UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 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

EVOLVING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware		84-1010843
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
9777 Pyramid Court, Suite 100 Englewood, Colorado		80112
(Address of principal executive offices)		(Zip Code)
(303) 802-1000
(Registrant’s telephone number, including area code)

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of accelerated filer and large accelerated filer: in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer x

 

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

As of July 31, 2007 there were 17,685,969 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

EVOLVING SYSTEMS, INC.

Quarterly Report on Form 10-Q

June 30, 2007

Table of Contents

PART I – FINANCIAL INFORMATION
Item 1		Financial Statements
		Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006 (Unaudited)
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006 (Unaudited)
		Condensed Consolidated Statements of Changes In Stockholders’ Equity and Comprehensive Income for the Six Months Ended June 30, 2007 (Unaudited)
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006 (Unaudited)
		Notes to Unaudited Condensed Consolidated Financial Statements
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3		Quantitative and Qualitative Disclosures About Market Risk
Item 4		Controls and Procedures
PART II– OTHER INFORMATION
Item 1		Legal Proceedings
Item 1A		Risk Factors
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds
Item 3		Defaults upon Senior Securities
Item 4		Submission of Matters to a Vote of Security Holders
Item 5		Other Information
Item 6		Exhibits
Signature

 

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PART I — FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

(unaudited)

		June 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents		$	9,898		$	5,076
Current portion of restricted cash		—			300
Contract receivables, net of allowance of $71 at June 30, 2007 and $70 at December 31, 2006		4,780			9,206
Unbilled work-in-progress		971			1,064
Deferred foreign income taxes		—			15
Prepaid and other current assets		1,702			1,686
Total current assets		17,351			17,347
Property and equipment, net		1,016			1,349
Amortizable intangible assets, net		5,481			6,155
Goodwill		26,492			26,027
Long-term restricted cash		100			—
Other long-term assets		374			460
Total assets		$	50,814		$	51,338
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of capital lease obligations		$	19		$	37
Current portion of long-term debt		2,250			2,000
Accounts payable and accrued liabilities		4,482			4,428
Deferred foreign income taxes		51			—
Unearned revenue		9,472			10,079
Total current liabilities		16,274			16,544
Long-term liabilities:
Capital lease obligations, net of current portion		90			34
Other long-term obligations		1,092			749
Long-term debt, net of current portion		9,936			11,370
Deferred foreign income taxes		1,097			1,202
Total liabilities		28,489			29,899
Commitments and contingencies (Note 10)
Series B convertible redeemable preferred stock		5,892			11,281
Stockholders’ equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized; 504,915 and 966,666 shares of Series B issued and outstanding as of June 30, 2007 and December 31, 2006, respectively (shown above)		—			—
Common stock, $0.001 par value; 40,000,000 shares authorized; 17,676,716 and 16,233,646 shares issued and outstanding as of June 30, 2007 and December 31, 2006, respectively		18			16
Additional paid-in capital		74,648			68,825
Accumulated other comprehensive income		2,170			1,466
Accumulated deficit		(60,403		)	(60,149		)
Total stockholders’ equity		16,433			10,158
Total liabilities and stockholders’ equity		$	50,814		$	51,338

 

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

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(unaudited)

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
REVENUE
License fees and services		$	4,742		$	3,966		$	8,733		$	7,865
Customer support		4,380			4,274			8,850			8,503
Total revenue		9,122			8,240			17,583			16,368
COSTS OF REVENUE AND OPERATING EXPENSES
Costs of license fees and services, excluding depreciation and amortization		1,941			1,657			3,865			3,532
Costs of customer support, excluding depreciation and amortization		1,716			1,551			3,209			3,177
Sales and marketing		2,186			2,241			4,225			4,796
General and administrative		1,648			1,381			3,199			2,788
Product development		358			799			907			1,546
Depreciation		252			283			540			576
Amortization		392			893			780			1,790
Impairment of goodwill and intangible assets		—			16,516			—			16,516
Restructuring and other expense (recovery)		—			(9		)	(1		)	(23		)
Total costs of revenue and operating expenses		8,493			25,312			16,724			34,698
Income (loss) from operations		629			(17,072		)	859			(18,330		)
Other income (expense):
Interest income		81			36			145			74
Interest expense		(451		)	(496		)	(915		)	(1,005		)
Gain on extinguishment of debt		—			—			42			—
Foreign currency exchange loss		(104		)	(29		)	(162		)	(30		)
Other expense, net		(474		)	(489		)	(890		)	(961		)
Income (loss) before income taxes		155			(17,561		)	(31		)	(19,291		)
Income tax expense (benefit)		83			(1,375		)	223			(1,454		)
Net income (loss)		$	72		$	(16,186	)	$	(254	)	$	(17,837	)
Basic and diluted income (loss) per common share		$	0.00		$	(0.85	)	$	(0.01	)	$	(0.93	)
Weighted average basic shares outstanding		19,180			19,090			19,167			19,078
Weighted average diluted shares outstanding		19,604			19,090			19,167			19,078

