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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission File Number: 0-24081

EVOLVING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

        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 ý    No o

        As of November 11, 2002 there were 13,296,835 shares outstanding of Registrant's Common Stock (par value $0.001 per share).

EVOLVING SYSTEMS, INC.
Quarterly Report on Form 10-Q
September 30, 2002
Table of Contents

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EVOLVING SYSTEMS, INC.
BALANCE SHEETS
(in thousands except share data)

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

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EVOLVING SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(in thousands except per share data)
(Unaudited)

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

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EVOLVING SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

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

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EVOLVING SYSTEMS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

(1)    Basis of Presentation

        Interim Financial Statements.    The accompanying financial statements of Evolving Systems, Inc. ("Evolving Systems", "the Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. However, management believes that the disclosures are adequate to make the information presented not misleading. The unaudited financial statements included in this document have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation in accordance with GAAP. The results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results that the Company will have for any subsequent quarter or full fiscal year. These financial statements should be read in conjunction with the audited financial statements and the notes to those statements for the year ended December 31, 2001 including the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

        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, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

        Reclassifications.    Certain prior period's balances have been reclassified to conform to the current year's presentation.

        During the first quarter of 2002, the Company adopted Emerging Issues Task Force (EITF) Issue No. 01-14 "Income Statement Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses Incurred." EITF Issue No. 01-14 requires reimbursements for out-of-pocket expenses to be reported as revenue in the statement of operations. Prior to adoption of EITF Issue No. 01-14, the Company recorded revenue and operating expenses net of reimbursable expenses. The Company's financial results of operations for prior periods have been reclassified to conform to the new presentation. In accordance with EITF Issue No. 01-14 reimbursable expenses of $31,000 and $102,000 for the three month and nine months ended September 30, 2001, respectively, were reclassified to conform to the new presentation. Reimbursements received for the three and nine months ended September 30, 2002 were $27,000 and $77,000, respectively. There was no impact on net income (loss) for any periods presented.

        Restructuring and other expenses relating to lease abandonment and employee severance aggregating $641,000 were previously included in cost of other services, excluding depreciation and amortization, sales and marketing, and general and administrative expenses in the Company's Form 10-Q for the three months ended March 31, 2002. For comparative purposes, these costs have been reclassified to restructuring and other expenses for the nine months ended September 30, 2002.

(2)    Significant Accounting Policies

        Revenue Recognition.    Evolving Systems recognizes revenue in accordance with the provisions of Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition". The Company derives revenue from license fees and services under the terms of both fixed-price and time-and-materials contracts. License fees and related services revenue consists of revenue from contracts involving software products and related services. Other services revenue consists of revenue from custom programming, systems integration, annual maintenance contracts and training.

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        License fees and related services revenue is generated from fixed-price contracts that provide for both licenses and services. Revenue under these arrangements, where the services are essential to the functionality of the delivered software, is generally recognized using the percentage-of-completion method of accounting in accordance with SOP No. 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts"("SOP No. 81-1"). The percentage-of-completion for each contract is determined based on the ratio of direct labor hours incurred to total estimated direct labor hours for each project. Amounts billed in advance of services being performed are recorded as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected during the succeeding 12 months.

        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 has occurred, the fee is fixed or determinable and collectibility is probable. Where applicable, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered to the extent that vendor specific objective evidence ("VSOE") of fair value exists. If VSOE does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist or all of the elements are delivered.

        Services revenue provided under fixed-price contracts is generally recognized using the percentage-of-completion method of accounting described above. Revenue from other services provided pursuant to time-and-materials contracts is recognized as the services are performed.

        Annual maintenance revenue is recognized ratably over the service period, which is generally 12 months. Revenue from training services is recognized as the training services are performed. When maintenance or training services are bundled with the original license fee arrangement, their fair value is deferred and recognized during the periods such services are provided.

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

(3)    Earnings (Loss) Per Common Share

        Basic earnings (loss) per common share ("EPS") was computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted EPS was computed using the weighted average number of common shares plus all dilutive potential common shares outstanding during the period unless the effect of the potential common shares is anti-dilutive.

        No reconciliation of the EPS numerators was necessary for the three and nine months ended September 30, 2002 and September 30, 2001 as net income (loss) was used as the numerator for each period. The reconciliation of the EPS denominator is as follows (in thousands):

        Options and warrants to purchase 2,350,000 and 2,000,000 shares of common stock were excluded from dilutive stock option calculations for the three and nine months ended September 30, 2001,

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respectively because their exercise prices were greater than the average fair market value of the Company's stock for the period and as such, they would be anti-dilutive. Options and warrants to purchase an additional 2,350,000 shares of common stock whose exercise prices were below the average fair market value of the Company's stock were excluded from the dilutive stock option calculation for the three months ended September 30, 2001 due to the net loss. Options and warrants to purchase 5,100,000 and 4,700,000 shares of common stock were excluded from the dilutive stock option calculation for the three and nine months ended September 30, 2002, respectively because their exercise prices were greater than the average fair market value of the Company's stock for the period and as such, they would be anti-dilutive. Options and warrants to purchase an additional 1,000,000 shares of common stock whose exercise prices were below the average fair market value of the Company's stock were excluded from the dilutive stock option calculation for the nine months ended September 30, 2002 due to the net loss for the period.

(4)    Concentration of Credit Risk

        For the three and nine months ended September 30, 2002, the Company recognized 60% (9%, 21% and 30%) and 62% (10%, 24% and 28%), respectively, of total revenue from three significant customers (greater than 10%), all in the telecommunications industry.

(5)    Income Taxes

        As of September 30, 2002 and December 31, 2001, the Company recorded a deferred tax valuation allowance equal to all of the total deferred tax assets. The Company considered a number of factors, including its cumulative operating losses, near-term projected losses due to the impact of delays in customer purchasing decisions, the state of the economy, as well as certain offsetting positive factors. The Company concluded that a full valuation allowance was required for all of its deferred tax assets.

(6)    Stock Option Exchange Program

        On September 4, 2002, the Company announced a voluntary stock option exchange program for its employees. Under the program, employees were given the opportunity to elect to cancel outstanding stock options held by them in exchange for an equal number of replacement options to be granted at a future date. The elections to cancel options were effective on October 2, 2002. The exchange resulted in voluntary cancellation of 1,586,254 employee stock options with varying exercise prices in exchange for the same number of replacement options. The replacement options will have the same terms and conditions as each optionee's cancelled options, including expiration date for the cancelled options, except that: (1) the replacement options will be granted no earlier than April 3, 2003; (2) all replacement options will have an exercise price equal to the greater of (a) the fair market value of our common stock on the replacement options grant date or (b) one dollar ($1.00); (3) six months will be added to the vesting schedule of the replacement options grant; and (4) the optionee must be an employee of the Company on the date of the replacement grant in order to receive replacement options. