10-Q 1 a12-13856_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 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)

 

Delaware

 

84-1010843

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

9777 Pyramid Court, Suite 100 Englewood, Colorado

 

80112

(Address of principal executive offices)

 

(Zip Code)

 

(303) 802-1000

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant 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 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.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting companyx

(Do not check if a smaller reporting company)

 

 

 

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

 

As of August 1, 2012 there were 11,289,122 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

 

 

 



Table of Contents

 

EVOLVING SYSTEMS, INC.

Quarterly Report on Form 10-Q

June 30, 2012

Table of Contents

 

PART I — FINANCIAL INFORMATION

Item 1

Financial Statements

 

Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 (Unaudited)

 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

Condensed Consolidated Statements of Other Comprehensive income for the Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2012 (Unaudited)

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

Notes to Unaudited Condensed Consolidated Financial Statements

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3

Quantitative and Qualitative Disclosures About Market Risk

Item 4

Controls and Procedures

 

PART II — OTHER INFORMATION

Item 1

Legal Proceedings

Item 1A

Risk Factors

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3

Defaults upon Senior Securities

Item 4

Mine Safety Disclosures

Item 5

Other Information

Item 6

Exhibits

 

 

Signature

 

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

(unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

10,035

 

$

34,290

 

Short-term restricted cash

 

52

 

50

 

Contract receivables, net of allowance for doubtful accounts of $22 and $52 at June 30, 2012 and December 31, 2011, respectively

 

5,161

 

4,540

 

Unbilled work-in-progress

 

2,890

 

1,361

 

Prepaid and other current assets

 

1,114

 

1,259

 

Interest receivable, long-term investments, related parties

 

 

357

 

Total current assets

 

19,252

 

41,857

 

Long-term investments, related party

 

 

16,448

 

Property and equipment, net

 

280

 

369

 

Amortizable intangible assets, net

 

393

 

584

 

Goodwill

 

15,947

 

15,782

 

Long-term restricted cash

 

 

2

 

Total assets

 

$

35,872

 

$

75,042

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of capital lease obligations

 

$

4

 

$

8

 

Accounts payable and accrued liabilities

 

3,944

 

3,657

 

Income taxes payable

 

359

 

848

 

Dividends payable

 

 

22,271

 

Unearned revenue

 

2,411

 

3,401

 

Total current liabilities

 

6,718

 

30,185

 

Long-term liabilities:

 

 

 

 

 

Capital lease obligations, net of current portion

 

18

 

 

Deferred income taxes

 

387

 

145

 

Total liabilities

 

7,123

 

30,330

 

 

 

 

 

 

 

Commitments and contingencies (Note 10)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued and outstanding as of June 30, 2012 and December 31, 2011

 

 

 

Common stock, $0.001 par value; 40,000,000 shares authorized; 11,465,462 shares issued and 11,286,573 outstanding as of June 30, 2012 and 11,314,493 shares issued and 11,135,604 outstanding as of December 31, 2011

 

11

 

11

 

Additional paid-in capital

 

90,553

 

90,062

 

Treasury stock 178,889 shares as of June 30, 2012 and December 31, 2011, at cost

 

(1,253

)

(1,253

)

Accumulated other comprehensive loss

 

(4,148

)

(4,247

)

Unrealized losses on investments, related parties, net of tax

 

 

(284

)

Accumulated deficit

 

(56,414

)

(39,577

)

Total stockholders’ equity

 

28,749

 

44,712

 

Total liabilities and stockholders’ equity

 

$

35,872

 

$

75,042

 

 

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(unaudited)

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

REVENUE

 

 

 

 

 

 

 

 

 

License fees and services

 

$

4,507

 

$

2,053

 

$

8,291

 

$

5,195

 

Customer support

 

2,147

 

2,391

 

4,271

 

4,640

 

Total revenue

 

6,654

 

4,444

 

12,562

 

9,835

 

 

 

 

 

 

 

 

 

 

 

COSTS OF REVENUE AND OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Costs of license fees and services, excluding depreciation and amortization

 

1,524

 

1,193

 

3,342

 

2,427

 

Costs of customer support, excluding depreciation and amortization

 

387

 

733

 

747

 

1,419

 

Sales and marketing

 

1,223

 

1,458

 

2,564

 

3,309

 

General and administrative

 

994

 

858

 

1,907

 

1,960

 

Product development

 

778

 

555

 

1,507

 

1,234

 

Depreciation

 

79

 

87

 

152

 

175

 

Amortization

 

100

 

181

 

199

 

359

 

Restructuring and other recovery

 

 

569

 

 

569

 

Total costs of revenue and operating expenses

 

5,085

 

5,634

 

10,418

 

11,452

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

1,569

 

(1,190

)

2,144

 

(1,617

)

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

29

 

6

 

50

 

14

 

Interest income, related party

 

100

 

 

532

 

 

Interest expense

 

 

(1

)

(1

)

(13

)

Gain on sale of investments

 

891

 

 

891

 

 

Foreign currency exchange gain (loss)

 

46

 

7

 

(50

)

117

 

Other income (expense), net

 

1,066

 

12

 

1,422

 

118

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

2,635

 

(1,178

)

3,566

 

(1,499

)

Income tax expense (benefit)

 

504

 

(125

)

678

 

(217

)

Income (loss) from continuing operations

 

$

2,131

 

$

(1,053

)

$

2,888

 

$

(1,282

)

Income from discontinued operations, net of tax

 

 

12,470

 

 

13,632

 

Net income

 

$

2,131

 

$

11,417

 

$

2,888

 

$

12,350

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per common share - continuing operations

 

$

0.19

 

$

(0.10

)

$

0.26

 

$

(0.12

)

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per common share - continuing operations

 

$

0.19

 

$

(0.10

)

$

0.25

 

$

(0.12

)

 

 

 

 

 

 

 

 

 

 

Basic income per common share - discontinued operations

 

$

 

$

1.15

 

$

 

$

1.26

 

 

 

 

 

 

 

 

 

 

 

Diluted income per common share - discontinued operations

 

$

 

$

1.11

 

$

 

$

1.22

 

 

 

 

 

 

 

 

 

 

 

Basic income per common share - net income

 

$

0.19

 

$

1.05

 

$

0.26

 

$

1.14

 

 

 

 

 

 

 

 

 

 

 

Diluted income per common share - net income

 

$

0.19

 

$

1.02

 

$

0.25

 

$

1.10

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared per common share

 

$

1.70

 

$

0.05

 

$

1.75

 

$

0.10

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic shares outstanding

 

11,261

 

10,833

 

11,213

 

10,793

 

Weighted average diluted shares outstanding

 

11,511

 

11,201

 

11,440

 

11,212

 

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME

(in thousands except per share data)

(unaudited)

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

2,131

 

$

11,417

 

$

2,888

 

$

12,350

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss)

 

(683

)

746

 

99

 

736

 

Unrealized gains on available-for-sale securities

 

 

 

 

 

 

 

 

 

Unrealized holding gain (loss) arising during period

 

(319

)

 

453

 

 

Other comprehensive income, before tax

 

(1,002

)

746

 

552

 

736

 

Income tax benefit (expense) related to components of other comprehensive income

 

120

 

 

 

(169

)

 

 

Other comprehensive income, net of tax

 

(882

)

746

 

383

 

736

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

1,249

 

$

12,163

 

$

3,271

 

$

13,086

 

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands, except share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Total

 

 

 

Common Stock

 

Paid-in

 

Treasury

 

Comprehensive

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Stock

 

Income (Loss)

 

(Deficit)

 

Equity

 

Balance at December 31, 2011

 

11,135,604

 

$

11

 

$

90,062

 

$

(1,253

)

$

(4,531

)

$

(39,577

)

$

44,712

 

Stock option exercises

 

152,206

 

 

349

 

 

 

 

349

 

Common Stock issued pursuant to the Employee Stock Purchase Plan

 

637

 

 

3

 

 

 

 

3

 

Stock-based compensation expense

 

 

 

139

 

 

 

 

139

 

Restricted stock issuance, net of cancellations

 

(1,874

)

 

 

 

 

 

 

Common stock cash dividends

 

 

 

 

 

 

(19,725

)

(19,725

)

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

2,888

 

 

 

Net unrealized losses on investments, related party, net of tax

 

 

 

 

 

 

 

 

 

284

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

99

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

3,271

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2012

 

11,286,573

 

$

11

 

$

90,553

 

$

(1,253

)

$

(4,148

)

$

(56,414

)

$

28,749

 

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

2,888

 

$

12,350

 

Income from discontinued operations

 

 

13,632

 

Income (loss) from continuing operations

 

2,888

 

(1,282

)

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation

 

152

 

175

 

Amortization of intangible assets

 

199

 

359

 

Amortization of debt issuance costs

 

 

 

11

 

Stock based compensation

 

139

 

322

 

Accretion of discount on marketable securities

 

(6

)

 

Gain on sale of marketable securities

 

(891

)

 

Unrealized foreign currency transaction (gains) and losses, net

 

50

 

(117

)

Provision for (recovery of) bad debt

 

187

 

 

(Benefit) expense from deferred income taxes

 

71

 

(821

)

Change in operating assets and liabilities:

 

 

 

 

 

Contract receivables

 

(585

)

2,787

 

Unbilled work-in-progress

 

(1,711

)

131

 

Prepaid and other assets

 

466

 

160

 

Accounts payable and accrued liabilities

 

(190

)

643

 

Unearned revenue

 

(1,009

)

(1,454

)

Net cash (used in) provided by operating activities of continuing operations

 

(240

)

914

 

Net cash provided by operating activities of discontinued operations

 

 

6,051

 

Net cash (used in) provided by operating activities

 

(240

)

6,965

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of property and equipment

 

(57

)

(58

)

Proceeds from sale of marketable securities, related party

 

17,831

 

 

Restricted cash

 

 

(3

)

Net cash provided by (used in) investing activities of continuing operations

 

17,774

 

(61

)

Net cash used in investing activities of discontinued operations

 

 

(345

)

Net cash provided by (used in) investing activities

 

17,774

 

(406

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Capital lease payments

 

(12

)

(6

)

Common stock cash dividends

 

(41,997

)

(1,070

)

Purchase of treasury stock

 

 

(849

)

Proceeds from the issuance of stock

 

353

 

784

 

Net cash used in financing activities of continuing operations

 

(41,656

)

(1,141

)

Net cash used in financing activities of discontinued operations

 

 

(4

)

Net cash used in financing activities

 

(41,656

)

(1,145

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(133

)

54

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(24,255

)

5,468

 

Cash and cash equivalents at beginning of period

 

34,290

 

10,801

 

Cash and cash equivalents at end of period

 

$

10,035

 

$

16,269

 

 

 

 

 

 

 

Supplemental disclosure of other cash and non-cash financing transactions:

 

 

 

 

 

Interest paid

 

$

 

$

2

 

Income taxes paid

 

693

 

89

 

Common stock dividend declared

 

19,725

 

548

 

Property and equipment purchased and included in accounts payable

 

5

 

11

 

 

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

 

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EVOLVING SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — BASIS OF PRESENTATION

 

Organization We are a provider of software solutions and services to the wireless, wireline and cable markets. We maintain long-standing relationships with many of the largest network operators worldwide. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (“OSS”).  We offer software products and solutions focused on activation and provisioning: our service activation solution, TertioTM (“TSA”) used to activate complex bundles of voice, video and data services for traditional and next generation wireless and wireline networks;  our SIM card activation solution, Dynamic SIM Allocation TM (“DSA”) used to dynamically allocate and assign resources to wireless devices that rely on SIM cards, and our connected devices activation solution, Intelligent M2M Controller that support the activation of M2M devices with intermittent or infrequent usage patterns.

 

Interim Consolidated Financial Statements — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in our opinion reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance with GAAP and SEC regulations for interim financial statements. The results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that we will have for any subsequent period.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2011 included in our Annual Report on Form 10-K.

 

Discontinued Operations - On April 21, 2011, we announced the execution of an Asset Purchase Agreement, dated as of April 21, 2011 (the “Purchase Agreement”), with NeuStar, Inc., a Delaware corporation (the “Buyer”).  Under the terms of the Purchase Agreement, we agreed to sell our Numbering Solutions Business (the “Numbering Business”) to the Buyer for $39.4 million in cash, subject to increase or decrease in accordance with a post-closing working capital adjustment and the assumption of certain liabilities related to the Numbering Business (the “Asset Sale”). 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. On July 1, 2011, we completed the Asset Sale of the Numbering Business. There was no post-closing working capital adjustment. 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. Refer to Note 9, Discontinued Operations, for more information regarding the Asset Sale.

 

Revisions and Reclassifications We have changed the classification of revenue totaling approximately $1,000 from continuing operations to discontinued operations and depreciation expense of approximately $20,000 from discontinued operations to continuing operations for the three months ended June 30, 2011.  Net income for the period remained at $11.4 million.  There was no effect on earnings per share of continuing or discontinued operations for the three months ended June 30, 2011 as a result of the reclassifications.  We have changed the classification of revenue totaling approximately $64,000 from continuing operations to discontinued operations and depreciation expense of approximately $42,000 from discontinued operations to continuing operations for the six months ended June 30, 2011.  Net income for the period remained at $12.4 million.  Basic and diluted loss per common share - continuing operations declined from ($0.11) to ($0.12) as a result of the aforementioned reclassification for the six months ended June 30, 2011.  Discontinued operations basic income per common share and diluted income per common share increased from $1.25 to $1.26 and $1.21 to $1.22, respectively, as a result of the aforementioned reclassification for the six months ended June 30, 2011.