 

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

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(in thousands, except share data)

(unaudited)

										Accumulated
							Additional			Other						Total
		Common Stock					Paid-in			Comprehensive			Accumulated			Stockholders’
		Shares		Amount			Capital			Income			Deficit			Equity
Balance at December 31, 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		38,129		1			35			—			—			36
Stock-based compensation expense		—		—			381			—			—			381
Preferred stock conversion		1,385,253		1			5,388			—			—			5,389
Comprehensive income:
Net loss		—		—			—			—			(254		)
Foreign currency translation adjustment		—		—			—			704			—
Comprehensive income																450
Balance at June 30, 2007		17,676,716		$	18		$	74,648		$	2,170		$	(60,403	)	$	16,433

 

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

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

		Six Months Ended June 30,
		2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(254	)	$	(17,837	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		540			576
Amortization of intangible assets		780			1,790
Amortization of debt issuance costs		125			134
Equity compensation		381			443
Impairment of goodwill and intangible assets		—			16,516
Gain on disposal of property and equipment		(1		)	(20		)
Gain on extinguishment of debt		(42		)	—
Foreign currency transaction losses, net		162			30
Benefit from foreign deferred income taxes		(65		)	(1,832		)
Change in operating assets and liabilities:
Contract receivables		4,502			5,115
Unbilled work-in-progress		109			57
Prepaid and other current assets		(16		)	(384		)
Accounts payable and accrued liabilities		197			(732		)
Unearned revenue		(657		)	(636		)
Other		343			—
Net cash provided by operating activities		6,104			3,220
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(322		)	(223		)
Proceeds from sale of property and equipment		1			20
Earnout payments from business combinations		(24		)	(151		)
Net cash used in investing activities		(345		)	(354		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital lease payments		(12		)	(17		)
Principal payments on long-term debt		(1,141		)	(500		)
Reduction in restricted cash		200			—
Proceeds from issuance of common stock		55			86
Net cash used in financing activities		(898		)	(431		)
Effect of foreign exchange rate changes on cash		(39		)	124
Net increase in cash and cash equivalents		4,822			2,559
Cash and cash equivalents at beginning of period		5,076			3,883
Cash and cash equivalents at end of period		$	9,898		$	6,442
Supplemental disclosure of other cash and non-cash transactions:
Interest paid		$	460		$	551
Income taxes paid		$	27		$	499
Conversion of preferred stock into common stock		$	5,389		$	—

 

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

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EVOLVING SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BASIS OF PRESENTATION

Organization – We are a global provider of software solutions and services to the wireless, wireline and IP carrier market. We maintain long-standing relationships with many of the largest wireline, wireless and IP communications carriers worldwide. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (“OSS”).  We offer software products and solutions in three core areas:  service activation solutions used to activate complex bundles of voice, video and data services for traditional and next generation wireless and wireline networks; numbering solutions that enable carriers to comply with government-mandated requirements regarding number portability as well as providing phone number management and assignment capabilities; and mediation solutions supporting data collection for both service assurance and billing applications.

Interim Consolidated Financial Statements – The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in our opinion, reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance with GAAP and SEC regulations for interim financial statements. The results for the six months ended June 30, 2007 are not necessarily indicative of the results that we will have for any subsequent period.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2006 included in our Annual Report on Form 10-K.

Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. We made estimates with respect to revenue recognition for estimated hours to complete projects accounted for using the percentage of completion method, allowance for doubtful accounts, income tax valuation allowance, fair values of long-lived assets, valuation of intangible assets and goodwill, useful lives for property, equipment and intangible assets, business combinations, capitalization of internal software development costs and fair value of stock-based compensation amounts.  Actual results could differ from these estimates.

Foreign Currency Translation – Our functional currency is the U.S. dollar.  The functional currency of our foreign operations, generally, is the respective local currency for each foreign subsidiary.  Assets and liabilities of foreign operations denominated in local currencies are translated at the spot rate in effect at the applicable reporting date.  Our consolidated statements of operations are translated at the weighted average rate of exchange during the applicable period.  The resulting unrealized cumulative translation adjustment, net of applicable income taxes, is recorded as a component of accumulated other comprehensive income (loss) in stockholders’ equity.  Realized and unrealized transaction gains and losses generated by transactions denominated in a currency different from the functional currency of the applicable entity are recorded in other income (loss) in the period in which they occur.

