are assets undercapital lease. Depreciation expense related to assets under capital leases was$21,000, $26,000 and $26,000 for the years ended December 31, 2007, 2006and 2005, respectively.

 
|                                           |   | **December 31,** |       |     |   |
|------------------------------------------------|--------|-----------------------|------------|----------|--------|
| **Accounts payable and accrued  liabilities:** |   | **2007**              | ** ** | **2006** |   |   |   |
| Accounts payable                               |   | $                     | 1,062      |     | $      | 930 |   |   |   |
| Accrued compensation and  related expenses     |   | 1,738                 |       | 1,388    |   |   |   |
| Accrued liabilities                            |   | 3,103                 |       | 2,110    |   |   |   |
|                                           |   | $                     | 5,903      |     | $      | 4,428 |   |   |   |

 

43

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**NOTE 4 - LONG-TERM DEBT**

 

Our notes payable consistof the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Senior  note payable to financial institution, interest at the one-month London  InterBank Offered Rate (“LIBOR”) plus a margin of 5.25% and 6.25% at  December 31, 2007 and 2006, respectively; however, the LIBOR rate cannot  be less than 3.75%, interest rate was 10.25% and 11.60% at December 31,  2007 and 2006, respectively; interest payments are due monthly, principal  installments are due quarterly with final maturity on November 14, 2010.  The margin of 6.25% reduced to 5.25% since December 31, 2006 as we met  and continue to maintain certain financial requirements (not met as of  December 31, 2006). The loan is secured by substantially all of our  assets and a pledge of the stock of our subsidiaries. |       | $                     | 4,419      |   | $ | 6,500 |   |
| $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% and 9.35% at December 31, 2007 and  2006, respectively; interest payments are due monthly with final maturity on  November 14, 2010. The loan is secured by substantially all of the assets  of Evolving Systems U.K.                                                                                                                                                                                                                                                                                                                                         |       | 2,000                 |       | 2,000 |   |
| Long-term  unsecured subordinated notes payable, interest ranges from 11-14% with a  weighted average rate of 12.82% at December 31, 2007 and 12.84% at  December 31, 2006, accrued interest and principal are due in full on  May 16, 2011                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       | 4,767                 |       | 4,870 |   |
| Total notes payable                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       | 11,186                |       | 13,370 |   |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       | (2,500                | )          | (2,000 | ) |
| Long-term debt, excluding  current installments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | $                     | 8,686      |   | $ | 11,370 |   |

 

In November 2005, weused proceeds obtained from the $8.5 million senior note payable to extinguishcertain Evolving U.K. seller financed notes through payment of $8.5 million incash and issuance of $4.87 million in long-term unsecured subordinated notespayable to the sellers.

 

The senior note payablesubjects us to certain affirmative and negative covenants, including financialcovenants related to minimum EBITDA (as defined in the agreement as amended),as well as minimum leverage and fixed charged ratios.  In addition, the agreement is secured bysubstantially all assets of Evolving Systems, Inc. and our U.S.subsidiaries and restricts capital expenditures to specified limits.  We may prepay the outstanding balance of thesenior note as long as we are in compliance with all financial covenants and noevents of default have occurred.  Inaccordance with the terms of our senior note payable agreement, we made andExcess Cash Flow payment (as defined in the agreement) to our senior lender inthe amount of $81,000 during March 2007.

 

Also in November 2005,we obtained a $4.5 million senior revolving credit facility.  We had approximately $2.5 million availableunder the senior revolving credit facility at December, 31, 2007.  The senior credit facility has an annualmanagement fee based upon 0.5% of the daily average maximum borrowings allowedunder the senior revolving credit facility and is paid monthly in arrears.  Borrowings under the senior revolving creditfacility are limited to a multiple of our EBITDA less the balance of the seniornote payable.  The multiple ranges from2.50 in the first year to 1.75 in the fourth year.  The agreement mandated an initial borrowingof $2.0 million which remains outstanding at December 31, 2007.  The senior revolving credit facility includesthe same covenants and restrictions as the senior note payable.  The senior revolving credit facilities aresecured by substantially all assets of Evolving Systems Holdings Ltd. andEvolving Systems Ltd.  Evolving Systems, Inc.and our U.S. subsidiaries executed a guaranty of the senior revolving creditfacility.

 

In March 2007, wepaid $77,000 to retire $119,000 of subordinated debt and related accruedinterest 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 

 

 

44

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extinguishment of thisdebt was reflected within our other income (expense) on the consolidatedstatement of operations.  The remaininglong-term unsecured subordinated notes payable of $4.8 million, at December 31,2007, bear interest at 11% through December 31, 2007 and 14%thereafter.  Interest expense wasrecognized using an effective rate of 12.82% at December 31, 2007 and12.84% at December 31, 2006.  Theunsecured subordinated notes are subordinate to the senior note and seniorrevolving credit facility.  The unsecuredsubordinated notes payable agreements subject us to certain affirmative andnegative covenants; however, certain covenants are not in effect until the seniornote and senior revolving credit facility are paid in full.  Outstanding amounts of the unsecuredsubordinated notes may be accelerated upon the occurrence of an uncured eventof default.  Accrued interest on theunsecured subordinated notes payable is separately reflected on the balance sheetunder “Other long-term obligations.”

 

We were in compliancewith all of our covenants as of December 31, 2007.

 

The scheduled principalpayments on our notes payable are as follows (in thousands):

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2008                              |       | $          | 2,500      |   |
| 2009                              |       | 1,919      |       |
| 2010                              |       | 2,000      |       |
| 2011                              |       | 4,767      |       |
| 2012                              |       | —     |       |
|                              |       | $          | 11,186     |   |

 

                See also, Note 13, Subsequent Events, for changes to our Long-Term Debt.