 

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

 

Foreign Currency Our functional currency is the U.S. dollar.  The functional currency of our foreign operations is the respective local currency for each foreign subsidiary.  Assets and liabilities of foreign operations denominated in local currencies are

 

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translated at the spot rate in effect at the applicable reporting date.  Our consolidated statements of operations are translated at the weighted average rate of exchange during the applicable period.  The resulting unrealized cumulative translation adjustment, net of applicable income taxes, is recorded as a component of accumulated other comprehensive income (loss) in stockholders’ equity.  Realized and unrealized transaction gains and losses generated by transactions denominated in a currency different from the functional currency of the applicable entity are recorded in other income (loss) in the consolidated statements of operations in the period in which they occur.

 

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

 

Goodwill Goodwill is the excess of acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested for impairment annually or whenever indicators of impairment exist. These indicators may include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. 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, 2011, when we had $16.9 million of goodwill which included the following reporting units, License and Services (“L&S”) — UK of $7.6 million and Customer Support (“CS”) — UK of $9.3 million. The fair value of each reporting unit was estimated using both market and income based approaches. Specifically, we incorporated observed market valuation multiples 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 2011 goodwill impairment analysis, the fair value of each reporting unit exceeded its carrying value.  Therefore the second step was not necessary.  A hypothetical 5% decrease in the estimated fair value of our CS-UK reporting unit still result in the estimated fair value exceeding its carrying value.  However, a hypothetical 5% decrease in the estimated fair value of our L&S-UK reporting unit would result in its carrying value exceeding its estimated fair value and therefore require the second step, which could result in impairment for that reporting unit.

 

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 assets are amortized using the straight-line method over their estimated lives.

 

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

 

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

 

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

 

·                  Significant negative industry or economic trends; and/or

 

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

 

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

 

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Intangible assets acquired in conjunction with our purchases of TSE and CMS were fully amortized as of December 31, 2009 and were part of the Asset Sale of our Numbering Business.

 

Fair Value Measurements Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

 

Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

Level 2 — Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 — Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

 

The valuation techniques used to measure our marketable debt securities were derived from quoted prices in active markets for identical assets or liabilities.

 

Cash, Cash Equivalents and Marketable Securities - All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. Our marketable debt securities have been classified and accounted for as available-for-sale and are reported at fair value.  Unrealized gains and losses related to changes in the fair value of securities are recognized in the accumulated other comprehensive income, net of tax in our consolidated balance sheets.  Changes in the fair value of available-for-sale securities impact our net income only when such securities are sold or an other-than-temporary impairment is recognized.  Realized gains and losses on the sale of securities are determined by specific identification of each security’s cost basis.  We review our marketable debt securities to determine if the securities are other-than-temporarily impaired, which would require us to record an impairment charge in the period any such determination is made.  In making the judgment, we evaluate, among other things, the duration and extent to which the fair value of the securities are less than its cost, the financial condition of the issuer and any changes thereto, our intent to sell, or whether it is more likely than not we will be required to sell, the securities before recovery of the investment’s amortized cost basis.  Management’s assessment on whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to our security.  Management determines the appropriate classification of its investments at the time of purchase and re-evaluates 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.

 

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.

 

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. 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.

 

Comprehensive Income - Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains, and losses that under GAAP are recorded as an element of shareholders’ equity but are excluded from net income. Other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency and unrealized gains and losses on marketable securities categorized as available-for-sale.

 

Income Taxes — We record deferred tax assets and liabilities for the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying condensed consolidated balance sheets, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled.  We reduce deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that these benefits will not be realized.

 

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.

 

Recent Accounting Pronouncements - In June 2011, the Financial Accounting Standards Board issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance was effective for us beginning March 31, 2012 and resulted in presentation changes only.

 

In September 2011, the Financial Accounting Standards Board issued guidance on testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). If an entity determines that the fair value of a reporting unit is greater than its carrying amount, the two-step goodwill impairment test is not required. The new guidance will be effective for us beginning July 1, 2012.

 

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NOTE 2 — FINANCIAL INSTRUMENTS

 

All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. 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 April 23, 2012 the investments were sold for approximately $17.8 million and we realized a gain on sale of approximately $891,000.

 

NOTE 3 — GOODWILL AND INTANGIBLE ASSETS

 

We recorded goodwill as a result of the acquisition of Evolving Systems U.K. in November 2004.

 

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

 

 

 

License and
Services

 

Customer
Support

 

Total

 

 

 

UK

 

UK

 

Goodwill

 

Balance as of December 31, 2011

 

$

7,059

 

$

8,723

 

$

15,782

 

Effects of changes in foreign currency exchange rates

 

74

 

91

 

165

 

Balance as of June 30, 2012

 

$

7,133

 

$

8,814

 

$

15,947

 

 

We conducted our annual goodwill impairment test as of July 31, 2011, and we determined that goodwill was not impaired as of the test date. From July 31, 2011 through the date of this report, no events have occurred that we believe may have impaired goodwill.

 

We amortized identifiable intangible assets on a straight-line basis over estimated lives ranging from one to seven years and include the cumulative effects of foreign currency exchange rates.  As of June 30, 2012 and December 31, 2011, identifiable intangibles were as follows (in thousands):

 

 

 

June 30, 2012

 

December 31, 2011

 

Weighted-

 

 

 

(1)
Gross
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

(1)
Gross
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Average
Amortization
Period

 

Purchased software

 

$

1,391

 

$

1,391

 

$

 

$

1,376

 

$

1,376

 

$

 

4.6 yrs

 

Trademarks and tradenames

 

701

 

601

 

100

 

694

 

545

 

149

 

7.0 yrs

 

Business partnerships

 

114

 

114

 

 

113

 

113

 

 

5.0 yrs

 

Customer relationships

 

2,053

 

1,760

 

293

 

2,031

 

1,596

 

435

 

5.3 yrs

 

 

 

$

4,259

 

$

3,866

 

$

393

 

$

4,214

 

$

3,630

 

$

584

 

5.2 yrs

 

 


(1)  Changes in intangible gross values as of June 30, 2012 compared to December 31, 2011 are the direct result of the changes in foreign currency exchange rates for the periods then ended.

 

All U.S. intangible assets were sold as part of the Asset Sale. Amortization expense of identifiable intangible assets was $0.1 million and $0.2 million for the three months ended June 30, 2012 and 2011, and $0.2 million and $0.4 million for the six months ended June 30, 2012 and 2011, respectively.  As Evolving Systems U.K. uses the British Pound Sterling as its functional currency, the amount of future amortization actually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related to identifiable intangibles based on our carrying amount as of June 30, 2012 was as follows (in thousands):

 

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For the Six Months Ended June 30,

 

 

 

2012

 

$

236

 

2013

 

157

 

 

 

$

393

 

 

NOTE 4 — EARNINGS PER COMMON SHARE

 

We compute basic earnings per share (“EPS”) by dividing net income or loss available to common stockholders by the weighted average number of shares outstanding during the period, including common stock issuable under participating securities. We compute diluted EPS using the weighted average number of shares outstanding, including participating securities, plus all potentially dilutive common stock equivalents. Common stock equivalents consist of stock options.