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

Goodwill – Goodwill is the excess of acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested 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 or disposition of a significant portion of the business or other factors. For purposes of the goodwill evaluation, we compare the fair value of each of our reporting units to its respective carrying amount. If the carrying value of a reporting unit were to exceed its fair value, we would then compare the fair value of the reporting unit’s goodwill to its carrying amount, and any excess of the carrying amount over the fair value would be charged to operations as an impairment loss.

Intangible Assets – Amortizable intangible assets consist primarily of purchased software and licenses, customer contracts and relationships, trademark and tradenames, and business partnerships acquired in conjunction with our purchases of CMS Communications, Inc. (“CMS”), Telecom Software Enterprises, LLC (“TSE”) and Tertio Telecoms Ltd. (“Evolving Systems U.K.”).  These finite life assets are amortized using the straight-line method over their estimated lives.

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

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

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

·                  Significant negative industry or economic trends; and/or

·                  Significant decline in our stock price for a sustained period.

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

Revenue Recognition – We recognize revenue from two primary sources: license fees and services, and customer support, in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended and interpreted by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.”  Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” provides further interpretive guidance for public companies on the recognition, presentation and disclosure of revenue in financial statements.  In addition to the criteria described below, we generally recognize revenue when an agreement is signed, the fee is fixed or determinable and collectibility is reasonably assured.

The majority of our license fees and services revenue is generated from fixed-price contracts, which provide for licenses to our software products and services to customize such software to meet our customers’ use.   Generally, when the services are determined to be essential to the functionality of the delivered software, we recognize revenue using the percentage-of-completion method of accounting, in accordance with SOP 97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.”  The percentage of completion for each contract is estimated based on the ratio of direct labor hours incurred to total estimated direct labor hours.  Since estimated direct labor hours, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and are reviewed regularly.  Amounts billed in advance of services being performed are recorded as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected within 12 months.

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

In arrangements where the services are not essential to the functionality of the software, we recognize license revenue upon delivery.  To the extent that Vendor-Specific Objective Evidence (“VSOE”) of the fair value of undelivered elements exists, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered.  If VSOE for the undelivered elements does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist on the undelivered elements or all of the elements have been delivered.

Services revenue from fixed-price contracts is generally recognized using the proportional performance method of accounting, which is similar to the percentage of completion method described above. Revenue from professional services provided pursuant to time-and-materials based contracts and training services are recognized as the services are performed, as that is when our obligation to our customers under such arrangements is fulfilled.

Customer support, including maintenance revenue, is generally recognized ratably over the service contract period. When maintenance is bundled with a license fee arrangement, its fair value, based upon VSOE, is deferred and recognized during the periods when services are provided.

Stock-based Compensation – We account for stock-based compensation under Statement of Financial Accounting Standards No. 123(Revised), “Share-Based Payment” (“SFAS 123R”).  This statement replaced SFAS No. 123, “Accounting for 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 to account for share-based payment transactions with employees and directors and record compensation cost for all stock awards granted after January 1, 2006 and awards modified, repurchased, or cancelled after that date. In addition, we record compensation costs associated with the vesting of unvested options outstanding at January 1, 2006 using the guidance under SFAS 123.  Stock-based compensation is a non-cash expense because we settle these obligations by issuing shares of our common stock instead of settling such obligations with cash payments.  Compensation cost for options is recognized on a straight-line basis over the vesting period using an estimated forfeiture rate.   Effective January 1, 2006, stock option grants and employee stock purchase plan purchases were accounted for under SFAS 123R.  We used the Black-Scholes model to estimate the fair value of each option grant on the date of grant.  This model requires the use of estimates for expected term of the options and expected volatility of the price of our common stock.

Recent Accounting Pronouncements – In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial

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Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 permits entities to choose to measure eligible items at fair value at specific election dates (the ‘‘fair value option’’). Unrealized gains and losses on items for which the fair value option has been elected shall be reported in earnings at each subsequent reporting period. This accounting standard is effective for us beginning January 1, 2008. We are currently assessing the impact 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 for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2007. We have not completed our evaluation of the impact of this standard on our consolidated financial statements or our future estimates of fair value.

NOTE 2 – GOODWILL AND INTANGIBLE ASSETS

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

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

		License and Services						Customer Support						Total
		U.S.			U.K.			U.S.			U.K.			Goodwill
Balance as of December 31, 2006		$	—		$	8,944		$	6,033		$	11,050		$	26,027
Effects of changes in foreign currency exchange rates		—			208			—			257			465
Balance as of June 30, 2007		$	—		$	9,152		$	6,033		$	11,307		$	26,492

 

We conducted our annual goodwill impairment test as of July 31, 2006, and we determined that goodwill was not impaired as of the test date.  From July 31, 2006 through June 30, 2007, no events have occurred that we believe may have impaired goodwill.