 

**NOTE 5 - INCOME TAXES**

 

**               **The pre-tax income (loss) on which the provision for income taxes wascomputed is as follows (in thousands):

 
| ** ** | ** ** | **For the Years Ended December 31,** | ** ** |
|------------|------------|-------------------------------------------|------------|
| ** ** | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Domestic   |       | $                                         | (2,398     | ) | $ | (7,113 | ) | $ | (2,161 | ) |
| Foreign    |       | 3,552                                     |       | (11,274 | ) | (1,140 | ) |
| Total      |       | $                                         | 1,154      |   | $ | (18,387 | ) | $ | (3,301 | ) |

 

Theexpense (benefit) for income taxes consists of the following (in thousands):

 
| ** **                       | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Current:                         |       |                                      |       |   |   |   |   |
| Federal                          |       | $                                         | —     |   | $ | — |   | $ | (10 | ) |
| Foreign                          |       | 835                                       |       | 287 |   | 791 |   |
| State                            |       | —                                    |       | — |   | — |   |
| Total current                    |       | 835                                       |       | 287 |   | 781 |   |
| Deferred:                        |       |                                      |       |   |   |   |   |
| Federal                          |       | —                                    |       | — |   | — |   |
| Foreign                          |       | (279                                      | )          | (1,891 | ) | (1,177 | ) |
| State                            |       | —                                    |       | — |   | — |   |
| Total deferred                   |       | (279                                      | )          | (1,891 | ) | (1,177 | ) |
| Net income tax expense (benefit) |       | $                                         | 556        |   | $ | (1,604 | ) | $ | (396 | ) |

 

                As of December 31, 2007 and 2006, we had netoperating loss carryforwards (“NOL”) of approximately $50.5 million and $49.5million, respectively, related to U.S. federal and state jurisdictions.  The federal NOL expires at various timesbeginning in 2018 and ending in 2028.  Inaddition, we have research and experimentation credit carryforwards ofapproximately $0.9 million which may expire at various times beginning in2011.  Of our $50.5 million NOL, $9.6million is related to stock compensation expense, the benefit of which, ifrealized, will be an increase to equity as opposed to a reduction in taxexpense.  The Internal Revenue Codeplaces certain limitations on the annual amount of net operating losscarryforwards which can be utilized if certain changes in ownership occur.Changes in our ownership have occurred that limit the future utilization of theNOL’s.

 

45

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

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Deferred tax assets:                               |       |                  |       |   |   |
| Net operating loss carryforwards                   |       | $                     | 18,872     |   | $ | 18,504 |   |
| Research and experimentation credit carryforwards  |       | 854                   |       | 1,287 |   |
| Equity compensation                                |       | 295                   |       | 137 |   |
| Deferred revenue                                   |       | —                |       | 35 |   |
| Depreciable assets                                 |       | 512                   |       | 512 |   |
| Acquired intangibles                               |       | 565                   |       | 406 |   |
| Other                                              |       | 116                   |       | 60 |   |
| Total deferred tax assets                          |       | 21,214                |       | 20,941 |   |
| Deferred tax liabilities:                          |       |                  |       |   |   |
| Undistributed foreign earnings                     |       | (541                  | )          | (180 | ) |
| Acquired intangibles                               |       | (1,151                | )          | (1,471 | ) |
| Total deferred tax liabilities                     |       | (1,692                | )          | (1,651 | ) |
| Net deferred tax asset  before valuation allowance |       | 19,522                |       | 19,290 |   |
| Valuation allowance                                |       | (20,430               | )          | (20,477 | ) |
| Net deferred tax liability                         |       | $                     | (908       | ) | $ | (1,187 | ) |
| ** **                                         | ** ** | ** **            | ** ** |
| ** **                                         | ** ** | **December 31,** | ** ** |
| ** **                                         | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Financial statement  classification:               |       |                  |       |   |   |
| Current deferred tax asset/(liability)             |       | $                     | (30        | ) | $ | 15 |   |
| Long-term deferred tax liability                   |       | (878                  | )          | (1,202 | ) |
| Net deferred tax liability                         |       | $                     | (908       | ) | $ | (1,187 | ) |
|                                                    |            |                       |            |  |  |  |  |  |  |

 

                In conjunction with the acquisition of EvolvingSystems U.K., certain identifiable intangible assets were recorded.  A deferred tax liability of $4.6 million wasestablished at the acquisition date for the expected difference between whatwould be expensed for financial reporting purposes and what would be deductiblefor income tax purposes. This deferred tax liability related to EvolvingSystems U.K. and has no impact on our ability to recover our U.S. baseddeferred tax assets.  As of December 31,2007 and 2006, this deferred tax liability was $1.2 million and $1.5 million,respectively.  This deferred taxliability will be recognized as the identifiable intangibles are amortized.

 

We continue to maintain afull valuation allowance on the domestic net deferred tax asset as we have determinedit is more likely than not that we will not realize our domestic deferred taxassets.  Such assets primarily consist ofcertain net operating loss carryforwards. We assessed the realizability of our domestic deferred tax assets usingall available evidence.  In particular,we considered both historical results and projections of profitability for thereasonably foreseeable future periods. We are required to reassess our conclusions regarding the realization ofour deferred tax assets at each financial reporting date. A future evaluationcould result in a conclusion that all or a portion of the valuation allowanceis no longer necessary which could have a material impact on our results ofoperations and financial position.

 

 

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                The income tax benefit differs from the amountcomputed 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,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                          |       |                                      |       |   |   |   |   |
| U.S. federal income tax  expense (benefit) at statutory rates |       | $                                         | 393        |   | $ | (6,252 | ) | $ | (1,122 | ) |
| State income tax expense  (benefit), net of federal impact    |       | (50                                       | )          | (163 | ) | (64 | ) |
| Goodwill impairment                                           |       | —                                    |       | 3,217 |   | — |   |
| Non-deductible meals                                          |       | 13                                        |       | 12 |   | 18 |   |
| Foreign rate differential                                     |       | (4                                        | )          | 240 |   | 75 |   |
| Foreign deemed dividends                                      |       | 63                                        |       | (77 | ) | 127 |   |
| Change in valuation  allowance                                |       | (47                                       | )          | 1,815 |   | 604 |   |
| Equity compensation                                           |       | 79                                        |       | 121 |   | — |   |
| Research and development  expenses                            |       | (312                                      | )          | (483 | ) | (59 | ) |
| FIN 48 adjustment                                             |       | 433                                       |       | — |   | — |   |
| Foreign taxes                                                 |       | 33                                        |       | — |   | — |   |
| Other, net                                                    |       | (45                                       | )          | (34 | ) | 25 |   |
| Income tax expense (benefit)                                  |       | $                                         | 556        |   | $ | (1,604 | ) | $ | (396 | ) |

 

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

 

                On January 1, 2007, we recorded a FIN 48transition adjustment consisting of a $0.4 million decrease in our deferred taxassets related to Research and Development Tax Credits that was offset by acorresponding decrease in our valuation allowance as we determined that it wasnot more likely 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 forresearch and development expenses related to a change in estimate based on ouras filed 2005 tax return for Evolving Systems U.K.  In addition, we recorded an income taxreceivable of approximately $275,000 as of December 31, 2006 primarily asa result of this change in estimate which is included in prepaid and othercurrent assets on our consolidated balance sheet as of December 31, 2006.