 

Our policy is to treat unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, as participating securities, included in the computation of both basic and diluted earnings per share.

 

The following is the reconciliation of the denominator of the basic and diluted EPS computations (in thousands, except per share data):

 

 

 

For the Three Months Ended June
30,

 

For the Six Months Ended June
30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

2,131

 

$

(1,053

)

$

2,888

 

$

(1,282

)

Income from discontinued operations, net of tax

 

$

 

$

12,470

 

$

 

$

13,632

 

Net income

 

$

2,131

 

$

11,417

 

$

2,888

 

$

12,350

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

11,261

 

10,833

 

11,213

 

10,793

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.19

 

$

(0.10

)

$

0.26

 

$

(0.12

)

Discontinued operations

 

$

 

$

1.15

 

$

 

$

1.26

 

Net Income

 

$

0.19

 

$

1.05

 

$

0.26

 

$

1.14

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

2,131

 

$

(1,053

)

$

2,888

 

$

(1,282

)

Income from discontinued operations, net of tax

 

$

 

$

12,470

 

$

 

$

13,632

 

Net income

 

$

2,131

 

$

11,417

 

$

2,888

 

$

12,350

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

11,261

 

10,833

 

11,213

 

10,793

 

Effect of dilutive securities - options

 

250

 

368

 

227

 

419

 

Diluted weighted average shares outstanding

 

11,511

 

11,201

 

11,440

 

11,212

 

 

 

 

 

 

 

 

 

 

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.19

 

$

(0.10

)

$

0.25

 

$

(0.12

)

Discontinued operations

 

$

 

$

1.11

 

$

 

$

1.22

 

Net Income

 

$

0.19

 

$

1.02

 

$

0.25

 

$

1.10

 

 

For the three months ended June 30, 2012 and 2011, 0.2 million and 0.4 million shares, respectively, of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

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For the six months ended June 30, 2012 and 2011, 0.2 million and 0.3 million shares, respectively of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

NOTE 5 — SHARE-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, using the modified prospective method. We record compensation costs associated with the vesting of unvested options on a straight-line basis over the vesting period. We recognized $0.1 million and $0.2 million of compensation expense in the consolidated statements of operations, with respect to our stock-based compensation plans for the three months ended June 30, 2012 and 2011 and $0.1 million and $0.3 million for the six months ended June 30, 2012 and 2011, respectively.  The following table summarizes stock-based compensation expenses recorded in the consolidated statement of operations (in thousands):

 

 

 

For the Three Months Ended June
30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Cost of license fees and services, excluding depreciation and amortization

 

$

5

 

$

11

 

$

10

 

$

22

 

Cost of customer support, excluding depreciation and amortization

 

1

 

1

 

2

 

3

 

Sales and marketing

 

6

 

16

 

12

 

39

 

General and administrative

 

52

 

108

 

105

 

224

 

Product development

 

5

 

10

 

10

 

34

 

Share based compensation - continuing operations

 

69

 

146

 

139

 

322

 

Discontinued operations

 

 

7

 

 

 

19

 

Total share based compensation

 

$

69

 

$

153

 

$

139

 

$

341

 

 

Stock Incentive Plans

 

In January 1996, our stockholders approved an Amended and Restated Stock Option Plan (the “Option Plan”).  Under the Option Plan, as amended, 4,175,000 shares were reserved for issuance.  Options issued under the Option Plan were at the discretion of the Board of Directors, including the vesting provisions of each stock option granted. Options were granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant. The Option Plan terminated on January 18, 2006; options granted before that date were not affected by the plan termination.  At June 30, 2012 and December 31, 2011, 0.4 million options remained outstanding under the Option Plan, respectively.

 

In June 2007, our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”) with a maximum of 1,000,000 shares reserved for issuance. In June 2010, our stockholders approved an amendment to the 2007 Stock Plan which increased the maximum shares that may be awarded under the plan to 1,250,000. Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years for employees and one year for directors and expire no more than ten years from the date of grant.  At June 30, 2012, there were approximately 0.1 million shares available for grant under the 2007 Stock Plan, as amended, as well as an increase of 64,069 authorized shares as a result of the antidilution modification in connection with the special dividend (see details below).  At June 30, 2012 and December 31, 2011, 0.5 million and 0.4 million options were issued and outstanding under the 2007 Stock Plan as amended, respectively.

 

During the three months ended June 30, 2012 and 2011, there were no grants of restricted stock to members of our Board of Directors and senior management.  During the three and six months ended June 30, 2012 and 2011, 2,000 and 9,000 shares of restricted stock vested, respectively.  Approximately 0 and 2,000 shares of restricted stock were forfeited during the three and six months ended June 30, 2012, respectively and approximately 6,000 and 7,000 during the three and six months ended June 30, 2011, respectively. The fair market value of restricted shares for share-based compensation expensing is equal to the closing price of our common stock on the date of grant. Stock-based compensation expense includes $9,000 and $18,000 for the three and six months ended June 30, 2012 and $47,000 and $92,000 for the three and six months ended June 30, 2011, respectively, of expense related to

 

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restricted stock grants. The restrictions on the stock awards are released quarterly, generally over four years for senior management and over one year for board members.As described above, on May 8, 2012, we declared a special cash dividend of $1.70 per share on all of the issued and outstanding common stock, or an aggregate of approximately $19.5 million, which was paid on May 29, 2012. In connection with the special dividend, the Compensation Committee of the Board of Directors of the Company approved anti-dilution adjustments to outstanding stock option awards pursuant to the Company’s equity-based compensation plans to take into account the payment of the special cash dividend. Outstanding stock option awards were adjusted on May 18, 2012 (the ex-dividend date), by reducing the exercise price and increasing the number of shares issuable upon the exercise of each option, in accordance with safe harbor provisions of Section 409A of the Internal Revenue Code, such that the aggregate difference between the market price and exercise price times the number of shares issuable upon exercise was substantially the same immediately before and after the payment of the special dividend. The antidilution modification made with respect to such options resulted in a decrease in the weighted average exercise price from $5.80 to $4.53 and an increase in the aggregate number of shares issuable upon exercise of such options by 64,069.  Since our Stock Plan permits, but does not require, antidilution modifications, (ASC) 718, Compensation — Stock Compensation requires a comparison of the fair value of each award immediately prior to and after the date of modification, assuming the value immediately prior to modification contains no antidilution protection, and the value immediately after modification contains full antidilution protection. This comparison resulted in no aggregate difference or additional compensation expense in the three months ended June 30, 2012.The fair value of each option grant is estimated on the date of grant using the Black-Scholes model.  The Black-Scholes model uses four assumptions to calculate the fair value of each option grant.  The expected term of share options granted is derived using the simplified method, which we adopted in January 2008. The risk-free interest rate is based upon the rate currently available on zero-coupon U.S. Treasury instruments with a remaining term equal to the expected term of the stock options.  The expected volatility is based upon historical volatility of our common stock over a period equal to the expected term of the stock options.  The expected dividend yield is based upon historical and anticipated payment of dividends.  The weighted-average assumptions used in the fair value calculations are as follows:

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Expected term (years)

 

5.4

 

5.3

 

5.7

 

5.3

 

Risk-free interest rate

 

0.76

%

1.53

%

0.83

%

1.53

%

Expected volatility

 

64.59

%

66.35

%

65.24

%

66.35

%

Expected dividend yield

 

3.65

%

3.00

%

3.53

%

3.00

%

 

The following is a summary of stock option activity under the plans for the six months ended June 30, 2012:

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

(1)

 

Weighted-

 

Remaining

 

Aggregate

 

 

 

Number of

 

Average

 

Contractual

 

Intrinsic

 

 

 

Shares

 

Exercise

 

Term

 

Value

 

 

 

(in thousands)

 

Price

 

(Years)

 

(in thousands)

 

Options outstanding at December 31, 2011

 

924

 

$

4.53

 

5.06

 

$

1,635

 

Options granted

 

69

 

$

4.52

 

 

 

 

 

Less options forfeited

 

(15

)

$

6.70

 

 

 

 

 

Less options exercised

 

(153

)

$

2.29

 

 

 

 

 

Options outstanding at June 30, 2012

 

825

 

$

4.91

 

5.02

 

$

1,763

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2012

 

688

 

$

5.21

 

4.36

 

$

1,475

 

 


(1)      Beginning balance of options outstanding as of December 31, 2011, was adjusted by 64,069 options due to the aforementioned anti-dilution adjustments to outstanding stock option awards.

 

There were 16,041 stock options granted during the three months ended June 30, 2012.  No stock options were granted during the three months ended June 30, 2011. The weighted-average grant-date fair value of stock options granted during the three months ended June 30, 2012 was $2.34.As of June 30, 2012, there was approximately $0.3 million of total unrecognized compensation costs related to unvested stock options.  These costs are expected to be recognized over a weighted average period of 1.7 years.  The total fair value of stock options vested during the three months ended June 30, 2012 and 2011 was $0.1 million, respectively. The total fair value of stock options vested during the six months ended June 30, 2012 and 2011 was $0.1 million and $0.3 million, respectively.

 

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The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $3,000 and $8,000 for the three months ended June 30, 2012 and 2011, respectively.  The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $7,000 and $22,000 for the six months ended June 30, 2012 and 2011, respectively.  Cash received from stock option exercises for the three months ended June 30, 2012 and 2011 was $0.2 million and $0.7 million, respectively.  Cash received from stock option exercises for the six months ended June 30, 2012 and 2011 was $0.4 million and $0.8 million, respectively.  During the three months ended March 31, 2011, we had net settlement exercises of stock options, whereby the optionee did not pay cash for the options but instead received the number of shares equal to the difference between the exercise price and the market price on the date of exercise. Net settlement exercises during the three months ended March 31, 2011, resulted in approximately 91,000 shares issued and 120,000 options cancelled in settlement of shares issued.  There were no net settlement exercises during the three or six months ended June 30, 2012.

 

Employee Stock Purchase Plan

 

Under the Employee Stock Purchase Plan (“ESPP”), we are authorized to issue up to 550,000 shares under the ESPP.  Under the terms of the ESPP, employees may elect to have up to 15% of their gross compensation withheld through payroll deduction to purchase our common stock, capped at $25,000 annually and no more than 10,000 shares per offering period. The purchase price of the stock is 85% of the lower of the market price at the beginning or end of each three-month participation period. As of June 30, 2012, there were approximately 73,000 shares available for purchase.  For the three months ended June 30, 2012 and 2011, we recorded compensation expense of $400 and $3,000, respectively, and $700 and $7,000 for the six month periods ended June 30, 2012 and 2011, respectively associated with grants under the ESPP which includes the fair value of the look-back feature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period primarily based on the level of employee participation.

 

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

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Expected term (years)

 

0.25

 

0.25

 

0.25

 

0.25

 

Risk-free interest rate

 

0.09

%

0.03

%

0.08

%

0.05

%

Expected volatility

 

42.7

%

33.7

%

39.0

%

37.8

%

Expected dividend yield

 

3.6

%

2.8

%

3.6

%

2.8

%

 

Cash received from employee stock plan purchases for the three months ended June 30, 2012 and 2011 was $2,000 and $10,000, respectively.  Cash received from employee stock plan purchases for the six months ended June 30, 2012 and 2011 was $3,000 and $17,000, respectively.

 

We issued shares related to the ESPP of approximately 300 and 2,000 for the three months ended June 30, 2012 and 2011.  We issued shares related to the ESPP of approximately 600 and 3,000 for the six months ended June 30, 2012 and 2011.

 

NOTE 6 — CONCENTRATION OF CREDIT RISK

 

For the three months ended June 30, 2012 and 2011, two significant customers (defined as contributing at least 10%) accounted for 34% (18% and 16%) and 23% (12% and 11%), respectively, of revenue from continuing operations.  The significant customers for the three months ended June 30, 2012 are large telecommunications operators in Europe and the Russian Federation.  The significant customers for the three months ended June 30, 2011 are large telecommunications operators in Europe and Africa.  For the six months ended June 30, 2012, two significant customers accounted for 33% (20% and 13%) of revenue from continuing operations. These customers are large telecommunications operators in the Russian Federation and Europe. For the six months ended June 30, 2011, one significant customer accounted for 12% of revenue from continuing operations.  This customer is large telecommunications operator located in Africa.

 

As of June 30, 2012, three significant customers accounted for approximately 39% (17%, 12% and 10%) of contract receivables and unbilled work-in-progress.  These customers are large telecommunications operators in Europe, the Russian Federation and Central America.  At December 31, 2011, three significant customers accounted for approximately 32% (12%, 10% and 10%) of contract receivables and unbilled work-in-progress.  These customers are two large telecommunications operators in Europe and one in Africa.

 

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NOTE 7 — INCOME TAXES

 

We recorded net income tax expense (benefit) of $0.5 million and ($0.1) million for the three months ended June 30, 2012 and 2011, respectively.  The net expense during the three months ended June 30, 2012 consisted of current income tax expense of $0.4 million and a deferred tax expense of $0.1 million. The current tax expense consists primarily of Alternative Minimum Tax (“AMT”), state tax and unrecoverable foreign withholding tax in the U.S., income tax from our U.K.-based operations and income taxes related to our operations in India. The deferred tax expense was net of a tax benefit primarily related to intangible assets from our U.K.-based operations. The net benefit during the three months ended June 30, 2011 consisted of current income tax expense of $0.4 million and a deferred tax benefit of $0.5 million. The current tax expense consists of income tax from our U.K.-based operations consisting primarily of unrecoverable foreign withholding tax, income taxes related to our operations in India and unrecoverable foreign withholding tax in the U.S. The deferred tax benefit was primarily related to the loss from continuing operations during the period and a tax benefit related to intangible assets from our U.K.-based operations.