Identifiable intangible assets are amortized on a straight-line basis over estimated lives ranging from one to seven years and include the cumulative effects of foreign currency exchange rates.  As of June 30, 2007 and December 31, 2006, identifiable intangibles were as follows (in thousands):

		June 30, 2007									December 31, 2006									Weighted-
								Net									Net			Average
		Gross			Accumulated			Carrying			Gross			Accumulated			Carrying			Amortization
		Amount			Amortization			Amount			Amount			Amortization			Amount			Period
Purchased software		$	2,078		$	472		$	1,606		$	2,038		$	237		$	1,801		4.7 yrs
Purchased licenses		227			97			130			227			49			178			2.3 yrs
Trademarks and tradenames		899			128			771			879			63			816			7.0 yrs
Business partnerships		147			29			118			143			14			129			5.0 yrs
Customer relationships		3,717			861			2,856			3,657			426			3,231			5.6 yrs
		$	7,068		$	1,587		$	5,481		$	6,944		$	789		$	6,155		5.4 yrs

 

Amortization expense of identifiable intangible assets was $0.4 million and $0.8 million for the three and six months ended June 30, 2007, respectively, and $0.9 million and $1.8 million for the three and six months ended June 30, 2006.  As Evolving Systems U.K. uses the Great British pound as its functional currency, the amount of future amortization actually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related to identifiable intangibles based on our carrying amount as of June 30, 2007 was as follows (in thousands):

Twelve months ending June 30,
2008		$	1,544
2009		1,133
2010		904
2011		891
2012		505
Thereafter		504
		$	5,481

 

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NOTE 3 – EARNINGS PER COMMON SHARE

Basic earnings per share (“EPS”) is computed by dividing net income or loss available to common stockholders by the weighted average number of shares outstanding during the period, including common stock issuable under participating securities, such as the Series B Convertible Redeemable Preferred Stock (“Series B Preferred Stock”). Diluted EPS is computed using the weighted average number of shares outstanding, including participating securities, plus all potentially dilutive common stock equivalents. Common stock equivalents consist of stock options and shares held in escrow. The following is the reconciliation of the denominator of the basic and diluted EPS computations (in thousands):

		Three Months Ended June 30,				Six Months Ended June 30,
		2007		2006		2007		2006
Weighted average common shares outstanding		17,665		16,190		17,180		16,178
Participating securities		1,515		2,900		1,987		2,900
Basic weighted average shares outstanding		19,180		19,090		19,167		19,078
Effect of dilutive securities		424		—		—		—
Diluted weighted average common shares outstanding		19,604		19,090		19,167		19,078

 

Weighted average options to purchase 1.1 million shares of common stock were excluded from the dilutive stock calculation for the six months ended June 30, 2007, as their effect would have been anti-dilutive as a result of the net loss for the period.  Weighted average options to purchase 2.3 million and 2.9 million shares of common stock were excluded from the dilutive stock calculation for the three and six months ended June 30, 2007 because their exercise prices were greater than the average fair value of our common stock for the period.

Weighted average options to purchase 0.6 million and 1.2 million shares of common stock were excluded from the dilutive stock calculation for the three and six months ended June 30, 2006, respectively, as their effect would have been anti-dilutive as a result of the net loss for the periods.   Weighted average options to purchase 3.6 million and 3.0 million shares of common stock were excluded from the dilutive stock calculation for the three and six months ended June 30, 2006, respectively, because their exercise prices were greater than the average fair value of our common stock for the period.

NOTE 4 – SHARE-BASED COMPENSATION

We adopted SFAS 123R effective January 1, 2006 using the modified prospective method.  We previously applied the intrinsic-value-based method in accounting for the recognition of stock-based compensation arrangements and the fair value method only for disclosure purposes.  Our statements of operations from January 1, 2006 forward include charges for stock-based compensation.  We recognized $132,000, or $0.01 per share, and $381,000, or $0.02 per share, of compensation expense in the statement of operations for the three and six months ended June 30, 2007, respectively with respect to our stock-based compensation plans.  We recognized $207,000, or $0.01 per share, and $443,000, or $0.02 per share, of compensation expense in the statement of operations for the three and six months ended June 30, 2006, respectively with respect to our stock-based compensation plans.  The following table summarizes stock-based compensation expenses recorded in the consolidated statements of operations (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Cost of license fee and services, excluding depreciation and amortization		$	12		$	15		$	34		$	32
Cost of customer support, excluding depreciation and amortization		1			2			(1		)	4
Sales and marketing		29			51			67			106
General and administrative		84			128			268			279
Product development		6			11			13			22
		$	132		$	207		$	381		$	443

 

The negative amount in the table above for the six months ended June 30, 2007 resulted from the true-up of estimated forfeitures to actual forfeitures.

