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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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, 2012

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)

(303) 802-1000

(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Act:

Securities registered under Section 12(g) of the Act: None

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

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

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

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

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

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

The aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the Nasdaq Capital Market, was approximately $31.0 million as of June 29, 2012.

The number of shares of Common Stock outstanding was 11,405,515 as of March 8, 2013.

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’s definitive proxy statement for the 2013 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the 2012 year.

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EVOLVING SYSTEMS, INC.

Annual Report on Form 10-K

For the year ended December 31, 2012

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FORWARD-LOOKING STATEMENTS

Except for the historical information contained in this document, this report contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995, including estimates, projections, statements relating to our business plans, objectives and expected operating results and assumptions. These forward-looking statements generally are identified by the words “believes,” “goals,” “projects,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” variations of these words and similar expressions. Forward-looking statements are based on current expectations, estimates, projections and assumptions regarding product, services, and customer support revenue; our expectations associated with Evolving Systems India and Evolving Systems U.K., and short- and long-term cash needs, and are subject to risks and uncertainties which may cause our actual results to differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to those discussed in the sections entitled “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise

PART I

ITEM 1.    BUSINESS

INTRODUCTION

Evolving Systems is a leading provider of service enablement and on-device activation solutions for network operators around the world. Our customers rely on us to develop, deploy, integrate, enhance and maintain software solutions supporting their traditional and next generation network technologies, convergent service offerings, and advanced wireless and other broadband networks. We maintain long-standing relationships with many major carriers worldwide.  Included among our more than 50 network operator customers are many tier-1 wireless carriers, including two of the world’s largest wireless carriers headquartered outside of North America.

We offer software products and solutions in four core areas:

·                  Service activation solutions used to activate complex bundles of voice, video and data services for traditional and next generation wireless, wireline and cable networks;

·                  SIM (Subscriber Identity Module) card activation and management solutions that improve the end user experience and dynamically allocate and assign resources to a wireless device when it is first used;

·                  Connected device solutions used to manage and activate machine-to-machine or M2M devices, such as e-readers, smart meters, gaming consoles, as well as other SIM-based industry specific devices; and

·                  Billing mediation solutions that support data collection for service assurance and billing applications.

We generate revenue by developing, licensing, and supporting our software products. We also provide consulting and product and solution support services. We report the operations of our business as two operating segments based on revenue type: license and services revenue and customer support revenue.  We report geographic information based upon revenue and long-lived assets in the United States, United Kingdom and all other foreign countries as a group.  Further information regarding our operating segments and geographical information is contained in Note 12 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

COMPANY BACKGROUND

Evolving Systems was founded in 1985. For nearly 20 years, we focused on providing custom software development, professional services and numbering solutions to telecommunications companies in the United States. In November 2004, we made a major expansion to our business with the acquisition of Tertio Telecoms Ltd. (“Evolving Systems UK”), a supplier of Operations Support Systems (“OSS”) software solutions for service activation and mediation to communication carriers throughout Europe, the Middle East, Africa and Asia. With this acquisition we not only expanded our markets beyond North America, we also added service activation and billing mediation solutions to our product portfolio. The acquisition significantly expanded our product and service capabilities, allowing us to address a larger portion of our customers’ OSS application needs with a balanced mix of products as well as services.

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On July 1, 2011, we sold our numbering solutions business to NeuStar, Inc. for $39.4 million in cash and the assumption of certain liabilities. The asset sale included all of our local number portability and number management solution products.

As a result, we are now best thought of as a service activation “pure play” company.  Our strategic focus is primarily on the wireless markets in the areas of subscriber activation, SIM card management and activation, and connected device activation.

INDUSTRY DYNAMICS

The market for communications activation and provisioning solutions is large and constantly evolving. Several key underlying factors are driving carrier demand for next generation solutions, supporting significant growth for specific products within the sector:

·                       Rapid adoption of smart phones and connected devices driving mobile data;

·                       On-going network investment to keep up with delivery speeds and capacity (Long Term Evolution, or “LTE”/4G);

·                       Margin pressure within the telecom services ecosystem due to higher network costs, lower Average Revenue Per User (ARPU), and increased competition from traditional vendors and new market entrants; and

·                       Large and expanding market share of prepaid subscribers in emerging and developing markets around the world.

Carriers are now compelled to offer a growing array of services through innovative bundles to deliver personalized and differentiated user experiences, reduce subscriber churn and all while maintaining or growing market share. In addition, these value-added services have to be delivered to the market in ever shorter windows as competitive pressure has increased the velocity at which carriers deliver new products and services. To achieve this objective, operators are increasingly reliant on flexible service enablement solutions that offer unlimited bundling capabilities.

As network migrations to 4G/LTE accelerate and pre-pay subscribers continue to drive growth in mobility, the SIM has emerged as a vital link in the telecom value chain. Evolving Systems’ solution for dynamically activating and managing the SIM is becoming a must-have component in the operators’ infrastructure, both to eliminate operating costs associated with other methods of provisioning SIM cards, as well as to improve the end-user experience.

We are a pioneer and leader in this market and we believe we are well-positioned to maintain our leadership role in this high-growth segment. To date our dynamic SIM allocation solution has activated well over 110 million SIM cards, providing rich functionality and significant operator savings.

PRODUCT PORTFOLIO

Dynamic SIM Allocation™

We introduced our Dynamic SIM Allocation™ solution, or “DSA,” in 2007. DSA offers carriers a radically improved alternative to the inefficient traditional SIM distribution and activation practices.

The SIM card is central to the provision of wireless access and services for most networks used today by wireless operators world-wide, as well as next generation 4G LTE technologies.  Typically, SIM cards are pre-provisioned before they are distributed to the retail environment. Pre-provisioning SIM cards requires that network resources be allocated well in advance of the wireless device becoming available for sale.  This leads to poor utilization of numbers and other network resources, increases unnecessary network costs, and delivers a poor user experience.

DSA’s core technological innovation, which recently received patent approval from the US Patent Office, enables new SIM cards that have not been pre-provisioned to be detected on first use, triggering an efficient dynamic provisioning process and eliminating the need for pre-provisioning. The SIM activation occurs only when a SIM card is first used.

During the activation process, the solution enables an on-device interaction with the end-user, delivering a differentiated user-experience which helps with reducing customer churn, lowering costs, and boosting revenue for the carrier.

The DSA solution offers a number of benefits including:

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·                  Improved user experience at lower cost: Carriers have various customer care processes, like those for mobile number portability, or replacing lost or stolen SIM cards.  These processes can be inefficient and have high operational costs. Our DSA solution helps carriers provide more customer self-care for an improved user experience at lower costs.

·                  Choice and Personalization on the device: Prepaid subscribers have traditionally been offered few choices at time of activation. With our solution, prepaid subscribers have an on-device language choice, a choice of product, package or tariff, the ability to select a number from a database of available numbers, including vanity number search and free or chargeable numbers, and the ability to select from a carrier’s promotions and value added services. In addition, on-device personalization is not limited to the point of first use. Using our DSA solution, subscribers can make changes to their service at any time.

·                  Improved efficiency and utilization: SIM cards that are never activated for a revenue-generating subscriber result in increased costs and wastage. Activating SIM cards dynamically on first use makes the SIM distribution process more efficient and flexible. SIM cards are not linked with any product or region until they are first used, allowing SIM stock to be moved freely to meet demand. The number of SIM types a carrier has to support is greatly reduced, resulting in less packaging cost and wastage.  Finally, by removing the need for SIM cards to be pre-provisioned, costly resources, such as numbers and network database capacity, are used only when needed.

·                  Availability to meet demand: Carriers can find it difficult to effectively and reliably manage their SIM inventory, especially when multiple SIM card variants and profiles are needed. Our DSA solution helps carriers to ensure new SIM cards and numbers are always available to meet demand.

·                  Increased revenue and market share: Our DSA solution supports the search, selection and payment for “vanity numbers” and allows a carrier the opportunity to monetize these numbers where, for example, each number can have a different price. Allowing number selection by any new subscriber is a market differentiator that will attract more subscribers. In addition, subscribers who select their own number are more likely to keep the number, which may result in greater subscriber lifespan and reduced churn.

DSA is an integrated solution comprised of several components:

·                        First Use Register (FUR) is responsible for the integration with the SS7/SIGTRAN network, detecting the first use of a SIM card, enabling the update of the card, and facilitating any optional dialogue with the subscriber in a highly secure manner. It triggers the provisioning process, including the allocation of a definitive International Mobile Subscriber Identity, or “IMSI,” and the Mobile Subscriber Integrated Services Digital Network-Number, or “MSISDN”. The IMSI identifies the SIM, while the MSISDN is used for routing calls to the subscriber.

·                  Task Management is a module that controls the process flow of tasks involved with completing the subscriber’s activation process. The module orchestrates the overall process, providing robust capabilities for processing high volume, low latency, and mission critical transactions.

·                  Resource Management is a component that records and controls the management and assignment of specific inventory elements and resources. The component allocates the resources used by the DSA solution, including IMSI and MSISDN values.

·                  Menu Server is a module that defines and controls the menu dialogue with a subscriber. The Menu Server provides carriers with the ability to customize the end user experience on the device. Working with a SIM applet, Menu Server allows the wireless carrier to quickly and easily customize the end user screens on their phones or other devices.

·                  Mobile Broadband Module allows DSA to support activation processes through a rich browser-based dialogue, as well as a dialogue through menus on a phone screen. With the Mobile Broadband Module, carriers can offer a customized experience for subscribers who are activating mobile broadband features for smart phones and/or a wide variety of connected devices.

·                  Promotions Engine enables DSA to offer dynamic promotions to end users as part of the on-device activation experience. Dynamic promotions are those which are selected as relevant to a specific user based on their device type, location, the time/date they activate their SIM, and other choices they make during the activation process.

·                  In-Life Interaction Engine enables many of the personalization options such as number and tariff choice, or promotions, to be offered to users via their device after first use, as well as during the first use period.

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·                  Operational Dashboard is a module that assists operators in the administration, operation, and maintenance of the DSA platform. Operational Dashboard offers carriers a powerful reporting tool and a flexible, easy-to-use tool that provides visibility into the performance of DSA.

·                  Direct Authentication is an extension module to the First Use Register which can generate Global System for Mobile Communication, or “GSM” SIM and Universal Mobile Telecommunications System, or “UMTS” SIM authentication. This removes the need to dedicate an Authentication Center (“AUC”) to perform this function for the First Use Register.

·                  SIM Reservation Portal™  extends the personalization capabilities of DSA to more of an operator’s customers. Working alongside DSA’s on-device personalization, it offers personalization in advance of SIM purchase, through a web portal that can be deployed on the public internet, or in a store kiosk.

Service Activation

Our service activation solution, Tertio™, is used by carriers to activate a new subscriber or to add a new service to an existing subscriber.  Our Tertio product provides a flexible operating environment for carriers to manage their voice, data, and content service needs for both their traditional and broadband IP networks.  Our solution is deployed as the service activation engine for over 50 networks around the world including two of the world’s largest wireless carriers.

Tertio is an integrated solution comprised of several components:

·                  Tertio Service Composer is a modeling tool that simplifies the creation of new services.

·                  Tertio Content Connector is a tool used for activation of next-generation services.

·                  Tertio Activation Designer is a tool designed to speed network feature activation.

·                  Tertio Service Activation is the platform that provides scalability and performance, flexibility and a graphical interface.

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

Our Tertio solution addresses the entire service lifecycle, allowing carriers to introduce new network technologies and easing the burden of integration with existing devices and systems. Service providers who use our Tertio solution can better plan, manage and execute the introduction of new services.

Intelligent Machine-to-Machine (M2M) Controller

Our Intelligent M2M Controller, which we sometimes call “IMC” is a connectivity services platform for M2M devices. The IMC solution virtualizes M2M device connections and is optimized for the specific connectivity use cases seen in M2M applications.

In many M2M scenarios, remote devices only need to connect to the network to send or receive data on a temporary, infrequent basis — this may be according to a schedule or in response to a specific event, like triggering of an alarm.  In these cases, the permanent allocation of a MSISDN and the provisioning of the MSISDN/IMSI pair into the network databases would be wasteful. Such resources would be unused for long periods of time as the device does not need to be continuously connected to the wireless network.

Our IMC allows an operator to avoid provisioning the device into the network databases completely — IMC itself acts as the virtual gateway between the device and the centralized systems. IMC becomes the effective database of subscriber information, or Home Location Register (“HLR”) /AUC and enables temporary sessions during which the device can send and receive data. During each session, IMC allocates a temporary MSISDN from a pool that is shared between devices, helping to improve MSISDN utilization.

Billing Mediation

Our billing mediation product is Evident™.  Billing mediation is the process of collecting network usage data and verifying that usage data is accurate and reconciles with billing system input.  It is a required pre-condition for generating accurate bills. Our Evident product enables customers to capture important usage data from network elements, allowing reconciliation of data inputs and outputs and facilitating compliance with relevant regulatory, accounting and data integrity requirements. The Evident solution supports convergent voice, data, and content services and also provides service usage data for business intelligence, revenue assurance, and next-generation billing solutions. Our Evident solution can be used by wireline, broadband and wireless carriers and provides carrier-grade reliability, performance, and scalability.

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PROFESSIONAL AND INTEGRATION SERVICES

Our Professional and Integration Services team provides expert consulting services and advice for the customization, integration and deployment of our products.  The team works closely with our Product Development and Engineering teams to ensure that our deployed products meet our customers’ requirements and that our products continue to evolve to meet future requirements.  Our services cover all aspects of the project lifecycle, including system architecture, design, software development and customization, system integration, testing, live deployment and production support, program and project level management, post-implementation maintenance and domain and product expertise.  Our teams work closely with customers and integration partners and have established long-term relationships with operators in the Americas, Europe, the Middle East, Africa and Asia Pacific regions.

PRODUCT DEVELOPMENT

We develop most of our products and services internally, conducting research to identify specific industry and customer business needs as well as market requirements and we use that information to determine our investment in product development (“PD”). We evaluate the market for new products and we leverage our existing product capabilities with enhancements of existing products.  Our product “roadmap” helps us identify which modifications and enhancements are most important and when they should be implemented. We build investment plans for our principal product areas and we make other investments in tools and product extensions to accelerate the development, implementation and integration process for customer solutions.

PD is expensed as incurred.  For the years ended December 31, 2012, 2011 and 2010, we expensed $3.1 million, $2.5 million and $2.5 million, respectively, in PD costs.  The majority of PD investments in 2012 have gone into enhancing our core service activation as well as the further development of our DSA solution.

SALES AND MARKETING

Our sales force is primarily a field-based organization structured to focus on specific geographical territories around the world: The Americas (North, Central and South), Europe, Middle East and Africa, the Commonwealth of Independent States (comprising of Russia and other former Soviet Republics) and Asia Pacific. Our sales activities cover both direct sales to carrier customers as well as sales through partners such as Gemalto and Oberthur, who include our products as part of their wider SIM-based solution offerings, and systems integrators such as Accenture and IBM who license our technology to customers as part of their delivery engagements.

Our solutions and our customers’ infrastructures are complex, and require a high degree of on-site consultative selling with new prospects as part of the sales process. In addition, our business relies on incremental revenue from existing customers, which requires regular interaction with customers to discuss enhancements to our existing solutions as well as the introduction of new value propositions. The sales team is also responsible for the generation of proactive proposals to prospects, as well as the management and delivery of responses to competitive tenders. This complex, highly involved approach creates a long sales cycle, requiring us to invest a considerable amount of time to developing business opportunities without guaranteed results.

Our marketing organization supports our sales activities by identifying markets for our products and establishing an awareness of our offerings in those markets through a combination of direct marketing, web marketing, and participation in shows, conferences, and industry bodies. The marketing organization is responsible for maintaining our web site and creating electronic and print-based sales collateral to support our sales activities.

COMPETITION

The market for telecommunications OSS products is intensely competitive and is subject to rapid technological change, changing industry standards, regulatory developments and consolidation. We face increasing demand for improved product performance, enhanced functionality, rapid integration capabilities coupled with pricing pressures. Our existing and potential competitors include many large domestic and international companies that often have substantially greater financial, technological, marketing, distribution and other resources, larger installed customer bases and longer-standing relationships with telecommunications customers. The market for telecommunications OSS software and services is extremely large and we currently hold only a small portion of total market share. We believe our increased focus on activation, as well as our work to establish the dynamic SIM allocation market, has resulted in our achieving a measurable and reasonable market share in those areas.

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Our principal competitors in service activation are Comptel, Sigma Systems and Oracle (as a result of its acquisition of Metasolv).  In mediation, our competitors include CSG Systems and Comptel. In the emerging area of dynamic SIM allocation, we believe we hold a significant leadership position; however, we are seeing competition from Giesecke & Devrient GmbH (as a result of their acquisition of SmartTrust) and Comptel, as well as a few other smaller regional competitors. In addition, some of the network equipment manufacturers’ next generation solutions address some of the benefits provided by our DSA solution.

For all of our products, our ability to compete successfully depends on a wide range of factors.  We deliver value by offering competitively priced quality solutions, tailored specifically to our customers’ network topography. After a customer implements one of our products, we often receive subsequent orders for enhancements and change requests to add functionality or increase capacity.  The growth of our solution, and the fact that it would be a complicated and expensive process to replace our software, provides us with an incumbent advantage.   Furthermore, many of our customer relationships span five years or more.  We believe all of these factors give us a competitive advantage and can be a barrier to entry for our competitors.

SIGNIFICANT CUSTOMERS

For the year ended December 31, 2012, three significant customers (defined as contributing at least 10%) accounted for 39% (15%, 14% and 10%) of revenue from continuing operations.  These customers are large telecommunications operators in Europe, the Commonwealth of Independent States and Mexico. For the year ended December 31, 2011 one significant customer accounted for 10% of revenue from continuing operations.  This customer is a large telecommunications operator in Europe.  For the year ended December 31, 2010 two significant customers accounted for 23% (12% and 11%) of revenue from continuing operations. These customers are large telecommunications operators in Europe and Asia.  The loss of any of these customers would have a material adverse effect on our business as a whole.

INTELLECTUAL PROPERTY

We rely on a combination of patents, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We presently have a patent in the U.S. on elements of our DSA product and patents pending in other countries on elements of our DSA and IMC products.

BACKLOG

We define backlog as firm non-cancelable sales orders that are anticipated to be delivered and recognized in revenue over the next twelve months. As of December 31, 2012 and 2011, our backlog was approximately $11.1 million and $12.6  million, respectively.  Our backlog at December 31, 2012 was comprised of license fees and services of $6.7 million and customer support of $4.4 million compared to license fees and services of $7.8 million and customer support of $4.8 million at December 31, 2011.

EMPLOYEES

As of December 31, 2012, we employed 160 people including 11 in the United States, 57 in the United Kingdom and 92 in Bangalore, India.  Of our worldwide staff, 88% are involved in product delivery, development, support and professional services, 6% in sales and marketing, and 6% in general administration.

AVAILABLE INFORMATION

You can find out more information about us at our Internet website located at www.evolving.com. The information on or accessible through 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 reports are available free of charge on our Internet website as soon as reasonably practicable after we electronically file or furnish such material with the SEC. Additionally, these reports are available at 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 be obtained by calling the SEC at 1-800-SEC-0330.

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ITEM 1A.    RISK FACTORS

Risks Related to Our Business

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

A significant part of our revenue comes from international sales.  Our success delivering solutions internationally and competing in international markets is subject to our ability to manage various risks and difficulties, including, but not limited to::

·                   our ability to effectively manage our employees at remote locations who are operating in different business environments from the United States;

·                  fluctuations in currency exchange rates;

·                   trade restrictions, political instability, disruptions in financial markets, and deterioration of economic conditions;

·                  compliance with the U.S. Foreign Corrupt Practices Acts and other anti-bribery laws and regulations;

·                   variations and changes in laws applicable to our operations in different jurisdictions, including enforceability of intellectual property and contract rights ;

·                   compliance with export regulations, tariffs and other barriers;

·                   timely collecting of accounts receivable from foreign customers;

·                   our ability to provide sufficient levels of technical support in different locations; and

·                   potentially adverse tax consequences in connection with repatriating funds.

Approximately forty percent of our revenue is transacted in non-U.S. Dollar denominated currencies (e.g. British Pound Sterling and Euro).  As a result, when the U.S. Dollar strengthens, our revenue, when converted to U.S. Dollars, is reduced.  At the same time, with more than 50% of our operating expenses originating overseas, the strengthening dollar conversely lowers expenses outside of the U.S. Although this has provided some defense against currency fluctuations for our bottom line results, we may not be able to maintain this ratio of revenue to expense in the future.  In addition, we may not be able to sustain or increase our international revenue or repatriate cash without incurring substantial risks involving floating currency exchange rates, our ability to recover or apply withholding taxes remitted to foreign governments, and income tax expenses.  Any of the foregoing factors may have a material adverse impact on our international operations and, therefore, our business, financial condition and results of operations.  In addition, there have been proposals to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form any proposed legislation may pass, if enacted it could have a material adverse impact on our tax expense and cash flow.

Impact of Long Sales Cycle: Our customers typically engage in significant review and detailed approval processes over an extended period of time.  Economic downturns, consolidations and corporate restructuring may interrupt these approval processes and result in the loss of our sale or deferral of revenue into later periods, adversely affecting our financial performance.

Large communications solutions used for enterprise-wide, mission-critical purposes, involve significant capital expenditures and lengthy implementation plans. Prospective customers often commit significant resources to the technical evaluation of our products and services and require us to spend substantial time, effort and money educating them about our solutions. This evaluation process often results in an extensive and lengthy sales cycle, typically ranging between three and twelve months. Likewise, customers’ budgetary constraints and internal acceptance reviews may cause potential customers to delay or forego a purchase, making it even more difficult for us to forecast the timing and magnitude of our contracts. In addition, our sales opportunities in any given quarter typically include a few high value opportunities. The delay or failure to complete one or more large contracts could materially harm our business, financial condition, results of operations and cash flows and cause our operating results to vary significantly from quarter to quarter and year to year.

Mergers and acquisitions of 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 are common. In addition, many of the companies in the communications industry have kept capital expenditures at historically low levels in response to changes in the communications marketplace; some companies have declared bankruptcy, cancelled contracts, delayed payments to their suppliers or delayed additional purchases.  The delay or failure to complete 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 from quarter to quarter and year to year.

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Our products are complex and have a lengthy implementation process; unanticipated difficulties or delays in the customer acceptance process could result in higher costs and delayed payments.

Implementing our solutions can be a relatively complex and lengthy process since we typically customize these solutions for each customer’s unique environment. Often our customers may also require rapid deployment of our software solutions, resulting in pressure on us to meet demanding delivery and implementation schedules. Inability to meet these demanding schedules, or quality issues resulting from accelerated delivery schedules may result in customer dissatisfaction and/or damage our reputation, which could materially harm our business.

The majority of our existing contracts provide for acceptance testing by the customer, which can be a lengthy process. Unanticipated difficulties or delays in the customer acceptance process could result in higher costs, delayed payments, and deferral of revenue recognition. In addition, if our software contains defects or we otherwise fail to satisfy acceptance criteria within prescribed times, the customer may be entitled to liquidated damages or to cancel its contract and receive a refund of all or a portion of amounts paid or other amounts as damages, which could exceed related contract revenue and which could result in a future charge to earnings. Any failure or delay in achieving final acceptance of our software and services could harm our business, financial condition, results of operations and cash flows.

We are a relatively small company with a limited number of products and staff.  Sales fluctuations and employee turnover may adversely affect our business.

We are a relatively small company.  Consequently, compared to larger companies, sales fluctuations could have a greater impact on our revenue and profitability on a quarter-to-quarter basis and a delayed contract could cause our operating results to vary significantly from quarter to quarter.  In addition, as a small company we have limited staff and are heavily reliant on certain key personnel to operate our business. If a key employee were to leave the company it could have a material impact on our business and results of operations as we might not have sufficient depth in our staffing to fill the role that was previously being performed.  A delay in filling the vacated position could put a strain on existing personnel or result in a failure to satisfy our contractual obligations or to effectively implement our internal controls, and materially harm our business.

Because our quarterly and annual operating results are difficult to predict and may fluctuate, the market price for our stock may be volatile.

Our operating results have fluctuated significantly in the past and may continue to fluctuate significantly in the future. Fluctuations in operating results may result in volatility of the price of our common stock. These quarterly and annual fluctuations may result from a number of factors, including:

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

·                  our rate of progress under our contracts;

·                  foreign exchange fluctuations;

·                  budgeting cycles of our customers;

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

·                  the mix of products and services sold;

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

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

·                  changes in our strategy;

·                  general economic conditions.

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Personnel costs are a significant component of our budgeted expense levels and, therefore, our expenses are relatively fixed. As discussed above, our revenue is difficult to forecast and our sales cycle and the size and timing of significant contracts vary substantially among customers. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenue. Any significant shortfall from anticipated levels of demand for our products and services could adversely affect our business, financial condition, results of operations and cash flows.

Based on these factors, we believe our future quarterly and annual operating results may vary significantly from quarter-to-quarter and year-to-year. As a result, quarter-to-quarter and year-to-year comparisons of operating results are not necessarily meaningful nor do they indicate what our future performance will be. Furthermore, we believe that in future reporting periods if our operating results fall below the expectations of public market analysts or investors, it is possible that the market price of our common stock could decrease.

Our results of operations could be negatively impacted if we are unable to manage our liquidity.

We paid approximately $44.2 million in dividends/return of capital to our stockholders in 2012.  Our cash forecast indicates that we will have sufficient liquidity to cover anticipated operating costs for at least the next twelve months, but this could be negatively impacted to the extent we are unable to invoice and collect from our customers in a timely manner, or an unexpected adverse event, or combination of events occurs. Therefore, if the timing of cash generated from operations is insufficient to satisfy our liquidity requirements, we may require access to additional funds to support our business objectives through a credit facility or possibly the issuance of additional equity. Additional financing may not be available at all or, if available, may not be obtainable on terms that are favorable to us and not dilutive.

The market for our service activation products is mature and the market for our DSA product is uncertain.  The industry in which we compete is subject to rapid technological change and we may not be able to generate sufficient demand for our DSA product and new products to remain competitive.

The market for our service activation product is mature.  Customer demand for our DSA product and enhancements to our DSA product is uncertain. In addition, the market for our products and services is subject to rapid technological changes, evolving industry standards, changes in carrier requirements and preferences and frequent new product introductions and enhancements. The introduction of products that incorporate new technologies and the emergence of new industry standards can make existing products obsolete and unmarketable. To compete successfully, we must continue to design, develop and sell enhancements to existing products and new products that provide higher levels of performance and reliability in a timely manner, take advantage of technological advancements and changes in industry standards and respond to new customer requirements. Investments in new products are speculative. We may not achieve significant revenue from new product and service investments for a number of years, if at all. Moreover, new products and services may not be profitable, and even if they are profitable, operating margins for new products and businesses may not be as high as the margins we have experienced historically. If we are unable to identify new product opportunities, sales and profit growth would be adversely affected.

If we are unable to properly supervise our software development subsidiary in India, or if political or other uncertainties interfere, we may be unable to satisfactorily perform our customer contracts.

In 2004, we formed Evolving Systems India, a wholly owned subsidiary of Evolving Systems, Inc.  We have experienced a high level of turnover with our Indian development staff as a result of strong competition for technology-based personnel in India. In addition, salary levels in India are steadily increasing, reducing the competitive advantages associated with offshore labor. If we are unable to effectively manage the Evolving Systems India development staff and/or we continue to experience high levels of staff turnover, we may fail to provide quality software in a timely fashion, which could negatively affect our ability to satisfy our customer contracts. Furthermore, political changes and uncertainties in India could negatively impact the business climate there.  As a result, we may be unable to satisfactorily perform our customer contracts and our business, financial condition and results of operations could be materially harmed.

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

Our customers may require, or we may find it necessary or advisable, to modify our products or services to address actual or anticipated changes in regulations affecting our customers. This could materially harm our business, financial condition, results of operations, and cash flows.  We are also subject to numerous regulatory requirements of foreign jurisdictions.  Any compliance failures or changes in such regulations could, likewise, materially harm our business, financial condition, results of operations and cash flows.

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Consolidation in the communications industry may impact our financial performance.

The communications industry has experienced and continues to experience significant consolidation, both in the United States and internationally.  These consolidations have caused us to lose customers and may result in fewer potential customers requiring OSS solutions in the future.  In addition, combining companies may re-evaluate their OSS solutions and their capital expenditures and may choose a competitive OSS solution used by one of the combining companies.  As our customers become larger, they generally have stronger purchasing power, which can result in reduced prices for our products, lower margins on our products and longer sales cycles.  All of these factors can have a negative impact on our financial performance, particularly in any fiscal quarter. Because of the uncertainty resulting from these consolidations and the variations in our quarterly operating results, it is extremely difficult for us to forecast our quarterly and annual revenue and we do not provide revenue guidance.

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

We earn a significant portion of our revenue from a small number of customers in the communications industry. The loss of any significant customer, delays in delivery or acceptance of any of our products by a customer, delays in the performance of services for a customer, or delays in collection of customer receivables could harm our business and operating results to a greater degree than other companies with a broader customer base.

Many of our products and services are sold on a fixed-price basis.  If we incur budget overruns this may reduce our profitability.

Currently, a large portion of our revenue is from fixed-price contracts and we expect this will continue. These contracts specify certain obligations and deliverables we must meet regardless of the actual costs we incur. Projects done on a fixed-price basis are subject to budget overruns. On occasion, we have experienced budget overruns, resulting in lower than anticipated margins. We may incur similar budget overruns in the future, including overruns that result in losses on these contracts. If we incur budget overruns, our margins may be harmed, thereby affecting our overall profitability.

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

The revenue for most of our contracts is accounted for on the percentage-of-completion method of accounting.  This method of accounting requires us to calculate revenue and profits to be recognized in each reporting period for each project based on our predictions of future outcomes, including our estimates of the total cost to complete the project, project schedule and completion date, the percentage of the project that is completed and the amounts of any probable unapproved change orders.  Our failure to accurately estimate these often subjective factors could result in reduced profits or losses for certain contracts.

The communications industry is highly competitive and 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 are intensely competitive and we face continuous demand for improved product performance, new product features and reduced prices, as well as intense pressure to accelerate the release of new products and product enhancements. Our existing and potential competitors include many large domestic and international companies, including some competitors that have substantially greater financial, manufacturing, technological, marketing, distribution and other resources, larger installed customer bases and longer-standing relationships with customers than we do. Our principal competitors in service activation are Oracle (as a result of its acquisition of Metasolv), Comptel and Sigma Systems.  In mediation, we compete with CSG Systems and Comptel. Our principal competitors in the SIM allocation market include Giesecke & Devrient GmbH (as a result of its acquisition of SmartTrust) and Comptel, as well as a few other smaller regional competitors. In addition, some of the network equipment manufacturers’ next generation solutions address some of the benefits provided by our DSA solution.

Customers also may offer competitive products or services in the future since customers who have purchased solutions from us are not precluded from competing with us. Many telecommunications companies have large internal development organizations, which develop software solutions and provide services similar to the products and services we provide. We also expect competition may increase in the future from application service providers, existing competitors and from other companies that may enter our existing or future markets with solutions which may be less costly, provide higher performance or additional features or be introduced earlier than our solutions.

We believe that our ability to compete successfully depends on numerous factors, including the quality and price competitiveness of our products and services compared to those of our competitors, the emergence of new industry standards and technical innovations and our ability to respond to those changes. Some of these factors are within our control, and others are not. A variety of potential actions by our competitors, including a reduction of product prices or increased marketing and promotion, accelerated introduction of new or enhanced products, or cooperative relationships among competitors and their strategic partners, could negatively impact the sales of our products and we may have to reduce the prices we charge for our products. Revenue and operating margins may consequently decline. We may not be able to compete successfully with existing or new competitors or to properly identify and address the demands of new markets. This is particularly true in new markets where standards are not yet established. Our failure to adapt to emerging market demands, respond to regulatory and technological changes or compete successfully with existing and new competitors would materially harm our business, financial condition, results of operations and cash flows.

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Our business depends largely on our ability to attract and retain talented employees.

Our business is based on successfully attracting and retaining talented employees and the market for skilled workers in our industry is very competitive. We may not be able to retain personnel or to hire additional personnel on a timely basis, if at all. Because of the complexity of our software solutions, a significant time lag exists between the hiring date of technical and sales personnel and the time when they become fully productive. We have at times experienced high employee turnover and difficulty in recruiting and retaining technical personnel. Our failure to retain personnel or to hire qualified personnel on a timely basis could adversely 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 detected until deployment.  Resolving warranty and product liability claims could be expensive and could negatively affect our reputation and profitability.

The provisions of our agreements with our customers are designed to limit our exposure to potential liability for damages arising out of the use of, or defects in, our products tend to vary from customer to customer and it is possible that these limitations of liability provisions may not be effective. In addition, to the extent that any successful product liability claim is not covered by our errors and omissions insurance or exceeds the coverage under our policy, we may be required to pay for a claim. This could be expensive, particularly since our software products may be used in critical business applications. As we may subcontract the development of deliverables under customer contracts, we could be required to indemnify 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 from a subcontractor the amounts we are required to pay to customers due to the subcontractor’s failure to perform. Defending against a product liability claim, regardless of its merits, could be expensive and require the time and attention of key management personnel, either of which could materially harm our business, financial condition and results of operations. In addition, our business reputation could be harmed by product liability claims, regardless of their merit or the eventual outcome of these claims.

Our measures to protect our intellectual property may not be adequate.

Our success and ability to compete are dependent to a significant degree on our proprietary technology. Protecting our global intellectual property rights is difficult.  We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We have a patent in the U.S. on elements of our DSA product and patents pending in other countries on elements of our DSA and IMC products. In addition, we have registered or filed for registration of certain of our trademarks. Our patent portfolio is relatively small and given the cost of obtaining patent protection, we may choose not to patent certain inventions that later become important. There is also the possibility that our means of protecting our proprietary right may not be adequate and a third party may copy or otherwise obtain and use our products or technology without authorization or may develop similar technology independently or design around our patents. In addition, the laws of some foreign countries may not adequately protect our proprietary rights.

If our intellectual property protection proves inadequate, we may lose our competitive advantage and our future financial results may suffer.

Third parties may claim we are infringing their intellectual property rights and we may incur significant expenses in resolving these claims.

It is also possible that our business activities may infringe upon the proprietary rights of others, or that other parties may assert infringement claims against us. Those claims may involve patent holding companies or other adverse patent owners who have no relevant product revenue of their own, and against whom our own patents may provide little or no deterrence. We could incur substantial costs in defending against any infringement claim and we could be required to develop non-infringing technology, obtain licenses, or to cease selling the applications that contain the infringing intellectual property. Adverse publicity related to any intellectual property litigation also could harm the sale of our products and damage our competitive position.

Certain software developed or used by Evolving Systems, as well as certain software acquired in our acquisition of Evolving Systems U.K., may include so called “open source” software that is made available under an open source software license.

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·                  Such open source software may be made available under licenses, certain of which may impose obligations on us in the event we were to distribute derivative works based on the open source software.  Certain licenses impose obligations that could require us to make source code for a derivative work available to the public or license the derivative work 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 interpreting the terms of certain of these open source licenses, including the terms addressing the extent to which software incorporating open source software may be considered a derivative work subject to these licenses.  We believe we have complied with our obligations under the various applicable open source licenses.  However, if the owner of any open source software were to successfully establish that we had not complied with the terms of an open source license for a particular product that includes such open source software, we may be forced to release the source code for that derivative work to the public or cease distribution of that work.

Disruptions from terrorist activities, geopolitical conditions or military actions may disrupt our business.

The continued threat of terrorism within the U.S. and throughout the world and acts of war may cause significant disruption to commerce throughout the world. Abrupt political changes and armed conflict pose a risk of economic disruption in affected countries, which may increase our operating costs and add uncertainty to the timing and budget for technology investment decisions by our customers. Our business and results of operations could be materially and adversely affected to the extent that such disruptions result in delays or cancellations of customer orders, delays in collecting cash, a general decrease in corporate spending on information technology, or our inability to effectively market, manufacture or ship our products. We are unable to predict whether war, political unrest and the threat of terrorism will result in any long-term commercial disruptions or if such activities will have any long-term material adverse effect on our business, results of operations, financial condition or cash flows.

We face risks associated with doing business through local partners.

In some countries, because of local customs and regulations or for language reasons, we do business with our customers through local partners who resell our products and services, with or without value-added services.  This can cause delays in closing contracts because of the increased complexity of having another party involved in negotiations.  In addition, where the local partner provides additional software, hardware and/or services to the end-user customer, our products and services may only be a small portion of the total solution.  As a result, payments made to us, as well as conditions surrounding acceptance, may be impacted by factors that are out of our control.  There may also be delays in getting payments made by the end-user customer through the reseller.  We have experienced delays in collecting from resellers and this situation may arise again in the future, negatively impacting our cash flows.  Doing business through local partners may also increase our risks under anti-bribery regulations, discussed below.

We face special risks associated with doing business in highly corrupt environments.

Our international business operations include projects in developing countries and countries torn by conflict.  To the extent we operate outside the U.S., we are subject to the Foreign Corrupt Practices Act (“FCPA”), which generally prohibits U.S. companies and their intermediaries from paying or offering anything of value to foreign government officials for the purpose of obtaining or keeping business, or otherwise receiving discretionary favorable treatment of any kind.  To the extent we do business through Evolving Systems UK, we are also subject to anti-bribery laws and regulations of the U.K.  In addition, we may be held liable for actions taken by our local partners and agents, even though such parties are not always subject to our control.  Any determination that we have violated the FCPA (whether directly or through acts of others, intentionally or through inadvertence) or other anti-bribery legislation could result in sanctions that could have a material adverse effect on our business.  While we have procedures and controls in place to monitor compliance, situations outside of our control may arise that could potentially put us in violation of the FCPA or other anti-bribery legislation inadvertently and thus negatively impact our business.

Cyber-attacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our competitive position.

Increased sophistication and activities of perpetrators of cyber attacks have resulted in an increase in information security risks in recent years. Hackers develop and deploy viruses, worms, and other malicious software programs that attack products and services and gain access to networks and data centers. A substantial portion of our software development and customer support is provided out of our India facility, which may be subject to increased risk of power loss, telecommunications failure, terrorist attacks and similar events. If we were to experience difficulties maintaining existing systems or implementing new systems, we could incur significant losses due to disruptions in our operations. Additionally, these systems contain valuable proprietary and confidential information and a breach, including cyber security breaches, could result in disruptions of our internal systems and business applications, impairment of our ability to provide services to our customers, product development delays, harm to our competitive position from the compromise of confidential business information, or other negative impacts on our business. Although we believe that we have robust information security procedures and other safeguards in place, many of our services do not have fully redundant systems or a formal disaster recovery plan, and we may not have adequate business interruption insurance to compensate us for losses that occur from a system outage. As cyber threats continue to evolve, we may be required to expend additional resources to continue to enhance our information security measures and/or to investigate and remediate any information security vulnerabilities.  Any of these consequences would adversely affect our revenue and margins.

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Sales of large blocks of our stock may result in the reduction in the market price of our stock and make it more difficult to raise funds in the future.

If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. The perception among investors that such sales will occur could also produce this effect. We currently have several stockholders who own large percentages of our stock. To the extent we continue to have one or more stockholders who own a large percentage of our stock and those stockholders chose to liquidate their holdings, it may have a dramatic impact on the market price of our stock. These factors also could make it more difficult to raise funds through future offerings of common stock.

We are subject to certain rules and regulations of federal, state and financial market exchange entities, the compliance with which requires substantial amounts of management time and company resources.  Last year, we identified a material weakness in our financial reporting which we remediated, but any future ineffectiveness of internal controls could adversely affect our business and the price of our common stock.

Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded.  These entities, including the Public Company Accounting Oversight Board, the SEC and NASDAQ, have issued requirements and regulations and are currently developing additional regulations and requirements in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011.  Our compliance with certain of these rules, such as Section 404 of the Sarbanes-Oxley Act, has required and will continue to require the commitment of significant managerial resources. In addition, establishment of effective internal controls is further complicated because we are a relatively small company with global operations, and multiple locations and IT systems.

We review our material internal control systems, processes and procedures for compliance with the requirements of Section 404.  Such a review resulted in identification of a material weaknesses in our internal controls and a conclusion that our disclosure controls and procedures and internal control over financial reporting were ineffective as of December 31, 2011.  While we took steps to remediate the weakness, there is no guarantee that we will not identify additional material weaknesses in our internal controls in the future.  Disclosures of material weaknesses in our SEC reports could cause investors to lose confidence in our financial reporting and may negatively affect the price of our stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud.  A material weakness in our internal control over financial reporting could negatively impact our business, results of operations and reputation.

Certain provisions of our charter documents, employment arrangements and Delaware law may discourage, delay or prevent an acquisition of us, even if an acquisition would be beneficial to our stockholders, and may prevent attempts by our stockholders to replace or remove our current management.

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

·                  our stockholders cannot take action by written consent; and

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

In addition, we are subject to the anti-takeover provisions of Section 203 of Delaware General Corporation Law, which prohibit us from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in the prescribed manner. The application of Section 203 and certain provisions of our restated certificate of incorporation may have the effect of delaying or preventing changes in control of our management, which could adversely affect the market price of our common stock by discouraging or preventing takeover attempts that might result in the payment of a premium price to our stockholders.

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Our named executive officers have entered into agreements with us that contain a change in control provision. These agreements generally provide for acceleration on vesting of options, 50% upon a change in control (as defined in such agreement) if the executive officer remains employed with the new entity, or 100% in the event the executive officer’s employment is terminated. The acceleration of vesting of options upon a change in control may be viewed as an anti-takeover measure and may have the effect of discouraging a merger proposal, tender offer or other attempt to gain control of us.

Our Amended and Restated Stock Option Plan provides for acceleration of vesting under certain circumstances. Upon certain changes in control of us, vesting on some options awarded to directors may be accelerated. In addition, the successor corporation may assume outstanding stock awards or substitute equivalent stock awards. If the successor corporation refuses to do so, such stock awards will become fully vested and exercisable for a period of 15 days after notice from us but the option will terminate if not exercised during that period. As noted above, the acceleration on vesting of options upon a change in control may be viewed as an anti-takeover measure.

General economic factors, domestically and internationally, that impact the communications industry, could negatively affect our revenue and operating results.

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

·                  difficulty forecasting, budgeting and planning due to limited visibility into the spending plans of current or prospective customers;

·                  pricing pressure that may adversely affect revenue and gross margin;

·                  lengthening sales cycles and slowing deployments;

·                  increased competition for fewer projects and sales opportunities;

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

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

We are unable to predict how long the current economic downturn will last and the magnitude of its effect on our business and results of operations.  If these conditions continue, or further weaken, our business and results of operations could be materially adversely affected.

General risk statement

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

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

We lease office space at various locations which are shown below.

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We believe that our facilities are adequate for our current and near-term needs, and that we will be able to locate additional facilities as needed.

ITEM 3.    LEGAL PROCEEDINGS

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

ITEM 4.    MINE SAFETY DISCLOSURES

Not applicable.

PART II

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

As of March 8, 2013, there were approximately 36 holders of record of our common stock.

Dividends

During the second and fourth quarters of 2012, our Board of Directors declared a special cash dividend of $1.70 per share and $0.15 per share, respectively.  During the first, third and fourth quarters of 2012, our Board of Directors declared a cash dividend of $0.05 per share.  There can be no guarantee that we will continue to pay dividends. The decision to declare dividends in the future will depend on general business conditions, the impact of such payment on our financial condition and other factors our Board of Directors may consider to be relevant. In addition, we may enter into a credit facility in the future which may require consent of the financial institution issuing the credit facility to declare a dividend.  Payment of future dividends can also affect our business as this could reduce our cash reserves to levels that may be inadequate to fund expansions to our business plan or unanticipated contingent liabilities.

Issuer Purchases of Equity Securities

Beginning on May 20, 2011, and continuing through December 31, 2012, we implemented a stock re-purchase plan to re-purchase our common stock at prevailing market prices either in the open market or through privately negotiated transactions up to $5.0 million.  The size and timing of such purchases, if any, were based on market and business conditions as well as other factors.  We were not obligated to purchase any shares.  Purchases under the program could have been discontinued at any time we determine additional purchases were not warranted.

From the inception of the plan through December 31, 2012, we purchased 178,889 shares of our common stock for $1.3 million or an average price of $6.97 per share. These shares are currently being held in treasury and recorded at cost as a component of stockholders’ equity. The stock re-purchase program expired on December 31, 2012.  There were no stock re-purchases made under the re-purchase plan during the fourth quarter of 2012.

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Stock Performance Graph

The following graph compares the cumulative 5-year total return provided to shareholders on Evolving Systems, Inc.’s common stock relative to the cumulative total returns of the NASDAQ Composite index, the DJ US MicroCap Total Stock Market Software index, and the RDG Software Composite index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each index on 12/31/2007 and its relative performance is tracked through 12/31/2012.

ITEM 6.    SELECTED FINANCIAL DATA

The selected financial data set forth below for each of the years in the five-year period ended December 31, 2012, has been derived from our consolidated financial statements. The following selected financial data should be read in conjunction with “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements and the notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K.

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(1)       On February 25, 2008, holders of 461,758 shares of Series B Preferred Stock with a carrying value of $5.4 million, or approximately 96% of the outstanding preferred stock, converted their shares of preferred stock into 692,637 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock. On March 19, 2008, a holder of 16,992 shares of Series B Preferred Stock with a carrying value of $0.2 million, which represented the remainder of the outstanding preferred stock, converted his shares of preferred stock into 25,488 shares of our common stock in accordance with the conversion provisions of the Series B Preferred Stock. As we previously included the Series B Convertible Preferred Stock as a participating security for basic EPS purposes, these conversions did not change our basic or diluted EPS calculations.

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

(3)       During 2009, we paid $6.2 million to retire our subordinated notes, including accrued interest. These payments were made from cash on hand and $1.5 million in borrowings on our U.K. revolving credit facility. The subordinated debt payments were unscheduled and reduced balances classified as long-term as of December 31, 2008.

(4)       During 2011, we completed the Asset Sale of our Numbering Solutions Business on July 1, 2011 for $39.4 million in cash and the assumption of certain liabilities to the buyer. The Asset Sale qualified for treatment as discontinued operations during the second quarter of 2011 upon receipt of shareholder approval at a special meeting of shareholders on June 23, 2011. This divested business is reflected in these consolidated financial statements as discontinued operations and historical information related to the divested business has been reclassified accordingly.

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

FORWARD-LOOKING STATEMENTS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, 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 with Evolving Systems 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 to identify forward-looking statements. The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in this section and in “Item 1A - Risk Factors.”

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OVERVIEW

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

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

RECENT DEVELOPMENTS

We reported net income of $5.6 million, $32.3 million and $5.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. Our ending backlog at December 31, 2012 was $11.1 million, consisting of $6.7 million of license and services and $4.4 million of customer support compared to total backlog of $12.6 million at December 31, 2011.

During 2012 we sold our investments in marketable debt securities for approximately $17.8 million and we realized a gain on sale of approximately $0.9 million.

We declared and paid a special cash dividend in the second and fourth quarters of 2012, of $1.70 per share and $0.15 per share, respectively.  During each of the first, third and fourth quarters of 2012, we declared and paid a cash dividend of $0.05 per share.

We have operations in foreign countries where the local currency is used to prepare the financial statements which are translated into our reporting currency, U.S. Dollars. Changes in the exchange rates between these currencies and our reporting currency are partially responsible for some of the changes from period to period in our financial statement amounts. The majority of the changes in 2012 and 2011 are a result of the U.S. Dollar strengthening on average versus the British Pound Sterling. The chart below summarizes what the effects on our revenue and expenses would be on a constant currency basis. The constant currency basis assumes that the exchange rate was constant for the periods presented (in thousands).

The net effect of our foreign currency translations for the year ended December 31, 2012 was a $0.5 million decrease in revenue and a $0.5 million decrease in operating expenses versus the year ended December 31, 2011. The net effect of our foreign currency translations for the year ended December 31, 2011 was a $0.6 million increase in revenue and a $0.5 million increase in operating expenses versus the year ended December 31, 2010.

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RESULTS OF OPERATIONS

The following table presents our consolidated statements of operations in comparative format.

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The following table presents our consolidated statements of operations reflected as a percentage of total revenue.

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Revenue

Revenue is comprised of license fees and services and customer support.  License fees and services revenue represent the fees we receive from the licensing of our software products and those services directly related to the delivery of the licensed product as well as integration services and time and materials work.  Customer support revenue includes annual support fees, recurring maintenance fees, minor product upgrades and warranty fees.  Warranty fees are typically bundled with a license sale and the related revenue, based on Vendor Specific Objective Evidence (“VSOE”), is deferred and recognized ratably over the warranty period.

License Fees and Services

License fees and services revenue increased 80%, or $7.8 million to $17.6 million for the year ended December 31, 2012 compared to $9.8 million for the year ended December 31, 2011.  The increase in license fee and services revenue is due to growth in Dynamic SIM Allocation (“DSA”) and Tertio Service Activation (“TSA”) revenues of $5.3 million and $2.5 million, respectively.

License fees and services revenue decreased 33%, or $4.8 million to $9.8 million for the year ended December 31, 2011 compared to $14.6 million for the year ended December 31, 2010.  The decrease is due to declines in DSA and TSA revenues of $2.7 million and $2.1 million, respectively.

Customer Support

Customer support revenue decreased 7%, or $0.7 million, to $8.6 million for the year ended December 31, 2012 from $9.3 million for the year ended December 31, 2011.  The decrease in customer support revenue is primarily due to a decline in support requirements for a DSA installed customer and a decline in our installed customer base for TSA.

Customer support revenue increased 13%, or $1.1 million, to $9.3 million for the year ended December 31, 2011 from $8.2 million for the year ended December 31, 2010.  The increase in customer support revenue was primarily the result of the increase in our DSA installed customer base as well as increased revenue from TSA.

Costs of Revenue, excluding depreciation and amortization

Costs of revenue consist primarily of personnel costs, facilities costs, the costs of third-party software and all other direct costs associated with these personnel. Costs of revenue, excluding depreciation and amortization were $8.2 million, $7.4 million and $8.6 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Costs of License Fees and Services, excluding depreciation and amortization

Costs of revenue for license fees and services increased 30%, or $1.5 million, to $6.7 million for the year ended December 31, 2012 from $5.2 million for the year ended December 31, 2011.  The increase in costs was primarily the result of third party software expense, partner fees, increased hours spent on license fees and services projects and subcontractors all a result of higher revenue.  As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 38% for the year ended December 31, 2012 from 53% for the year ended December 31, 2011.  The decrease in costs as a percentage of licenses fees and services revenue is primarily related to increased revenue during the period.

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Costs of revenue for license fees and services decreased 14%, or $0.8 million, to $5.2 million for the year ended December 31, 2011 from $6.0 million for the year ended December 31, 2010.  The decrease in costs was primarily the result of reduced staff, subcontractors and third party software expense, all a result of lower revenue.  As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, increased to 53% for the year ended December 31, 2011 from 41% for the year ended December 31, 2010.  The increase in costs as a percentage of licenses fees and services revenue is primarily related to lower revenue during the period.

Costs of Customer Support, excluding depreciation and amortization

Costs of revenue for customer support decreased 33%, or $0.7 million, to $1.5 million for the year ended December 31, 2012 from $2.2 million for the year ended December 31, 2011.  The decrease in costs is related to fewer hours spent on support projects. As a percentage of customer support revenue, costs of customer support revenue, excluding depreciation and amortization, decreased to 17% for the year ended December 31, 2012 from 24% for the year ended December 31, 2011. The decrease in costs as a percentage of customer support revenue is due primarily to the aforementioned decrease in costs during the period.

Costs of revenue for customer support decreased 14%, or $0.4 million, to $2.2 million for the year ended December 31, 2011 from $2.6 million for the year ended December 31, 2010.  The decrease in costs is related to fewer hours spent on support projects. As a percentage of customer support revenue, costs of customer support, excluding depreciation and amortization, decreased to 24% for the year ended December 31, 2011 from 32% for the year ended December 31, 2010. The decrease in costs as a percentage of customer support revenue is due primarily to the aforementioned decrease in costs as well as increased revenue during the period.

Sales and Marketing

Sales and marketing expenses primarily consist of compensation costs, including incentive compensation and commissions, other employee related costs, travel expenses, advertising and occupancy expenses.  Sales and marketing expenses decreased 19%, or $1.1 million, to $5.1 million for the year ended December 31, 2012 from $6.2 million for the year ended December 31, 2011.  The decrease in costs is primarily related to reduced employee count, travel and marketing expenses.  As a percentage of total revenue, sales and marketing expenses for the year ended December 31, 2012 decreased to 19% from 33% for the year ended December 31, 2011.  The decrease as a percentage of revenue is due to increased revenue and the aforementioned decrease in costs during the period.

Sales and marketing expenses decreased 3%, or $0.2 million, to $6.2 million for the year ended December 31, 2011 from $6.4 million for the year ended December 31, 2010.  The decrease in costs is primarily related to lower marketing expenses related to cost control initiatives.  As a percentage of total revenue, sales and marketing expenses for the year ended December 31, 2011 increased to 33% from 28% for the year ended December 31, 2010.  This increase as a percentage of revenue is primarily due to lower revenue during the period.

General and Administrative

General and administrative expenses consist principally of employee related costs, professional fees and occupancy costs for the following departments: facilities, finance, legal, human resources and executive management.  General and administrative expenses for each of the years ended December 31, 2012 and 2011, was $3.6 million.  As a percentage of total revenue, general and administrative expenses decreased to 14% for the year ended December 31, 2012 from 19% for the year ended December 31, 2011.  The decrease in expenses as a percentage of revenue is primarily related to the increased revenue during the period.

General and administrative expenses decreased 18%, or $0.8 million, to $3.6 million for the year ended December 31, 2011 from $4.4 million for the year ended December 31, 2010.  The decrease in costs was primarily due to lower incentive compensation, equity compensation and professional fees. As a percentage of total revenue, general and administrative expenses decreased to 19% for the year ended December 31, 2011 from 20% for the year ended December 31, 2010.  The decrease in expenses as a percentage of revenue is primarily related to the aforementioned decreased expenses, partially offset by lower revenue during the period.

Product Development

Product development expenses consist primarily of employee-related costs for product development.  Product development expenses increased 24%, or $0.6 million, to $3.1 million for the year ended December 31, 2012 from $2.5 million for the year ended December 31, 2011.  The increase in costs was primarily the result of higher employee expenses, increased hours spent on research and development projects, subcontractors and patent fees.  As a percentage of total revenue, product development expenses decreased to 12% for the year 2012 from 13% for the year 2011.  The decrease as a percentage of total revenue is due to increased revenue during the period.

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Product development expenses remained at $2.5 million for the years ended December 31, 2011 and the year ended December 31, 2010.  As a percentage of total revenue, product development expenses increased to 13% in 2011 from 11% in 2010.  The increase as a percentage of total revenue is due to lower revenue during the period.

Depreciation

Depreciation expense consists of depreciation of long-lived property and equipment.  Depreciation expenses were approximately $0.3 million for the years ended December 31, 2012 and 2011.  As a percentage of revenue, depreciation expense decreased to 1% for the year ended December 31, 2012 from 2% for the year ended December 31, 2011.  The decrease as a percentage of total revenue is primarily due to increased revenue during the period.

Depreciation expenses were approximately $0.3 million for the years ended December 31, 2011 and 2010.  As a percentage of revenue, depreciation expense remained at 2% for the years ended December 31, 2011 and 2010.

Amortization

Amortization expense consists of amortization of identifiable intangibles related to our acquisition of Evolving Systems U.K.  Amortization expense decreased 29%, to $0.4 million for the year ended December 31, 2012 from $0.6 million for the year ended December 31, 2011.  The decrease in amortization expense was due to certain intangible assets becoming fully amortized during 2011.  As a percentage of revenue, amortization expense decreased to 2% for the year ended December 31, 2012 from 3% for the year ended December 31, 2011.   The decrease of amortization expense as a percentage of total revenue is due to increased revenues during the period and the aforementioned decrease of expense.

Amortization expenses decreased 19%, to $0.6 million for the year ended December 31, 2011 from $0.7 million for the year ended December 31, 2010.  The decrease in amortization expense was due to purchased software assets of Evolving Systems UK becoming fully amortized during 2011.  As a percentage of revenue, amortization expense remained at 3% for the years ended December 31, 2011 and 2010.

Interest Income

Interest income includes interest income earned on cash, cash equivalents and long-term investments.  Interest income decreased 27%, or $0.2 million, to $0.6 million for the year ended December 31, 2012 from $0.8 million for the year ended December 31, 2011. The decrease was due primarily to the sale of our long-term investments in the second quarter of 2012.

Interest income increased 6139%, or $0.8 million, to $0.8 million for the year ended December 31, 2011 from $13,000 for the year ended December 31, 2010. The increase was due to interest from our long-term investments.

Interest Expense

Interest expense includes interest expense on our long-term debt and capital lease obligations as well as amortization of debt issuance costs.  Interest expense for the year ended December 31, 2012 decreased 79% or $11,000 to $3,000 as compared to $14,000 for the year ended December 31, 2011.  This decrease was primarily due to interest expense from our capital lease.

Interest expense for the year ended December 31, 2011 decreased 86% or $88,000 to $14,000 as compared to $0.1 million for the year ended December 31, 2010.  This decrease was a result of the retirement of our senior term loan and revolving credit facility in the first quarter of 2010.  The 2011 expense was primarily the interest of a capital lease.

Gain on sale of investments

Gain on the sale of investments for the year ended December 31, 2012 of $0.9 million increased by 303% or $0.7 million as compared to the $0.2 million gain on the sale of investments for the year ended December 31, 2011.  The gain is a result of the sale of our remaining long-term investments in the second quarter of 2012.

Gain on the sale of investments for the year ended December 31, 2011 was $0.2 million.  The gain was a result of the sale of long-term investments.  There were no long-term investments for the year ended December 31, 2010.

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Gain (Loss) on Foreign Exchange Transactions

Gain (loss) on foreign exchange transactions consists of realized and unrealized foreign currency transaction gains and losses.  Foreign currency transaction gains and losses result from transactions denominated in a currency other than the functional currency of the respective subsidiary.  The foreign currency transaction loss of $0.1 million for the year ended December 31, 2012 compared to a $0.3 million gain for the year ended December 31, 2011 resulted in a year over year decline of 132% or $0.4 million.  The loss and gain were generated through the re-measurement of certain non-functional currency denominated financial assets and liabilities of our Evolving Systems U.K. and India subsidiaries.

Foreign currency transaction gain of $0.3 million for the year ended December 31, 2011 compared to a $0.1 million loss for the year ended December 31, 2010 for a year over year improvement of 373% or $0.4 million.  The gain and loss were generated through the re-measurement of certain non-functional currency denominated financial assets and liabilities of our Evolving Systems U.K. and India subsidiaries.

Income Tax Expense

We recorded income tax expense (benefit) of $1.4 million, ($0.4) million and  ($0.4) million for the years ended December 31, 2012, 2011 and 2010, respectively.  The net expense during year ended December 31, 2012 consisted of current income tax expense of $1.7 million and a net deferred tax benefit of ($0.3) million. The current tax expense consists primarily of income tax from our U.S., U.K. and India based operations, Alternative Minimum Tax (“AMT”) and unrecoverable foreign withholding tax in the U.S. and U.K.  U.S. income taxes payable of $1.0 million were offset due to realization of Net Operating Losses (“NOL”) comprised of windfall tax benefits related to stock-based compensation. Unused windfall tax benefits may not be recorded as an asset on our Consolidated Balance Sheets but are recorded as a reduction to our taxes payable when realized, with a corresponding credit to additional paid in capital.  The foreign withholding taxes are typically used to offset our income tax liability, but we did not have enough taxable income to utilize the foreign withholding taxes during the year. The deferred tax benefit was related primarily to a reduction to our foreign deferred tax liability on unremitted foreign earnings related to our Indian operations offset by the utilization of certain deferred tax assets in the U.S., the monetization of the U.K. NOL and the utilization of Minimum Alternative Tax (“MAT”) assets in India. The net benefit during year ended December 31, 2011 consisted of current income tax expense of $0.2 million offset by a net deferred tax benefit of $0.6 million. The current tax expense consists primarily of income tax from our U.K.-based operations and income tax related to our operations in India and AMT. The majority of the U.K. income tax expense is related to unrecoverable foreign withholding taxes. The foreign withholding taxes are typically used to offset our income tax liability, but we did not have enough taxable income to utilize the foreign withholding taxes during the year. The deferred tax benefit was related primarily to the partial release of our valuation allowance on our domestic deferred tax assets during the second quarter of 2011 as a result of the anticipated gain on Numbering Solutions Business which closed in the third quarter of 2011. We also had a deferred tax benefit related to the release of our valuation allowance on our tax asset from our Indian operations as we began to utilize MAT payments made during our tax holiday.  These MAT payments can be applied toward future taxes payable since the tax holiday expired on March 31, 2011.  In addition, we had a tax benefit related to intangible assets from our U.K.-based operations.

The income tax benefit of $0.4 during the year ended December 31, 2010 consisted of current tax expense of $0.3 million offset by a deferred tax benefit of $0.7 million. The current tax expense consists of income tax from our U.K.-based operations, unrecoverable foreign withholding tax in the U.S. and MAT from our Indian operations. The deferred tax benefit was related to intangible assets from our U.K.-based operations and losses from continuing operations in the U.S.

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 December 31, 2012 and 2011, this deferred tax liability was $39,000 and $0.1 million, respectively.  The deferred tax liability relates to Evolving Systems U.K. and has no impact on our ability to recover the U.S. based deferred tax assets.  This deferred tax liability will be recognized as the identifiable intangibles are amortized.

We use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.  As of December 31, 2012 and 2011, we had no liability for unrecognized tax benefits.  We do not believe there will be any material changes to our unrecognized tax positions over the next twelve months.

Discontinued Operations

On July 1, 2011, we completed the sale of our Numbering Solutions business for $39.4 million. During the third quarter of 2011, we recorded a $30.5 million gain on the asset disposition, net of taxes. The results of continuing operations were reduced by the revenue and costs associated with the business which are included in the Income from Discontinued Operations, net of tax, in our Consolidated Statements of Operations.

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FINANCIAL CONDITION

Our working capital position of $13.7 million at December 31, 2012 reflects an increase of $2.0 million from our working capital position of $11.7 million at December 31, 2011.  Our working capital position increased at December 31, 2012 despite $22.6 million of cash dividends partly paid from cash and partly from the proceeds from the sale of $16.5 million of long-term investments not accrued as of December 31, 2011.  The increase is primarily related to an increase in our contract receivables and unbilled work-in-progress balances and a reduction in our deferred revenue balance.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed operations through cash flows from operations as well as debt and equity transactions.  At December 31, 2012, our principal sources of liquidity were $8.8 million in cash and cash equivalents, $4.8 million in contract receivables, net of allowances and $5.0 million of unused availability under our revolving credit facility.

Net cash provided by (used in) operating activities for the year ended December 31, 2012, 2011 and 2010 was ($0.2) million, $4.9 million and $5.8 million, respectively.  The decrease in cash provided by operating activities for the year ended December 31, 2012 was due to an increase in unbilled work-in-progress, a decrease in unearned revenue partially offset by a decrease in prepaid and other assets. Net cash provided by (used in) continuing operating activities was ($0.2) million, ($1.4) million and $14,000 for the years ended December 31, 2012, 2011 and 2010, respectively.  The decrease in net cash used by continuing operating activities for the year ended December 31, 2012 was primarily due to an increase in net income coupled by a decrease in accounts payable, accrued liabilities and prepaid and other assets, partially offset by an increase in contract receivables, unbilled work-in-progress and a decrease in unearned revenue.

The decrease in cash provided by operating activities for the year ended December 31, 2011 compared to 2010 was due to a decrease in accounts payable and accrued liabilities and an increase in prepaid and other assets, partially offset by an increase in contract receivables.

Net cash provided by (used in) investing activities was $17.8 million, $20.1 million and ($0.4) million for the years ended December 31, 2012, 2011 and 2010, respectively.  The decrease in cash provided by investing activities for the year ended December 31, 2012 was related to the sale of long term marketable securities compared to the Asset Sale, partially offset by the purchase of investments in 2011.  During 2012, 2011 and 2010, we purchased $79,000, $90,000 and $0.3 million in property and equipment to support operations, respectively.  Historically, capital expenditures have been financed by cash from operating activities.

Net cash provided by (used in) financing activities was ($43.2) million, ($1.4) million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.  The net cash used in financing activities is primarily due to payments of $44.8 million for common stock dividends, partially offset by $1.0 million of windfall tax benefits related to stock-based compensation and $0.6 million of proceeds from the exercise of stock options.  The net cash used by financing activities during 2011 was primarily due to payments of $2.2 million for common stock dividends and $1.2 million for the purchase of treasury stock, partially offset by $2.0 million of proceeds from the exercise of stock options. The net cash provided by financing activities during 2010 was primarily the result of cash received from the exercise of stock options of $3.0 million, offset by net payments of $1.8 million to retire our senior term notes and pay off our U.K. revolving credit facility, and $1.0 million for common stock dividends.

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

·                  Our cash and cash equivalents balance at December 31, 2012 of $8.8 million;

·                  Our working capital balance of $13.9 million;

·                  Our ability to generate positive operating cash flows;

·                  The declaration of our quarterly cash dividends of $0.05 per share for the first, third and fourth quarters of 2012, the special cash dividends of $1.70 per share in the second quarter and $0.15 per share in the fourth quarter and the possibility of future dividends;

·                  Our backlog of approximately $11.1 million, including $6.7 million in license fees and services and $4.4 million in customer support at December 31, 2012; and

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·                  Our planned capital expenditures of less than $1.0 million during 2013.

We are exposed to foreign currency rate risks which impact the carrying amount of our foreign subsidiaries and our consolidated equity, as well as our consolidated cash position due to translation adjustments. For the years ended December 31, 2012, 2011 and 2010, the effect of exchange rate changes resulted in a $0.2 million, ($59,000) and ($43,000) increase (decrease) to consolidated cash, respectively.  We do not currently hedge our foreign currency exposure, but we closely monitor the rate changes and may hedge our exposures in the future.