 

**               **We conduct business globally and, as aresult, Evolving Systems, Inc. or one or more of our subsidiaries fileincome tax returns in the U.S. federal jurisdiction and various state andforeign jurisdictions.  In the normalcourse of business, we are subject to examination by taxing authoritiesthroughout the world, namely the United Kingdom, Germany and India.  With few exceptions, we are no longer subjectto U.S. federal, state and local, or non-U.S. income tax examinations for yearsbefore 2003.

 

                During2004, we formedEvolving Systems India, a wholly owned subsidiary of Evolving Systems, Inc.which is used for offshore product development.  We weregranted a tax holiday by India which extends through March 2009.  Under the terms of the tax holiday, we arenot liable for income taxes associated with our operations in India.

 

**NOTE 6 - STOCKHOLDERS’ EQUITY**

 

## ***(a)           Series BConvertible Redeemable Preferred Stock***

## *** ***

                On November 2, 2004, we issued 966,666 shares of Series BPreferred Stock in connection with our acquisition of Evolving SystemsU.K.  During 2007, holders of 487,916shares of Series B Preferred Stock, or approximately 50% of theoutstanding preferred stock as of December 31, 2006, with an aggregatecarrying value of $5.7 million, converted their shares of preferred stock into1,463,748 shares of our common stock in accordance with the conversionprovisions of the Series B Preferred Stock.  As wepreviously included the Series B Preferred Stock as a participatingsecurity for basic EPS purposes, these conversions did not change our basic ordiluted EPS calculations.

 

 

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Based on the specificfeatures of the Series B Preferred Stock, the issuance date fair value wasestimated to be approximately the same as its value upon redemption, which isthe same as its value upon liquidation. The Series B Preferred Stock isentitled to dividends on an as-converted basis with the common stock and is,therefore, considered a participating security and shares issuable uponconversion are included in weighted average shares outstanding for purposes ofcalculating basic earnings per share. Upon the occurrence of certain material events (liquidation, merger,etc.), the holders of Series B Preferred Stock are entitled to receive apreference payment that is senior to the common stock, but subordinate to oursenior and unsecured subordinate debt, equal to the sum of the number of sharesof common stock into which each share of Series B Preferred Stock isconvertible as of the date of such event multiplied by $3.89 per share (subjectto adjustment for stock splits and combinations), or $5.6 and $11.3 million at December 31,2007 and 2006, respectively.

 

Shares of Series BPreferred Stock may be converted into our common stock at the option of theholder at any time.  Each share of Series BPreferred Stock is initially convertible into three shares of commonstock.  The conversion ratio is subjectto adjustment as a result of price-based anti-dilution protections forissuances of our common stock below $3.50 per share.  We may also cause the Series B PreferredStock to automatically convert after November 2, 2006 in the event thatthe 45 day average market price for our common stock is equal to or greaterthan $8.75 (subject to adjustment for stock splits and combinations).

 

The holders of Series BPreferred Stock vote with the holders of the shares of common stock as oneclass with each share of Series B Preferred Stock entitled toapproximately 2.7 votes due to the application of Nasdaq Marketplace Rule 4351which provides certain voting limitations on shares issued below marketprice.  A majority of holders of Series BPreferred Stock must also consent to certain corporate actions prior to usengaging in such actions (*i.e*.,issuing certain additional classes of stock, amending our charter documents inan adverse manner to the Series B Preferred Stock, changing the size orterm of the Board, or repurchasing or redeeming other classes of stock).Additionally, subject to certain limitations, for so long as the Series Bholders hold no less than five percent of our common stock (on an as convertedbasis), they shall as a group be entitled to elect one person to the Board.

 

Additionally, the Series BPreferred Stock contains certain weighted average price based anti-dilutionprotections that, as long as those securities remain outstanding, would betriggered if we issued shares of our common stock (subject to certainadjustments and standard exclusions relating to stock options) below $3.89 pershare.

 

The holders of Series BPreferred Stock may also require us to redeem all or any portion of the Series BPreferred Stock for a price equal to $11.67 per share (subject to adjustmentfor stock splits and combinations) in the event that we fail to maintain theshelf registration of the common stock underlying such shares or otherwisebreach certain other covenants.  If weare not able to maintain effectiveness of the shelf registration, we would berequired to revalue the Series B Preferred Stock at fair value andreclassify the instrument to liabilities.

 

Since theconversion price of the Series B Preferred Stock was fixed in the purchaseagreement to equal $3.50 per common share, a beneficial conversion featureexisted on the acquisition date equal to the difference between the value ofour common stock on the acquisition date, or $4.64, and the conversion pricestated in the purchase agreement.  Thebeneficial conversion feature was recognized as a reduction in net incomeavailable to common stockholders of $3.3 million on November 2, 2004 sincethe Series B Preferred Stock was immediately convertible to common stock.

 

See also, Note 13, Subsequent Events, forchanges to our Stockholders’ Equity.