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Stock Option Plan

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

In March 2007 upon the hiring of our Vice President of World Wide Sales and Marketing, in accordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv) the board of directors approved an inducement award under a stand-alone equity incentive plan.  We granted 100,000 non-qualified options to purchase shares of our common stock at an exercise price equal to the closing price of our common stock on the date of grant.  The options vest over four years and expire ten 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 issued under the 2007 Stock Plan.  Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant.

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

		Three Months Ended June 30,				Six Months Ended June 30,
		2007		2006		2007		2006
Expected term (years)		6.3		*		6.2		6.1
Risk-free interest rate		5.03	%	*		4.71	%	4.35	%
Expected volatility		108.1	%	*		108.0	%	121.14	%
Expected dividend yield		0	%	*		0	%	0	%

 

*   None granted.

The following is a summary of stock option activity under the three stock incentive plans for the six months ended June 30, 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		170		$	1.98
Less options forfeited		(16	)	$	2.15
Less options expired		(48	)	$	3.80
Less options exercised		(20	)	$	0.98
Options outstanding at June 30, 2007		4,144		$	3.10		6.14		$	1,062
Options exercisable at June 30, 2007		3,302		$	3.34		5.49		$	936

 

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The weighted-average grant-date fair value of stock options granted during the three and six months ended June 30, 2007 was $1.99 and $1.67, respectively.

As of June 30, 2007, there were approximately $1.2 million of total unrecognized compensation costs related to unvested stock options.  These costs are expected to be recognized over a weighted average period of 1.3 years.

The total intrinsic value of stock option exercises for the three months ended June 30, 2007 and 2006 was $23,000 and $0, respectively.  The total fair value of stock options vested during the three months ended June 30, 2007 and 2006 was $0.2 million and $0.1 million, respectively.

The total intrinsic value of stock option exercises for the six months ended June 30, 2007 and 2006 was $23,000 and $13,000, respectively.  The total fair value of stock options vested during both of the six months ended June 30, 2007 and 2006 was $0.3 million.

The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $8,000 and $7,000 for the three months ended June 30, 2007 and 2006, respectively.  The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $19,000 and $14,000 for the six months ended June 30, 2007 and 2006, respectively.

Cash received from stock option exercises for the three months ended June 30, 2007 and 2006 was $19,000 and $0, respectively.  Cash received from stock option exercises for the six months ended June 30, 2007 and 2006 was $19,000 and $13,000, respectively.

Employee Stock Purchase Plan

Under the Employee Stock Purchase Plan (“ESPP”), we are authorized to issue up to 1,100,000 shares of our common stock to full-time employees, nearly all of whom are eligible to participate. Under the terms of the ESPP, employees may elect to have up to 15% of their gross compensation withheld through payroll deduction to purchase our common stock, capped at $25,000 annually. The purchase price of the stock is 85% of the lower of the closing price on the first day or the last day of each three-month participation period. As of June 30, 2007, there were 315,000 shares available for purchase.  For the three and six months ended June 30, 2007, we recorded compensation expense of $5,000 and $11,000, respectively, and for the three and six months ended June 30, 2006, we recorded compensation expense of $10,000 and $25,000, respectively, associated with grants under the ESPP which includes the fair value of the look-back feature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period based upon employee participation.

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

		Three Months Ended June 30,				Six Months Ended June 30,
		2007		2006		2007		2006
Expected term (years)		0.25		0.25		0.25		0.25
Risk-free interest rate		5.0	%	5.17	%	5.1	%	4.98	%
Expected volatility		70.1	%	78.36	%	70.1	%	82.3	%
Expected dividend yield		0	%	0	%	0	%	0	%

 

Cash received from employee stock plan purchases for the three months ended June 30, 2007 and 2006 was approximately $19,000 and $35,000, respectively.  Cash received from employee stock plan purchases for the six months ended June 30, 2007 and 2006 was approximately $36,000 and $73,000, respectively.

NOTE 5 – CONCENTRATION OF CREDIT RISK

For the three and six months ended June 30, 2007, two significant customers (defined as contributing at least 10%) accounted for 37% (22% and 15%) and 36% (22% and 14%), respectively, of total revenue.  These customers are large telecommunications operators located in the U.S. and U.K., respectively.  For the three and six months ended June 30, 2006, two significant customers accounted for 24% (13% and 11%) and 25% (13% and 12%), respectively, of total revenue.  These customers are large telecommunications operators located in the U.S. and U.K., respectively.