 

We recorded net income tax expense (benefit) of $0.7 million and ($0.2) million for the six months ended June 30, 2012 and 2011, respectively.  The net expense during the six months ended June 30, 2012 consisted of current income tax expense of $0.6 and a deferred tax expense of $43,000.  The current tax expense consists primarily of income tax from our U.K.-based operations, income taxes related to our operations in India and AMT, unrecoverable foreign withholding taxes and state income taxes in the U.S.  The deferred tax expense was primarily related to the decrease in deferred tax assets related to stock compensation and accrued liabilities in the period and a tax benefit related to intangible assets from our U.K.-based operations.  The net benefit during the six months ended June 30, 2011 consisted of current income tax expense of $0.5 million and a deferred tax benefit of $0.7 million. The current tax expense consists primarily of income tax from our U.K.-based operations, income taxes related to our operations in India and AMT and state income taxes in the U.S. The majority of the U.K. income tax expense was related unrecoverable foreign withholding taxes. The deferred tax benefit was primarily related to the loss from continuing operations during the period, a tax benefit related to intangible assets from our U.K.-based operations and a benefit related to the release of our valuation allowance on our tax asset from our Indian operations as we will begin to utilize Minimum Alternative Tax (“MAT”) payments made during our tax holiday, which can be applied toward future taxes payable since the tax holiday expired on March 31, 2011.

 

Our effective tax rate of 19% for the three months ended June 30, 2012 was increased from our effective tax rate of 11% for the three months ended June 30, 2011.  This increase in our effective tax rate relates principally to the decrease in deferred tax assets related to stock compensation and accrued liabilities.

 

Our effective tax rate of 19% for the six months ended June 30, 2012 was increased from an effective tax rate of 14% for the six months ended June 30, 2011.  This increase in our effective tax rate relates principally to the decrease in deferred tax assets related to stock compensation and accrued liabilities and the release of our valuation allowance on our MAT tax asset from our Indian operations in 2011.

 

In conjunction with the acquisition of Evolving Systems U.K., we recorded certain identifiable intangible assets.  Since the amortization of these identifiable intangibles is not deductible for income tax purposes, we established a long-term deferred tax liability of $4.6 million at the acquisition date for the expected difference between what would be expensed for financial reporting purposes and what would be deductible for income tax purposes. As of June 30, 2012 and December 31, 2011, this component of the deferred tax liability was $0.1 million, respectively.  This deferred tax liability relates to Evolving Systems U.K., and has no impact on our ability to recover U.S.-based deferred tax assets.  This deferred tax liability will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized.

 

As of June 30, 2012 and December 31, 2011 we continued to maintain a valuation allowance on portions of our domestic net deferred tax asset as we have determined it is more likely than not that we will not realize these deferred tax assets.  Such assets primarily consist of certain net operating loss carryforwards and other tax credits.  We assessed the realizability of our domestic deferred tax assets using all available evidence.  In particular, we considered both historical results and projections of profitability for the reasonably foreseeable future periods.  We are required to reassess our conclusions regarding the realization of our deferred tax assets at each financial reporting date. A future evaluation could result in a conclusion that all or a portion of the valuation allowance is no longer necessary, which could have a material impact on our results of operations and financial position.  The $0.4 million of deferred tax liabilities as of June 30, 2012, were comprised of the following:

 

 

 

June 30, 2012

 

Deferred tax assets:

 

 

 

Net operating loss carryforwards

 

$

4,141

 

Research & Development Credits

 

303

 

AMT/MAT credit

 

937

 

Stock Compensation

 

619

 

Depreciable assets

 

100

 

Accrued liabilities and reserves

 

111

 

Total deferred tax assets

 

6,211

 

 

 

 

 

Deferred tax liabilities

 

 

 

Undistributed Foreign Earnings

 

$

(1,476

)

Intangibles

 

(119

)

Total deferred tax liability

 

(1,595

)

 

 

 

 

Net deferred tax assets, before valuation allowance

 

$

4,616

 

Valuation allowance

 

(5,003

)

Net deferred tax liability

 

$

(387

)

 

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Table of Contents

 

As of June 30, 2012 and December 31, 2011 we had no liability for unrecognized tax benefits.  We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

 

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

 

NOTE 8 — RESTRUCTURING

 

During the second and fourth quarter of 2011, we undertook a reduction in workforce involving the termination of employees resulting in an expense of $1.1 million primarily related to severance for the affected employees. The reduction in workforce was related to the Asset Sale and was completed by December 31, 2011. There were no additional restructuring expenses during the three or six months ended June 30, 2012.

 

As of June 30, 2012, $0.2 million remains as an accrued liability which will be fully paid by the fourth quarter of 2012.

 

NOTE 9 — DISCONTINUED OPERATIONS

 

On July 1, 2011, we completed the Asset Sale related to our Numbering Business. The Asset Sale qualified for treatment as discontinued operations during the second quarter of 2011 upon receipt of stockholder approval at a special meeting of stockholders on June 23, 2011. Summary results of operations of the Numbering Business for the three and six months ended June 30, 2011 and components of the net gain on the transaction were as follows (in thousands):

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2011

 

2011

 

Revenues

 

$

3,384

 

$

6,553

 

 

 

 

 

 

 

Income before income tax

 

$

1,646

 

$

2,789

 

Income tax expense (benefit)

 

(11,356

)

(11,525

)

Loss on sale of discontinued operations, net of income tax

 

(532

)

(682

)

Income from discontinued operations, net of income tax

 

$

12,470

 

$

13,632

 

 

There have been no allocations of corporate interest or general and administrative expenses to discontinued operations.

 

NOTE 10 — STOCKHOLDERS’ EQUITY

 

Common Stock Dividend

 

On May 8, 2012, our Board of Directors declared a special cash dividend of $1.70 per share, payable May 29, 2012, to stockholders of record May 18, 2012.

 

Any determination to declare a future quarterly dividend, as well as the amount of any cash dividend which may be declared, will be based on our financial position, earnings, financial covenants to which we are subject, earnings outlook and other relevant factors at that time.

 

Treasury Stock

 

Beginning on May 20, 2011, and continuing through December 31, 2012, we intend to make re-purchases of our common stock at prevailing market prices either in the open market or through privately negotiated transactions up to $5.0 million.  The size

 

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Table of Contents

 

and timing of such purchases, if any, will be based on market and business conditions as well as other factors.  The Company is not obligated to purchase any shares.  Purchases under the program can be discontinued at any time the Company determines additional purchases are not warranted.

 

From the inception of the plan through June 30, 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.

 

Certain Anti-Takeover Provisions/Agreements with Stockholders

 

Our restated certificate of incorporation allows the board of directors to issue up to 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Issuance of preferred stock, while providing desired flexibility in connection with possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire a majority of our outstanding voting stock. As of June 30, 2012 and December 31, 2011, no shares of preferred stock were outstanding.

 

On February 11, 2011, our Board of Directors agreed to amend the stockholder rights plan effectively terminating the plan as of March 1, 2011.

 

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 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.