 

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

 

Our restated certificate of incorporation allows the board of directorsto issue up to 2,000,000 shares of preferred stock and to determine the price,rights, preferences and privileges of those shares without any further vote oraction by our stockholders. The rights of the holders of our common stock willbe subject to, and may be adversely affected by, the rights of the holders ofany preferred stock that may be issued in the future. Issuance of preferredstock, while providing desired flexibility in connection with possibleacquisitions and other corporate purposes, could make it more difficult for athird party to acquire a majority of our outstanding voting stock. In 1999, ourBoard of Directors designated 250,000 shares of Series A JuniorParticipating Preferred Stock that contain “poison pill” provisions. Inconnection with the Evolving Systems U.K. acquisition, we issued 966,666 sharesof Series B Preferred Stock.  As of December 31,2007, 478,750 shares of Series B Preferred Stock are outstanding.

 

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

 

 

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bydiscouraging or preventing takeover attempts that might result in the paymentof a premium price to our stockholders.

 

                Seealso, Note 13, Subsequent Events, for changes to our Stockholders’ Equity.

 

**NOTE 7 - SHARE-BASED COMPENSATION**

 

                We adopted SFAS 123R effective January 1, 2006 using the modified prospectivemethod.  We previously applied theintrinsic-value-based method in accounting for the recognition of stock-basedcompensation arrangements and the fair value method only for disclosure purposes.  Because we historically granted options withexercise prices equal to the fair market value of our common stock at the grantdate, the adoption of SFAS 123R on January 1, 2006 did not result in asignificant impact on our financial statements. Further, as a result of the preceding, our consolidated statements ofoperations from January 1, 2006 forward include charges for stock-basedcompensation. We recognized $0.7 million and $0.8 million of compensationexpense in the consolidated statements of operations for the years ended December 31,2007 and 2006, respectively, with respect to our stock-based compensationplans.  The following table summarizesstock-based compensation expenses recorded in the statement of operations (inthousands):

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

 

**                StockOption/Incentive Plans**

 

                In January 1996, our stockholders approved “The Amended andRestated Stock Option Plan” (the “Option Plan”).  Initially, 3,150,000 shares were reserved forissuance under the Option Plan. Subsequently, the Option Plan was amended, as approved by thestockholders, to increase the number of shares available for issuance to8,350,000.Options issued under theOption Plan were at the discretion of the Board of Directors, including thevesting provisions of each stock option granted. Options were granted with anexercise price equal to the closing price of our common stock on the date ofgrant, generally vest over four years and expire no more than ten years fromthe date of grant. The Option Plan terminated on January 18, 2006; optionsgranted before that date were not affected by the plan termination.

 

                In March 2007upon the hiring of our Vice President of World Wide Sales and Marketing, inaccordance with NASDAQ MarketplaceRule 4350(i)(1)(a)(iv) the boardof directors approved an inducement award under a stand-alone equity incentiveplan.  We granted 100,000 non-qualifiedoptions to purchase shares of our common stock at an exercise price equal tothe closing price of our common stock on the date of grant.  The options vest over four years and expireten years from the date of grant.

 

                In June 2007,our stockholders 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, RestrictedStock Units, 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 and expire no more than ten years from the date of grant.

 

                In December 2007,under the 2007 Stock Plan, we awarded a total of 137,500 shares of restrictedstock to members of our board of directors and senior management.  The fair market value for share-basedcompensation expensing is equal to the closing price of our common stock on thedate of grant.  The restrictions on thestock award are released generally over four years.

 

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

 

 

49

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| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Expected term (years)   |       | 6.1                                       |       | 6.1 |   | 5.94 |   |
| Risk-free interest rate |       | 3.98                                      | %          | 4.35 | % | 4.31 | % |
| Expected volatility     |       | 105.74                                    | %          | 121.14 | % | 122.50 | % |
| Expected dividend yield |       | 0                                         | %          | 0 | % | 0 | % |

 

                The following is a summary ofstock option activity under the plan for the year ended December 31, 2007:

 
| ** **                                     | ** ** | **Number of Shares  (in thousands)** | ** ** | **Weighted-Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|---------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Options outstanding at  December 31, 2006 |       | 4,058                                |       | $                                     | 3.14       |                                                        |       |                                            |       |   |
| Options granted                                |       | 625                                  |       | 2.20                                  |       |                                                        |       |                                            |       |
| Less options forfeited                         |       | (49                                  | )          | 2.21                                  |       |                                                        |       |                                            |       |
| Less options expired                           |       | (80                                  | )          | 3.60                                  |       |                                                        |       |                                            |       |
| Less options exercised                         |       | (20                                  | )          | 0.98                                  |       |                                                        |       |                                            |       |
| Options outstanding at  December 31, 2007 |       | 4,534                                |       | $                                     | 3.02       |                                                        | 6.04       |                                            | $          | 2,845 |   |
|                                           |       |                                 |       |                                  |       |                                                        |       |                                            |       |
| Options exercisable at  December 31, 2007 |       | 3,440                                |       | $                                     | 3.28       |                                                        | 5.12       |                                            | $          | 1,979 |   |

 

                Theweighted-average grant-date fair value of stock options granted during theyears ended December 31, 2007, 2006 and 2005 was $1.83, $2.05 and $1.94,respectively.

 

                As of December 31,2007, there were approximately $2.0 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 1.5 years.

 

                The total intrinsicvalue of stock option exercises for the years ended December 31, 2007,2006 and 2005 was $23,000, $15,000 and $0.2 million, respectively.  The total fair value of stock awards vestedduring the years ended December 31, 2007, 2006 and 2005 was $0.7 million,$0.4 million and $5.3 million, respectively.

 

                The deferred incometax benefits from stock options expense related to Evolving Systems U.K.totaled approximately $41,000 and $27,000 for the years ended December 31,2007 and 2006, respectively.

 

                Cash received fromstock option exercises was $19,000, $14,000 and $71,000 for the years ended December 31,2007, 2006 and 2005, respectively.

 

                Prior to the adoption of SFAS123R on January 1, 2006, we applied the intrinsic-value-based method inaccounting for the recognition of employee stock-based compensationarrangements and the fair value method for disclosure purposes.