As of June 30, 2007, three significant customers accounted for approximately 36% (15%, 11% and 10%) of contract receivables.  These customers are large telecommunications operators located in the U.K., Germany and U.S., respectively.  At

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December 31, 2006, two significant customers accounted for approximately 51% (40% and 11%) of contract receivables.  These customers are large telecommunications operators located in the U.S. and Luxembourg, respectively.

NOTE 6 – LONG-TERM DEBT

Notes payable consist of the following (in thousands):

		June 30,			December 31,
		2007			2006
Senior note payable to financial institution, interest at one-month London InterBank Offered Rate (“LIBOR”) plus a margin of 6.25%; however, the LIBOR rate cannot be less than 3.75%; interest rate was 11.57% at June 30, 2007 and 11.60% at December 31, 2006, respectively; interest payments are due monthly, principal installments are due quarterly with final maturity on November 14, 2010. The margin of 6.25% can be reduced to 5.25% if we meet and maintain certain financial requirements (not met as of June 30, 2007 or December 31, 2006). The loan is secured by substantially all of our assets and a pledge of the stock of our subsidiaries.		$	5,419		$	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 9.32% at June 30, 2007 and 9.35% at December 31, 2006, respectively; interest payments are due monthly with final maturity on November 14, 2010. 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 June 30, 2007 and 12.84% at December 31, 2006, accrued interest and principal are due in full May 16, 2011.		4,767			4,870
Total notes payable		12,186			13,370
Less current portion		(2,250		)	(2,000		)
Long-term debt, excluding current portion		$	9,936		$	11,370

 

In accordance with the terms of our senior note payable agreement, we made an Excess Cash Flow payment (as defined in the agreement) to our senior lender in the amount of $81,000 during March 2007.

In March 2007, we paid $77,000 to retire $119,000 of subordinated debt and related accrued interest held by one of our subordinated note holders.  The retirement included principal of $103,000 and accrued interest of $16,000.  The $42,000 gain on extinguishment of this debt was reflected within other income (expense) on the consolidated statement of operations.

The senior note payable and senior revolving credit facility subject us to certain financial covenants.  We were in compliance with these covenants as of June 30, 2007.

NOTE 7 – INCOME TAXES

We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”) effective January 1, 2007.  FIN 48 clarifies the accounting for uncertainty in income tax benefits recognized in an enterprise’s financial statements in accordance with SFAS 109.  FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Upon adoption of FIN 48, no adjustment to the Consolidated Financial Statements was required. As of the date of adoption, we had an unrecognized domestic tax benefit of approximately $0.4 million which did not change significantly during the six months ended June 30, 2007.  The application of FIN 48 would have resulted in a decrease to retained earnings of $0.4 million, except that the decrease was fully offset by the application of a valuation allowance.  In addition, future changes in the unrecognized tax benefit will have no impact on the effective tax rate while the valuation allowance exists.  We expect that the unrecognized tax benefit will not change significantly within the next twelve months.

We file our tax returns as prescribed by the tax laws of federal as well as various state and foreign jurisdictions in which we operate.  We may be subject to examination by the Internal Revenue Service (“IRS”) for calendar years 2003 through 2006 and HM

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Revenue and Customs in the U.K. for calendar years 2005 and 2006.  Additionally, any domestic net operating losses that were generated in prior years and utilized in these years may also be subject to examination by the IRS.

Effective April 2007, our Indian subsidiary is subject to a 10% minimum alternative tax.  This tax did not have a material effect on our results for the three and six months ended June 30, 2007 and we do not expect this tax to have a material impact on future results.

We recorded income tax expense of $0.1 million for the three months ended June 30, 2007 and income tax benefit of $1.4 million for the three months ended June 30, 2006.  The net income tax expense during the three months ended June 30, 2007 consisted of current foreign income tax expense of $72,000 and a deferred foreign tax expense of $11,000, of which all is related to our UK-based operations, with the exception of $7,000 of current foreign income tax expense related to our India-based operations.  The net income tax benefit during the three months ended June 30, 2006 consisted of current foreign income tax expense of $290,000 and a deferred foreign tax benefit of $1.6 million both of which are related to our UK-based operations.

We recorded income tax expense of $0.2 million for the six months ended June 30, 2007 and income tax benefit of $1.5 million for the six months ended June 30, 2006.  The net income tax expense during the six months ended June 30, 2007 consisted of current foreign income tax expense of $262,000 and a deferred foreign tax benefit of $39,000 of which all is related to our UK-based operations, with the exception of $7,000 of current foreign income tax expense related to our India-based operations.  The net income tax benefit during the six months ended June 30, 2006 consisted of current foreign income tax expense of $374,000 and a deferred foreign tax benefit of $1.8 million both of which are related to our UK-based operations.

In conjunction with the acquisition of Evolving Systems U.K., we recorded certain identifiable intangible assets.  Since the amortization of these identifiable intangibles is not deductible for income tax purposes, we established a long-term deferred tax liability of $4.6 million at the acquisition date for the expected difference between what would be expensed for financial reporting purposes and what would be deductible for income tax purposes. As of June 30, 2007 and December 31, 2006, this deferred tax liability was $1.1 million and $1.5 million, respectively.  This deferred tax liability relates to Evolving Systems U.K., and has no impact on our ability to recover U.S.-based deferred tax assets.  This deferred tax liability will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized.

As of June 30, 2007 and December 31, 2006, we continued to maintain a full valuation allowance on our domestic net deferred tax asset as we determined it was more likely than not that we will not realize our domestic deferred tax assets.  Such assets primarily consist of net operating loss carryforwards.  We assessed the realizability of our domestic deferred tax assets using all available evidence.  In particular, we considered both historical results and projections of profitability for reasonably foreseeable future periods.  We are required to reassess conclusions regarding the realization of deferred tax assets at each financial reporting date. A future evaluation could result in a conclusion that all or a portion of the valuation allowance is no longer necessary which could have a material impact on our results of operations and financial position.

NOTE 8 – STOCKHOLDERS’ EQUITY

On March 15, 2007, holders of 441,377 shares of Series B Preferred Stock with a carrying value of $5.1 million, or approximately 46% of the outstanding preferred stock, converted their shares of preferred stock into 1,324,131 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock.  As we previously included the Series B Preferred Stock as a participating security for basic EPS purposes, this conversion did not change our basic or diluted EPS calculations.

On April 13, 2007, holders of 20,374 shares of Series B Preferred Stock with a carrying value of $0.2 million, or approximately 4% of the outstanding shares, converted their shares of preferred stock into 61,122 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock.  Because we previously included the Series B Preferred Stock as a participating security for basic EPS purposes, this conversion did not change our basic or diluted EPS calculations.

NOTE 9 – SEGMENT INFORMATION

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

We currently operate our business as two operating segments based on revenue type:  license fees and services revenue and customer support revenue (as shown on the consolidated statements of operations).  License fees and services (L&S) revenue represents the fees received from the license of software products and those services directly related to the delivery of the licensed products, as well as fees for custom development, integration services and time and materials work.  Customer support (CS) revenue includes annual support fees, recurring maintenance fees, fees for maintenance upgrades and warranty services.  Warranty services that are similar to software maintenance services are typically bundled with a license sale. Total assets by segment have not been disclosed as the information is not available to the CODM.

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Segment information is as follows (in thousands):

		Three Months Ended June 30,						Six Months Ended  June 30,
		2007			2006			2007			2006
Revenue
License fees and services		$	4,742		$	3,966		$	8,733		$	7,865
Customer support		4,380			4,274			8,850			8,503
		9,122			8,240			17,583			16,368
Revenue less cost of revenue, excluding depreciation and amortization
License fees and services		2,801			2,309			4,868			4,333
Customer support		2,664			2,723			5,641			5,326
		5,465			5,032			10,509			9,659
Unallocated costs
Other operating expenses		4,192			4,421			8,331			9,130
Depreciation and amortization		644			1,176			1,320			2,366
Impairment of goodwill and intangible assets		—			16,516			—			16,516
Restructuring and other		—			(9		)	(1		)	(23		)
Interest income		(81		)	(36		)	(145		)	(74		)
Interest expense		451			496			915			1,005
Gain on debt extinguishment		—			—			(42		)	—
Foreign currency exchange loss		104			29			162			30
Income (loss) before income taxes		$	155		$	(17,561	)	$	(31	)	$	(19,291	)

 

Geographic Regions

We are headquartered in Englewood, a suburb of Denver, Colorado.  We use customer locations as the basis for attributing revenues to individual countries.  We provide products and services on a global basis through our headquarters and our London-based Evolving Systems U.K. subsidiary.  Additionally, personnel in Bangalore, India provide software development services to our global operations.  Financial information relating to operations by geographic region, as reviewed by the CODM, is as follows (in thousands):