 

NOTE 11 — SEGMENT INFORMATION

 

We define operating segments as components of our enterprise for which separate financial information is reviewed regularly by the chief operating decision-makers to evaluate performance and to make operating decisions. We have identified our Chief Executive Officer and Vice President of Finance as our chief operating decision-makers (“CODM”). These chief operating decision makers review revenues by segment and review overall results of operations.

 

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

 

Segment information is as follows (in thousands):

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenue

 

 

 

 

 

 

 

 

 

License fees and services

 

$

4,507

 

$

2,053

 

$

8,291

 

$

5,195

 

Customer support

 

2,147

 

2,391

 

4,271

 

4,640

 

Total revenue

 

6,654

 

4,444

 

12,562

 

9,835

 

 

 

 

 

 

 

 

 

 

 

Revenue less costs of revenue, excluding depreciation and amortization

 

 

 

 

 

 

 

 

 

License fees and services

 

2,983

 

860

 

4,949

 

2,768

 

Customer support

 

1,760

 

1,658

 

3,524

 

3,221

 

 

 

4,743

 

2,518

 

8,473

 

5,989

 

Unallocated Costs

 

 

 

 

 

 

 

 

 

Other operating expenses

 

2,995

 

2,871

 

5,978

 

6,503

 

Depreciation and amortization

 

179

 

268

 

351

 

534

 

Restructuring and other recovery

 

 

569

 

 

569

 

Interest income

 

(29

)

(6

)

(50

)

(14

)

Interest income, related party

 

(100

)

 

(532

)

 

Interest expense

 

 

1

 

1

 

13

 

Gain on sale of investments

 

(891

)

 

(891

)

 

Foreign currency exchange (gain) loss

 

(46

)

(7

)

50

 

(117

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

$

2,635

 

$

(1,178

)

$

3,566

 

$

(1,499

)

 

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Table of Contents

 

Geographic Regions

 

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

 

 

 

For the Three Months Ended June 30,

 

 

 

2012

 

2011

 

 

 

L&S

 

CS

 

Total

 

L&S

 

CS

 

Total

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United Kingdom

 

$

1,141

 

$

493

 

$

1,634

 

$

276

 

$

566

 

$

842

 

Russian Federation

 

1,042

 

 

1,042

 

 

 

 

Mexico

 

519

 

82

 

601

 

39

 

93

 

132

 

Other

 

1,805

 

1,572

 

3,377

 

1,738

 

1,732

 

3,470

 

Total revenues

 

$

4,507

 

$

2,147

 

$

6,654

 

$

2,053

 

$

2,391

 

$

4,444

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

 

 

L&S

 

CS

 

Total

 

L&S

 

CS

 

Total

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United Kingdom

 

$

1,518

 

$

996

 

$

2,514

 

$

558

 

$

1,113

 

$

1,671

 

Russian Federation

 

2,453

 

 

2,453

 

 

 

 

Mexico

 

745

 

164

 

909

 

73

 

186

 

259

 

Other

 

3,575

 

3,111

 

6,686

 

4,564

 

3,341

 

7,905

 

Total revenues

 

$

8,291

 

$

4,271

 

$

12,562

 

$

5,195

 

$

4,640

 

$

9,835

 

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

Long-lived assets, net

 

 

 

 

 

 

 

United States

 

$

77

 

$

84

 

United Kingdom

 

16,496

 

16,566

 

Other

 

47

 

85

 

 

 

$

16,620

 

$

16,735

 

 

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Table of Contents

 

NOTE 12 — COMMITMENTS AND CONTINGENCIES

 

(a)           Other Commitments

 

As permitted under Delaware law, we have agreements with officers and directors under which we agree to indemnify them for certain events or occurrences while the officer or director is, or was, serving at our request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments we could be required to make under these indemnification agreements; however, we maintain Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of June 30, 2012 or December 31, 2011.

 

We enter into standard indemnification terms with customers and suppliers, in the ordinary course of business, for third party claims arising under our contracts. In addition, 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 indemnification, the potential amount of future payments we could be required to make under these indemnification agreements may be unlimited. We may be able to recover damages from a subcontractor or other supplier if the indemnification results from the subcontractor’s or supplier’s failure to perform. To the extent we are unable to recover damages from a subcontractor or other supplier, we could be required to reimburse the indemnified party for the full amount. We have never incurred costs to defend lawsuits or settle claims relating to an indemnification. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of June 30, 2012 or December 31, 2011.

 

Our standard license agreements contain product warranties that the software will be free of material defects and will operate in accordance with the stated requirements for a limited period of time.  The product warranty provisions require us to cure any defects through any reasonable means.  We believe the estimated fair value of the product warranty provisions in the license agreements in place with our customers is minimal.  Accordingly, there were no liabilities recorded for these product warranty provisions as of June 30, 2012 or December 31, 2011.

 

Our software arrangements generally include a product indemnification provision whereby we will indemnify and defend a customer in actions brought against the customer for claims that our products infringe upon a copyright, trade secret, or valid patent of a third party. We have not historically incurred any significant costs related to product indemnification claims. Accordingly, there were no liabilities recorded for these indemnification provisions as of June 30, 2012 or December 31, 2011.

 

(b)          Litigation

 

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

 

NOTE 13 — RELATED PARTY TRANSACTIONS

 

Effective October 15, 2009, George A. Hallenbeck resigned from our Board of Directors and we entered into a consulting agreement with him to provide consulting services. Mr. Hallenbeck is one of the founders of the Company. Under the consulting agreement, we will pay Mr. Hallenbeck an annual fee of $10,000 for his services through May 31, 2012. We had current obligations in the consolidated balance sheets under the agreement of $1,667 and $2,500 as of June 30, 2012 and December 31, 2011, respectively. We recorded $1,667 and $2,500 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three months ended June 30, 2012, and 2011, respectively.  For the six months ended June 30, 2012 and 2011, we recorded $4,167 and $5,000, respectively of general and administrative expense in the consolidated statements of operations.

 

In connection with the restructuring of our business after the sale of the Numbering Business, we eliminated the position of Sr. Vice President and General Counsel held by Anita T. Moseley, effective July 1, 2011. We entered into a consulting agreement with Ms. Moseley to provide consulting services to the Company through December 31, 2011, and was extended through June 30, 2013 on an as-needed basis.  We had obligations in the consolidated balance sheets of approximately $4,000 as of June 30, 2012 and $125 as of December 31, 2011 related to this agreement.  We recorded approximately $5,000 and $10,000 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three and six months ended June 30, 2012, respectively.

 

In connection with the restructuring of our business after the sale of the Numbering Business, we eliminated the position of Executive Vice President and Chief Financial Officer held by Brian R. Ervine, effective November 30, 2011. We entered into a consulting agreement with Mr. Ervine to provide consulting services to the Company through December 31, 2012, on an as-needed basis. We had no obligations in the consolidated balance sheets as of June 30, 2012 and approximately $8,000 as of December 31, 2011 related to this agreement.  We recorded approximately $1,000 and $11,000 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three and six months ended June 30, 2012, respectively.