 

 

50

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                The following table illustrates the effect on net lossif the fair value method had been applied to all outstanding and unvestedawards in each period (in thousands, exceptper share data):

** **
| ** **                                                                                                                                | ** ** | **For the Year   Ended   December 31,   2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                                                                                                                      |       |                                                |       |
| Net loss, as reported                                                                                                                     |       | $                                                   | (2,905     | ) |
| Stock-based compensation expense that would have been included in net  loss if the fair-value-based method had been applied to all awards |       | (5,210                                              | )          |
| Pro forma net loss                                                                                                                        |       | $                                                   | (8,115     | ) |
| Loss per common and  preferred share, as reported:                                                                                        |       |                                                |       |
| Basic and Diluted                                                                                                                         |       | $                                                   | (0.16      | ) |
| Pro forma loss per common  and preferred share:                                                                                           |       |                                                |       |
| Basic and Diluted                                                                                                                         |       | $                                                   | (0.43      | ) |

 

                Fair value stock basedcompensation expense for the year ended December 31, 2005 in the abovetable includes $2.5 million of compensation expense associated with theacceleration of vesting of options in December 2005 whereby we accelerated the vesting of unvested and “out-of-the-money”stock options with an exercise price equal to or greater than $4.64.  Theacceleration of vesting was effective for stock options outstanding as of December 12,2005.  As a result of the acceleration, approximately 603,000 stockoptions with a range of exercise prices of $4.64 to $14.15 and a weightedaverage exercise price of $6.17 (including approximately 341,000 stock optionsheld by directors and executive officers with a weighted average exercise priceof $7.12) became exercisable on December 12, 2005.  This price range was selected as it coveredthe most significant portion of future compensation costs for out-of-the-moneyoptions.  In addition, we believe thatbecause the options accelerated have exercise prices in excess of the currentmarket value of our common stock, the options have limited economic value andare not fully achieving their original objective of incentive compensation andemployee retention.  Aside from theacceleration of the vesting date, the terms and conditions of the stock optionagreements governing the underlying stock options remain unchanged.  The purpose of the acceleration was toeliminate future compensation expense associated with the accelerated optionsupon the adoption of SFAS 123R effective January 1, 2006.

 

                In December 2005,we granted 1,130,000 options to purchase shares of our common stock at anexercise price of $2.15 per share to employees and directors in light of thepending expiration of our stock option plan on January 18, 2006.  We structured the grants in order to reducethe future impact on earnings as a result of the implementation of SFAS 123R byimmediately vesting 25% of the options on the date of grant.  The remaining 75% of the options vest inequal quarterly tranches beginning March 28, 2007.  The pro forma disclosures for the year ended December 31,2005 reflect approximately $0.6 million of compensation expense associated withthe immediate vesting of 25% of the options.

 

**                Employee StockPurchase Plan**

 

                Under the EmployeeStock Purchase Plan (“ESPP”), we are authorized to issue up to 1,100,000 sharesof our common stock to full-time employees, nearly all of whom are eligible toparticipate. Under the terms of the ESPP, employees may elect to have up to 15%of their gross salaries withheld through payroll deduction to purchase ourcommon stock, capped at $25,000 annually. The purchase price of the stock is85% of the lower of the market price at the beginning or end of eachthree-month participation period.  As of December 31,2007, there were 293,000 shares available for purchase.  For the years ended December 31, 2007,2006 and 2005, we recorded compensation expense of $22,000,  $46,000 and $0, respectively, associated withgrants under the ESPP which includes the fair value of the look-back feature ofeach grant as well as the 15% discount on the purchase price.  This expense fluctuates each period basedupon employee participation.

 

                The fair value ofeach grant made under our ESPP is estimated on the date of grant using theBlack-Scholes model.  The Black-Scholesmodel uses four variables to calculate the fair value of each optiongrant.  The expected term of each grantis based upon the three-month (six-month in 2005) participation period of eachgrant.  The risk-free interest rate isbased upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of each grant.  The expected volatility is based upon historicalvolatility of our common stock.  Theexpected dividend yield is based upon historical and anticipated payment ofdividends.  The weighted averageassumptions used in the fair value calculations are as follows:

 

 

51

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| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Expected term (years)   |       | 0.25                                      |       | 0.25 |   | 0.5 |   |
| Risk-free interest rate |       | 4.58                                      | %          | 5.02 | % | 3.04 | % |
| Expected volatility     |       | 67.52                                     | %          | 78.18 | % | 90.59 | % |
| Expected dividend yield |       | 0                                         | %          | 0 | % | 0 | % |

 

                Cash received fromemployee stock plan purchases was $70,000, $112,000 and $55,000 for the yearsended December 31, 2007, 2006 and 2005, respectively.

 

**NOTE 8 - BENEFIT PLANS**

 

                We have established a definedcontribution retirement plan for our employees under section 401(k) of theInternal Revenue Code (the “401(k) Plan”) that is available to all U.S.employees 21 years of age or older with a month of service. Employees maycontribute up 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, 2006 and 2005, we made discretionarymatching contributions using funds available in the 401(k) Plan’sforfeiture account.

 

                Evolving Systems U.K. has established a definedcontribution pension scheme that is available to all employees in their firstfull month of employment.  Employees maycontribute a percentage of their earnings, the amount of which is dependentupon the age of the employee, not to exceed the maximum statutory contributionamount.  We match 5% of employeecontributions.  All contributions areimmediately vested in their entirety.

 

                During 2007, 2006 and 2005, werecorded a consolidated expense of $483,000, $366,000, and $295,000,respectively, under the aforementioned plans.