		Three Months Ended June 30,
		2007									2006
		L&S			CS			Total			L&S			CS			Total
Revenue
Americas		$	1,626		$	2,560		$	4,186		$	704		$	2,661		$	3,365
Europe, Middle East, Africa and Asia		3,116			1,820			4,936			3,262			1,613			4,875
Total Revenue		$	4,742		$	4,380		$	9,122		$	3,966		$	4,274		$	8,240

 

		Six Months Ended June 30,
		2007									2006
		L&S			CS			Total			L&S			CS			Total
Revenue
Americas		$	2,648		$	5,214		$	7,862		$	1,449		$	5,367		$	6,816
Europe, Middle East, Africa and Asia		6,085			3,636			9,721			6,416			3,136			9,552
Total Revenue		$	8,733		$	8,850		$	17,583		$	7,865		$	8,503		$	16,368

 

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		June 30,			December 31,
		2007			2006
Long-lived assets, net
Americas		$	7,462		$	7,903
Europe, Middle East, Africa and Asia		25,527			25,628
Total long-lived assets, net		$	32,989		$	33,531

 

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

		Three Months Ended June 30,						Six Months Ended  June 30,
		2007			2006			2007			2006
Revenue
Activation		$	4,905		$	4,341		$	9,478		$	8,551
Numbering solutions		3,279			2,588			6,081			5,332
Mediation		938			1,311			2,024			2,485
		$	9,122		$	8,240		$	17,583		$	16,368

 

NOTE 10 – COMMITMENTS AND CONTINGENCIES

(a)          Lease Commitments

During the three months ended June 30, 2007, we entered into a lease amendment for our headquarters location in Englewood, Colorado.  This amendment extended the term of our existing agreement for an additional 65 month period, reduced our rentable square footage and reduced our monthly rent obligation.

During the three months ended June 30, 2007, we also terminated our existing capital lease agreement for certain assets at our headquarters location and replaced it with a new capital lease agreement.

Future minimum commitments under these new agreements are:

		Operating Leases			Capital Leases
2007		$	78		$	15
2008		470			30
2009		482			30
2010		494			30
2011		506			30
Thereafter		430			11
Total minimum lease payments		$	2,460		146
Less: Amount representing interest					(37		)
Principal balance of capital lease obligations					109
Less: Current portion of capital lease obligations					(19		)
Long-term portion of capital lease obligations					$	90

 

(b)          Other Commitments

As permitted under Delaware law, we have agreements with officers and directors under which we agree to indemnify them for certain events or occurrences while the officer or director is, or was serving, at our request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments we could be required to make under these indemnification agreements; however, we maintain Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of June 30, 2007 and December 31, 2006.

From time to time, we enter into standard indemnification terms with customers and suppliers, in the ordinary course of business.  As we may subcontract the development of deliverables under customer contracts, we could be required to indemnify

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customers for work performed by subcontractors. Depending upon the nature of the customer indemnification, the potential amount of future payments we could be required to make under these indemnification agreements may be unlimited. We may be able to recover damages from a subcontractor if the indemnification to customers results from the subcontractor’s failure to perform. To the extent we are unable to recover damages from a subcontractor, we could be required to reimburse the indemnified party for the full amount. We have never incurred costs to defend lawsuits or settle claims relating to indemnification arising out of subcontractors’ failure to perform. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of June 30, 2007 and December 31, 2006.

Our standard license agreements contain product warranties that the software will be free of material defects and will operate in accordance with the stated requirements for a limited period of time.  The product warranty provisions require us to cure any defects through any reasonable means.  We believe the estimated fair value of the product warranty provisions in the license agreements in place with our customers is minimal.  Accordingly, there were no liabilities recorded for these product warranty provisions as of June 30, 2007 and December 31, 2006.

Our software arrangements generally include a product indemnification provision whereby we will indemnify and defend a customer in actions brought against the customer for claims that our products infringe upon a copyright, trade secret, or valid patent. We have not historically incurred any significant costs related to product indemnification claims. Accordingly, there were no liabilities recorded for these indemnification provisions as of June 30, 2007 and December 31, 2006.

In relation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreed to indemnify certain parties from any losses, actions, claims, damages or liabilities (or actions in respect thereof) resulting from any claim raised by a third party.  We do not believe that there will be any claims related to these indemnifications. Accordingly, there were no liabilities recorded for these agreements as of June 30, 2007 and December 31, 2006.

During the fourth quarter of 2006, a previous software vendor filed a complaint in the Superior Court of New Jersey against us asserting we breached certain provisions of a license agreement.  While the outcome of this matter is uncertain, we believe we have paid all fees due under our license agreement and we are vigorously defending this claim.

We are involved in various other legal matters arising in the normal course of business.  Losses were recorded for these matters to the extent they were probable of loss and the amount of loss could be reasonably estimated.

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