 

During the year ended December 31, 2011, we purchased $16.9 million of Primus Telecommunications Group, Inc. (“PTGI”) senior secured notes, net of purchase discounts, on the open market through a registered broker dealer. The Singer Family Trust, our largest shareholder, owns approximately 22% of our outstanding common shares and approximately 14% of the outstanding shares of

 

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Table of Contents

 

PTGI.  Richard Ramlall, Senior Vice President of Corporate Development and Chief Communications Officer of PTGI, serves on our board of directors but is not on our Investment Committee of the Board and as such is not involved in any of our investment decisions, nor is Mr. Ramlall involved with any oversight of the financial operations of PTGI.

 

During the three months and six months ended June 30, 2012, we recorded interest income of $0.1 million and $0.5 million in our Consolidated Statements of Operations related to the PTGI senior secured notes.  As of April 23, 2012 the investments were sold for approximately $17.8 million and we realized a gain on sale of approximately $891,000.

 

NOTE 14 — SUBSEQUENT EVENTS

 

On August 1, 2012, our Board of Directors declared a third quarter cash dividend of $0.05 per share, payable October 12, 2012, to stockholders of record September 7, 2012.

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q 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 maintenance revenue, annual savings associated with the organizational changes effected in prior years, 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 statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any forward-looking statements.  Risks and uncertainties of our business include those set forth in our Annual Report on Form 10-K for the year ended December 31, 2011 under “Item 1A. Risk Factors” as well as additional risks described in this Form 10-Q.  Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.  However, readers should carefully review the risk factors set forth in other reports or documents we file from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

 

OVERVIEW

 

We are a provider of software solutions and services to the wireless, wireline and cable markets. We maintain long-standing relationships with many of the largest network operators worldwide. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of OSS.  We offer software products and solutions focused on activation and provisioning: our service activation solution, TSA used to activate complex bundles of voice, video and data services for traditional and next generation wireless and wireline networks;  our SIM card activation solution, DSA used to dynamically allocate and assign resources to wireless devices that rely on SIM cards, and our connected devices activation solution, Intelligent M2M Controller that supports the activation of M2M devices with intermittent or infrequent usage patterns.

 

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

 

RECENT DEVELOPMENTS

 

During the third quarter of 2011, we completed the Asset Sale of the Numbering Business to NeuStar, Inc. The Numbering Business is reflected in these interim consolidated financial statements as discontinued operations and historical information related to the divested business has been reclassified accordingly. Refer to Note 9, Discontinued Operations, for more information regarding the Asset Sale.

 

Consolidated revenue increased to $6.7 million and $12.6 million from $4.4 million and $9.9 million for three and six months ended June 30, 2012 and 2011, respectively.  The increase in revenue for both periods is due to higher license and services revenue primarily from DSA and TSA, partially offset by lower customer support revenue.

 

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Our twelve month backlog increased to $11.4 million as of June 30, 2012, compared to $7.0 million as of June 30, 2011.

 

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 chart below summarizes how our revenue and expenses would change had they been reported on a constant currency basis. The constant currency basis assumes that the exchange rate was constant for the periods presented (in thousands).

 

 

 

For the Three Months Ended June
30,

 

For the Six Months Ended June
30,

 

 

 

2012 vs. 2011

 

2012 vs. 2011

 

Revenue

 

$

(220

)

$

(280

)

Costs of revenue and operating expenses

 

(228

)

(377

)

Operating Gain

 

$

8

 

$

97

 

 

The net effect of our foreign currency translations for the three months ended June 30, 2012 was a $0.2 million decrease in revenue and a $0.2 million decrease in operating expenses versus the three months ended June 30, 2011.  The net effect of our foreign currency translations for the six months ended June 30, 2012 was a $0.3 million decrease in revenue and a $0.4 million decrease in operating expenses versus the six months ended June 30, 2011.

 

RESULTS OF OPERATIONS

 

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

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

REVENUE

 

 

 

 

 

 

 

 

 

License fees and services

 

68

%

46

%

66

%

53

%

Customer support

 

32

%

54

%

34

%

47

%

Total revenue

 

100

%

100

%

100

%

100

%

 

 

 

 

 

 

 

 

 

 

COSTS OF REVENUE AND OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Costs of license fees and services, excluding depreciation and amortization

 

23

%

27

%

27

%

25

%

Costs of customer support, excluding depreciation and amortization

 

6

%

17

%

6

%

14

%

Sales and marketing

 

18

%

33

%

20

%

34

%

General and administrative

 

15

%

19

%

15

%

20

%

Product development

 

12

%

12

%

12

%

12

%

Depreciation

 

1

%

2

%

1

%

2

%

Amortization

 

1

%

4

%

2

%

3

%

Restructuring and other recovery

 

 

13

%

 

6

%

Total costs of revenue and operating expenses

 

76

%

127

%

83

%

116

%

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

24

%

(27

)%

17

%

(16

)%

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

0

%

0

%

0

%

0

%

Interest income, related party

 

2

%

 

4

%

 

Interest expense

 

 

(0

)%

(0

)%

(0

)%

Gain on sale of investments

 

13

%

 

7

%

 

Foreign currency exchange gain (loss)

 

1

%

0

%

(0

)%

1

%

Other income (expense), net

 

16

%

0

%

11

%

1

%

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

40

%

(27

)%

28

%

(15

)%

Income tax expense (benefit)

 

7

%

(3

)%

5

%

(2

)%

Income (loss) from continuing operations

 

33

%

(24

)%

23

%

(13

)%

Income from discontinued operations, net of tax

 

 

280

%

 

139

%

Net income

 

33

%

256

%

23

%

126

%

 

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Revenue

 

Revenue is comprised of license fees/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 and consulting services.  Customer support revenue includes annual support, recurring maintenance, maintenance upgrades and warranty services.  Warranty services consist of maintenance services and 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.

 

Revenue for the three months ended June 30, 2012 and 2011 was $6.7 million and $4.4 million, respectively.  Revenue for the six months ended June 30, 2012 and 2011 was $12.6 million and $9.9 million, respectively.  Increased revenue in both periods is primarily due to increased license and services revenue from our DSA and TSA products partially offset by decreased customer support revenue.

 

License Fees and Services

 

License fees and services revenue increased $2.4 million, or 120%, to $4.5 million for the three months ended June 30, 2012 from $2.1 million for the three months ended June 30, 2011.  The increase in revenue is primarily related to higher revenue from DSA and TSA.

 

License fees and services revenue increased $3.0 million, or 60%, to $8.3 million for the six months ended June 30, 2012 from $5.3 million for the six months ended June 30, 2011.  The increase in revenue is primarily related to higher revenue from DSA and TSA.

 

Customer Support

 

Customer support revenue decreased $0.3 million, or 10%, to $2.1 million for the three months ended June 30, 2012 from $2.4 million for the three months ended June 30, 2011. The decline in customer support revenue is due to lower revenue from DSA.