 

**NOTE 9 — EARNINGS PER SHARE**

 

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

 
| ** **                                                       | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Basic income (loss) per  common and preferred share:             |       |                                      |       |   |   |   |   |
| Net income (loss) available to common and preferred shareholders |       | $                                         | 598        |   | $ | (16,783 | ) | $ | (2,905 | ) |
| Weighted average common shares outstanding                       |       | 17,467                                    |       | 16,200 |   | 16,054 |   |
| Participating securities                                         |       | 1,731                                     |       | 2,900 |   | 2,641 |   |
| Basic weighted average shares outstanding                        |       | 19,198                                    |       | 19,100 |   | 18,695 |   |
| Basic income (loss) per  common and preferred share              |       | $                                         | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) |
|                                                             |       |                                      |       |   |   |   |   |
| Diluted income (loss) per  common and preferred share:           |       |                                      |       |   |   |   |   |
| Net income (loss) available to common and preferred shareholders |       | $                                         | 598        |   | $ | (16,783 | ) | $ | (2,905 | ) |
| Weighted average common shares outstanding                       |       | 17,467                                    |       | 16,200 |   | 16,054 |   |
| Participating securities                                         |       | 1,731                                     |       | 2,900 |   | 2,641 |   |
| Effect of dilutive securities - options                          |       | 378                                       |       | — |   | — |   |
| Diluted weighted average shares outstanding                      |       | 19,576                                    |       | 19,100 |   | 18,695 |   |
| Diluted income (loss) per  common and preferred share            |       | $                                         | 0.03       |   | $ | (0.88 | ) | $ | (0.16 | ) |

 

                Weighted average options to purchase 3.2 million, 3.3million and 2.4 million shares of common stock equivalents were excluded fromthe computation of diluted weighted average shares outstanding for the yearsended December 31, 2007, 2006 and 

 

 

52

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2005, 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 and 1.1 million shares ofcommon stock were excluded from the computation of diluted weighted averageshares outstanding for the years ended December 31, 2006 and 2005,respectively, as their effect would have been anti-dilutive as a result of thenet loss for the period.

 

**NOTE 10 - COMMITMENTS AND CONTINGENCIES**

 

**(a)           LeaseCommitments**

 

                We lease office and operatingfacilities and equipment under non-cancelable operating leases. Currentfacility leases include our headquarters; the London, England, Bath, Englandand Munich, Germany offices which were assumed as part of the Evolving SystemsU.K. acquisition; the Bangalore, India office; the Kuala Lumpur, Malaysia officeand the Windsor, England office. Rent expense was $1.4 million, $1.6 millionand $1.6 million for the years ended December 31, 2007, 2006 and 2005,respectively. Rent expense is net of sublease rental income of $117,000,$142,000and $279,000 for the years ended December 31, 2007, 2006 and 2005,respectively.

 

                Our headquarters facility leasecontains a clause that adjusts the lease rate every year. The lease rateincreases annually as of November 1. We account for the effect of such escalating lease payments as if thelease rate were consistent over the lease term.

 

                Future minimum commitments undernon-cancelable operating leases and capital leases as of December 31, 2007are as follows (in thousands):

** **
| ** **                                          | ** ** | **Operating   Leases** | ** ** | **Capital   Leases** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| 2008                                                |       | $                      | 984        |                 | $          | 30 |   |
| 2009                                                |       | 961                    |       | 30                   |       |
| 2010                                                |       | 757                    |       | 30                   |       |
| 2011                                                |       | 506                    |       | 30                   |       |
| 2012                                                |       | 430                    |       | 10                   |       |
| Total minimum lease  payments                       |       | $                      | 3,638      |                 | 130        |   |
| Less: Amount representing  interest                 |       |                   |       | (31                  | )          |
| Principal balance of  capital lease obligations     |       |                   |       | 99                   |       |
| Less: Current portion of  capital lease obligations |       |                   |       | (20                  | )          |
| Long-term portion of  capital lease obligations     |       |                   |       | $                    | 79         |   |

 

**(b)           OtherCommitments**

 

As permitted underDelaware law, we have agreements with officers and directors under which weagree to indemnify them for certain events or occurrences while the officer ordirector is, or was serving, at our request in this capacity. The term of theindemnification period is indefinite. There is no limit on the amount of futurepayments we could be required to make under these indemnification agreements;however, we maintain Director and Officer insurance policies, as well as anEmployment Practices Liability Insurance Policy, that may enable us to recovera portion of any amounts paid. As a result of our insurance policy coverage, webelieve the estimated fair value of these indemnification agreements isminimal. Accordingly, there were no liabilities recorded for these agreementsas of December 31, 2007 and 2006.

 

We enter into standardindemnification terms with customers and suppliers, as discussed below, in theordinary course of business.  As we maysubcontract the development of deliverables under customer contracts, we couldbe required to indemnify customers for work performed by subcontractors.Depending upon the nature of the customer indemnification, the potential amountof future payments we could be required to make under these indemnificationagreements may be unlimited. We may be able to recover damages from asubcontractor if the indemnification to customers results from the subcontractor’sfailure to perform. To the extent we are unable to recover damages from asubcontractor, we could be required to reimburse the indemnified party for thefull amount. We have never incurred costs to defend lawsuits or settle claimsrelating to indemnification arising out of subcontractors’ failure to perform.As a result, we believe the estimated fair value of these agreements isminimal. Accordingly, there were no liabilities recorded for these agreementsas of December 31, 2007 and 2006.

 

Our standard licenseagreements contain product warranties that the software will be free ofmaterial defects and will operate in accordance with the stated requirementsfor a limited period of time.  Theproduct warranty provisions require us to cure any defects through anyreasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, there were no liabilitiesrecorded for these product warranty provisions as of December 31, 2007 and2006.

 

 

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Our software arrangementsgenerally include a product indemnification provision whereby we will indemnifyand defend a customer in actions brought against the customer for claims thatour products infringe upon a copyright, trade secret, or valid patent. We havenot historically incurred any significant costs related to productindemnification claims. Accordingly, there were no liabilities recorded forthese indemnification provisions as of December 31, 2007 and 2006.

 

                In relation to the acquisitions of Evolving SystemsU.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, there were no liabilities recorded for these agreements as of December 31,2007 and 2006.

 

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

 

                During the fourth quarter of2006, a previous vendor filed a complaint in the Superior Court of New Jerseyagainst us asserting we breached certain provisions of a licenseagreement.  While the outcome of thismatter is uncertain, we believe we have paid all fees due under our licenseagreement and will vigorously defend this claim.

 

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

 

**NOTE 11 - SEGMENT INFORMATION**

 

In accordance with SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” wedefine operating segments as components of an enterprise for which separatefinancial information is reviewed regularly by the chief operatingdecision-making group to evaluate performance and to make operating decisions.We have identified our Chief Executive Officer and Chief Financial Officer asour chief operating decision-makers (CODM). These chief operating decision makersreview revenues by segment and review overall results of operations.

 

We currently operatebusiness as two operating segments based on revenue type:  license fees and services revenue andcustomer support revenue (as shown on the consolidated statements ofoperations).  License fees and services(L&S) revenue represents the fees received from the license of 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 segmentswas as follows (in thousands):

 
| ** **                                                                 | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenue**                                                                | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                  |       | $                                         | 17,895     |   | $ | 15,883 |   | $ | 19,779 |   |
| Customer support                                                           |       | 18,058                                    |       | 17,950 |   | 19,673 |   |
|                                                                       |       | 35,953                                    |       | 33,833 |   | 39,452 |   |
|                                                                       |       |                                      |       |   |   |   |   |
| **Revenue less cost of revenue,  excluding depreciation and amortization** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| License fees and services                                                  |       | 9,872                                     |       | 8,541 |   | 10,288 |   |
| Customer support                                                           |       | 11,821                                    |       | 12,256 |   | 13,094 |   |
|                                                                       |       | 21,693                                    |       | 20,797 |   | 23,382 |   |
| **Unallocated costs**                                                      | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other operating expenses                                                   |       | 16,795                                    |       | 17,172 |   | 18,382 |   |
| Depreciation and amortization                                              |       | 2,464                                     |       | 3,680 |   | 6,658 |   |
| Impairment of goodwill and intangible assets                               |       | —                                    |       | 16,516 |   | — |   |
| Restructuring and other                                                    |       | (4                                        | )          | (21 | ) | (49 | ) |
| Interest income                                                            |       | (304                                      | )          | (160 | ) | (116 | ) |
| Interest expense                                                           |       | 1,747                                     |       | 1,992 |   | 1,636 |   |
| Gain on extinguishment of debt                                             |       | (42                                       | )          | — |   | — |   |
| Foreign currency exchange (gain) loss                                      |       | (117                                      | )          | 5 |   | 172 |   |
| **Income (loss) before income  taxes**                                     |       | $                                         | 1,154      |   | $ | (18,387 | ) | $ | (3,301 | ) |

 

 

54

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** **

**GeographicRegions**

 

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

 
| ** **     | ** ** | **For the Year Ended December 31, 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 |   |

 
| ** **     | ** ** | **For the Year Ended December 31, 2005** | ** ** |
|----------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **L&S**                                   | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States  |       | $                                             | 5,917      |   | $ | 12,747 |   | $ | 18,664 |   |
| United Kingdom |       | 4,878                                         |       | 4,513 |   | 9,391 |   |
| Other          |       | 8,984                                         |       | 2,413 |   | 11,397 |   |
| Total revenues |       | $                                             | 19,779     |   | $ | 19,673 |   | $ | 39,452 |   |

 
| ** **                 | ** ** | ** ** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|------------|------------|-----------------------|------------|
| ** **                 | ** ** | ** ** | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **Long-lived assets, net** | ** ** | ** ** | ** ** | ** **            |       |   |   |   |   | ** ** |
| United States              | ** ** | ** ** | ** ** | ** **            | $          | 7,814 |   | $ | 7,986 | ** ** |
| United Kingdom             |       |       |       | 24,883                |       | 25,406 |   |
| Other                      |       |       |       | 84                    |       | 139 |   |
|                       |       |       |       | $                     | 32,781     |   | $ | 33,531 |   |

 

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

 
| ** **          | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| ** **          | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenue**         |       |                                      |       |   |   |   |   |   |   |   |
| Activation          |       | $                                         | 19,533     |   | $ | 16,717 |   | $ | 18,868 |   |
| Numbering solutions |       | 11,919                                    |       | 12,006 |   | 15,336 |   |
| Mediation           |       | 4,501                                     |       | 5,110 |   | 5,248 |   |
| Total revenues      |       | $                                         | 35,953     |   | $ | 33,833 |   | $ | 39,452 |   |

 

 

55

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

 

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

 
| ** **                                         | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                         | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                               |       |        |       |        |       |        |       |        |       |
| **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      | )           | $          | (0.00       | )          | $           | 0.03       |   | $ | 0.01 |   |
| Diluted                                            |       | $           | (0.02      | )           | $          | (0.00       | )          | $           | 0.03       |   | $ | 0.01 |   |
|                                               |       |        |       |        |       |        |       |        |       |
| **Year Ended December 31,  2006**             | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Total revenue                                      |       | $           | 8,128      |        | $          | 8,240       |       | $           | 8,667      |   | $ | 8,798 |   |
| Less: cost of revenue and operating expenses       |       | 9,386       |       | 25,312      |       | 7,989       |       | 7,696       |       |
| Income (loss) from  operations                     |       | (1,258      | )          | (17,072     | )          | 678         |       | 1,102       |       |
| Income (loss) before  income taxes                 |       | (1,730      | )          | (17,561     | )          | 218         |       | 686         |       |
| Net income (loss)                                  |       | $           | (1,651     | )           | $          | (16,186     | )          | $           | 42         |   | $ | 1,012 |   |
| Net income (loss) per  common and preferred share: |       |        |       |        |       |        |       |        |       |
| Basic                                              |       | $           | (0.09      | )           | $          | (0.85       | )          | $           | (0.00      | ) | $ | 0.05 |   |
| Diluted                                            |       | $           | (0.09      | )           | $          | (0.85       | )          | $           | (0.00      | ) | $ | 0.05 |   |

 

**NOTE 13 — SUBSEQUENT EVENTS**

 

**Long-TermDebt**

 

**               **On February 22, 2008, 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 creditfacility (“U.S. Revolving Facility”) and a $5.0 million U.K. revolving creditfacility (“U.K. Revolving Facility”).

 

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

 

                The scheduled principal payments on ournotes payable are as follows (in thousands):

 

| **Year ending December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2008                              |       | $          | 1,667      |   |
| 2009                              |       | 2,000      |       |
| 2010                              |       | 333        |       |
|                              |       | $          | 4,000      |   |

 

                Additionally,we obtained a new $1.0 million U.S. Revolving Facility that bears interest atPrime Rate plus 0.5%.  Prime Rate was6.00% as of February 22, 2008. Borrowings under the senior revolving facilities are limited to apercentage of our eligible accounts receivable and cash.  The U.S. Revolving Facility is secured by allassets of Evolving Systems, Inc. and is subject to the same covenants asthe senior term loan.  All accruedinterest on outstanding borrowings under the U.S. Revolving Facility is paidmonthly, with any 

 

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outstanding balance due with a final maturity of February 22,2011.  As of February 22, 2008, wehad no borrowing outstanding under this U.S. Revolving Facility.