Off-Balance Sheet Arrangements

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

Contractual Obligations and Commercial Commitments

The following summarizes our significant contractual obligations as of December 31, 2012, which are comprised of a capital lease and operating leases (in thousands).

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are disclosed in Note 1 of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.  The following discussion addresses our most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.

Revenue Recognition

We recognize revenue when an agreement is signed, the fee is fixed or determinable and collectability is reasonably assured. We recognize revenue from two primary sources: license fees and services, and customer support.  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.  When the customization 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 these types of arrangements, we do not typically have vendor specific objective evidence (“VSOE”) of fair value on the license fee/services portion (services are related to customizing the software) of the arrangement due to the large amount of customization required by our customers; however, we do have VSOE for the warranty/maintenance services based on the renewal rate of the first year of maintenance in the arrangement. The license/services portion is recognized using the percentage-of-completion method of accounting and the warranty/maintenance services are separated based on the renewal rate in the contract and recognized ratably over the warranty or maintenance period. We estimate the percentage-of-completion for each contract based on the ratio of direct labor hours incurred to total estimated direct labor hours and recognize revenue based on the percent complete multiplied by the contract amount allocated to the license fee/services.  Since estimated direct labor hours, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and we review them regularly. If the arrangement includes a customer acceptance provision, the hours to complete the acceptance testing are included in the total estimated direct labor hours; therefore, the related revenue is recognized as the acceptance testing is performed. Revenue is not recognized in full until the customer has provided proof of acceptance on the arrangement.  Generally, our contracts are accounted for individually. However, when certain criteria are met, it may be necessary to account for two or more contracts as one to reflect the substance of the group of contracts. We record amounts billed in advance of services being performed 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.

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We may encounter budget and schedule overruns on fixed-price contracts caused by increased labor or overhead costs. We make adjustments to cost estimates in the period in which the facts requiring such revisions become known. We record estimated losses, if any, in the period in which current estimates of total contract revenue and contract costs indicate a loss. If revisions to cost estimates are obtained after the balance sheet date but before the issuance of the interim or annual financial statements, we make adjustments to the interim or annual financial statements accordingly.

In arrangements where the services are not essential to the functionality of the delivered software, we recognize license revenue when a license agreement has been signed, delivery and acceptance have occurred, the fee is fixed or determinable and collectability is reasonably assured. Where applicable, we unbundle and record as revenue fees from multiple element arrangements as the elements are delivered to the extent that VSOE of fair value of the undelivered elements exist. If VSOE for the undelivered elements does not exist, we defer fees from such arrangements until the earlier of the date that VSOE does exist on the undelivered elements or all of the elements have been delivered.

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

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

Allowance for Doubtful Accounts

We make judgments related to our ability to collect outstanding accounts receivable. We provide allowances for receivables when their collection becomes doubtful by recording an expense. We determine the allowance based on our assessment of the realization of receivables using historical information and current economic trends, including assessing the probability of collection from customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments owed to us, an increase in the allowance for doubtful accounts would be required. We evaluate the adequacy of the allowance regularly and make adjustments accordingly. Adjustments to the allowance for doubtful accounts could materially affect our results of operations.

Income Taxes

Significant judgment is required in determining our provision for income taxes. We assess the likelihood that our deferred tax asset will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we establish a valuation allowance. We consider future taxable income projections, historical results and ongoing tax planning strategies in assessing the recoverability of deferred tax assets. However, adjustments could be required in the future if we determine that the amount to be realized is less or greater than the amount that we recorded. Such adjustments, if any, could have a material impact on our results of our operations.

We use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.  The Company uses the incremental approach to recognizing excess tax benefits associated with equity compensation.  As of December 31, 2012 and 2011, we had no liability for unrecognized tax benefits.  We do not believe there will be any material changes to our unrecognized tax positions over the next twelve months.

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. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit.

We performed our annual goodwill impairment test as of July 31, 2012, at which time we had $16.0 million of goodwill included in the following reporting units, License and Services (“L&S”) — UK of $7.2 million and Customer Support (“CS”) — UK of $8.8 million. The fair value of each reporting unit was estimated using both market and income based approaches. Specifically, we incorporated observed market multiple data from selected guideline public companies and values arrived at through the application of discounted cash flow analyses which in turn were based upon our financial projections as of the valuation date. We believe that a market participant would weigh both possibilities without a bias to one or the other. Consequently, we gave equal consideration to both. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. 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. If the projected future performance of either of our segments as estimated in the income valuation approach is adjusted downward or is lower than expected in the future, we could be required to record a goodwill impairment charge.  As a result of the first step of the 2012 goodwill impairment analysis, the fair value of each reporting unit exceeded its carrying value.  Therefore the second step was not necessary.

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Intangible Assets

Amortizable intangible assets consist primarily of purchased software and licenses, customer contracts and relationships, trademarks and tradenames, and business partnerships acquired in conjunction with our purchase of Tertio Telecoms Ltd. (“Evolving Systems U.K.”).  These definite 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.

If 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 recognize an impairment loss representing the excess of the asset’s carrying value over its estimated fair value.

Capitalization of Internal Software Development Costs

We expend amounts on product development, particularly for new products and/or for enhancements of existing products. For internal development of software products that are to be licensed by us, we expense the cost of developing software prior to establishing technological feasibility and those costs are capitalized once technological feasibility has been established. Capitalization ceases upon general release of the software. The determination of whether internal software development costs are subject to capitalization is, by its nature, highly subjective and involves significant judgments. This decision could significantly affect earnings during the development period.  Further, once capitalized, the software costs are generally amortized on a straight-line basis over the estimated economic life of the product. The determination of the expected useful life of a product is highly judgmental. Finally, capitalized software costs must be assessed for impairment if facts and circumstances warrant such a review.

We did not capitalize any internal software development costs during the years ended December 31, 2012, 2011, or 2010. In addition, we did not have any capitalized internal software development costs included in our December 31, 2012 and 2011 Consolidated Balance Sheets. We believe that during these periods no material internal software development costs were required to be capitalized. Our conclusion is primarily based on the fact that the feature-rich, pre-integrated, and highly-scalable nature of our products requires that our development efforts include complex design, coding and testing methodologies, which include next generation software languages and development tools. Development projects of this nature carry a high degree of development risk.

Substantially all of our internal software development efforts are of this nature, and therefore, we believe the period between achieving technological feasibility and the general release of the software to operations is so short that any costs incurred during this period are not material.

Stock-based Compensation

We account for stock-based compensation by applying a fair-value-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. We record compensation costs associated with the vesting of unvested options on a straight-line basis over the vesting period.  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.  We use 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.

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ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest Rate Risks

Our cash balances are subject to interest rate fluctuations and as a result, interest income amounts may fluctuate from current levels.

Market Risks

Our exposure to market risk related primarily to our investment portfolio. Any significant future declines in their market values could have a material adverse affect our financial condition and operating results. When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. Our investment policy requires investments to be rated B- or better. Marketable debt securities have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the available-for-sale designations as of each balance sheet date. We classify our marketable debt securities as either short-term or long-term based on each instrument’s underlying contractual maturity date. Marketable debt securities with maturities of 12 months or less are classified as short-term and marketable debt securities with maturities greater than 12 months are classified as long-term.

As of December 31, 2012, we had no long-term investments.

Foreign Currency Risk

We are exposed to fluctuations of the U.S. dollar (our functional currency) against the currencies of our operating subsidiaries. Any increase (decrease) in the value of the U.S. dollar against any foreign currency that is the functional currency of one of our operating subsidiaries will cause the parent company to experience unrealized foreign currency translation losses (gains) with respect to amounts already invested in such foreign currencies.  In addition, we and our operating subsidiaries are exposed to foreign currency risk to the extent that we enter into transactions denominated in currencies other than our respective functional currencies, such as revenue and related accounts receivable (including intercompany amounts) that are denominated in a currency other than their own functional currency. Changes in exchange rates with respect to these items will result in unrealized (based upon period-end exchange rates) or realized foreign currency transaction gains and losses upon settlement of the transactions. In addition, we are exposed to foreign exchange rate fluctuations related to our operating subsidiaries’ monetary assets and liabilities and the financial results of foreign subsidiaries and affiliates when their respective financial statements are translated into U.S. dollars for inclusion in our consolidated financial statements. We record cumulative translation adjustments in accumulated other comprehensive income (loss) as a separate component of equity. As a result of foreign currency risk, we may experience economic loss and a negative impact on earnings and equity with respect to our holdings solely as a result of foreign currency exchange rate fluctuations.

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

At the present time, we do not hedge our foreign currency exposure or use derivative financial instruments that are designed to reduce our long-term exposure to foreign currency exchange risk.  We continually monitor our foreign currency exchange risk and we may consider various options to reduce this risk in the future.

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ITEM 8.        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Evolving Systems, Inc.

We have audited the accompanying consolidated balance sheet of Evolving Systems, Inc. (a Delaware corporation, the “Company”) as of December 31, 2012, and the related consolidated statements of operations, comprehensive income,  changes in stockholders’ equity, and cash flows for the year ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Evolving Systems, Inc. as of December 31, 2012, and the results of their operations and their cash flows for the year ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.

/s/ FRIEDMAN LLP

East Hanover, New Jersey

March 12, 2013

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Evolving Systems, Inc.

We have audited the accompanying consolidated balance sheet of Evolving Systems, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2011, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Evolving Systems, Inc. and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

/s/ GRANT THORNTON LLP

Denver, Colorado

March 30, 2012

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