 

                Wealso entered into a $5.0 million U.K. Revolving Facility that bears interest atPrime Rate plus 0.5%.  Prime Rate was6.00% as of February 22, 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 Limited and is subject to the same covenantsas the 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 February 22, 2008, wehad no borrowing outstanding under this U.K. Revolving Facility.

 

                Relatedto the replacement of our existing senior term note and senior revolvingfacility with the new senior term loan and U.S. Revolving Facility and the U.K.Revolving Facility, we recorded, on February 22, 2008, a one timewrite-off of debt issuance costs associated with the retired senior debt ofapproximately $0.3 million.  As of February 22,2008, we also capitalized debt issuance costs related to our new senior debt ofapproximately $0.3 million.  These newcapitalized debt issuance costs will be amortized over the term of the newsenior debt.

 

**               **On February 22, 2008, we paid$272,000 to retire $279,000 of subordinated debt and related accrued interestheld by two 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 will be reflected within our other income (expense)on the 2008 consolidated statement of operations.  On February 22, 2008, we also paid$728,000 in accrued interest to the remaining subordinated note holders.

 

**Stockholders’ Equity**

 

**               **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.

 

 

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** **

**ITEM 9.    CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.    CONTROLSAND 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 inevaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

 

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

 

Based on ourevaluation under the framework in Internal Control — Integrated Framework, ourmanagement concluded that our internal control over financial reporting was effectiveas of December 31, 2007.

 

This Annual Reporton Form 10-K does not include an attestation report of our registeredpublic accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by our registered public accounting firm pursuant totemporary rules of the Securities and Exchange Commission that permit usto 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, 2007, 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, EXECUTIVE OFFICERS AND CORPORATEGOVERNANCE**

 

Incorporated by reference to the sections of Evolving Systems, Inc.2008 Proxy Statement, anticipated to be filed within 120 days of December 31,2007, entitled “Proposal No. 1—Election of Directors,” “Management” and “InformationRegarding the Board and Its Committees.”

 

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**ITEM 11.    EXECUTIVECOMPENSATION**

 

                Incorporated by reference to thesection of Evolving Systems, Inc. 2008 Proxy Statement, anticipated to befiled within 120 days of December 31, 2007, entitled “ExecutiveCompensation.”

 

**ITEM 12.    SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

                Incorporated by reference to thesection of the Evolving Systems, Inc. 2008 Proxy Statement, anticipated tobe filed within 120 days of December 31, 2007, entitled “Information Regarding Beneficial Ownership ofPrincipal Stockholders, Directors, and Management.”

 

**ITEM 13.    CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

                Incorporated byreference to the sections of the Evolving Systems, Inc. 2008 ProxyStatement, anticipated to be filed within 120 days of December 31,2007, entitled “Certain Relationships and Related Transactions” and “InformationRegarding the Board and Its Committees.”

 

**ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES**

 

                Incorporated by reference to thesection of the Evolving Systems, Inc. 2008 Proxy Statement, anticipated tobe filed within 120 days of December 31, 2007, entitled “Report ofthe Audit Committee.”

 

**PART IV**

 

**ITEM 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

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

 

                Consolidated Financial Statements.

 

                Consolidated Financial Statement Schedules have beenomitted because the required information is not present, or not present inamounts sufficient to require submission of the schedules or because therequired information is provided in the Consolidated Financial Statements orNotes 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.                                                                                                                                                                                                                                                                                                  |
| 10.10† |   | 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.                                                                                                                                                                                                                      |
| 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.                                                                                                                                                                  |

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†                                          Incorporated byreference to the Registrant’s Registration Statement on Form S-1 No. 333-43973.

 

*                                         Identifies each management contract orcompensatory plan or arrangement.

 

 

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**SIGNATURES**

 

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

 

**EVOLVING SYSTEMS, INC.**

 
| By:      /s/  THADDEUS DUPPER | Chief  Executive Officer, President and Director | March 12,  2008 |
|-------------------------------------------------------------|--------------------------------------------------|----------------------|
| Thaddeus Dupper                                             |                                             |                 |

 

**POWER OF ATTORNEY**

 

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

 

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

 
| **Signature**                                                             | ** ** | **Title**                                                    | ** ** | **Date**             |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------|
| ** **                                                                | ** ** | ** **                                                   | ** ** | ** **           |
| By:      /s/  THADDEUS DUPPER          |       | Chief  Executive Officer, President and Director             |       | March 12,  2008 |
| Thaddeus Dupper                                                           |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/  BRIAN R. ERVINE               |       | Executive  Vice President, Chief Financial Officer(Principal |       | March 12,  2008 |
| Brian R. Ervine                                                           |       | Financial  and Accounting Officer)                           |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/  STEPHEN K. GARTSIDE, JR. |       | Chairman  of the Board of Directors                          |       | March 12,  2008 |
| Stephen K. Gartside, Jr.                                             |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/ GEORGE A. HALLENBECK           |       | Director                                                     |       | March 12,  2008 |
| George A. Hallenbeck                                                      |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/  DAVID J. NICOL                |       | Director                                                     |       | March 12,  2008 |
| David J. Nicol                                                            |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/  PHILIP M. NECHES              |       | Director                                                     |       | March 12,  2008 |
| Philip M. Neches                                                          |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/  STEVE B. WARNECKE             |       | Director                                                     |       | March 12,  2008 |
| Steve B. Warnecke                                                         |       |                                                         |       |                 |
|                                                                      |       |                                                         |       |                 |
| By:      /s/ BRUCE W. ARMSTRONG             |       | Director                                                     |       | March 12,  2008 |
| Bruce W. Armstrong                                                        |       |                                                         |       |                 |

 

 

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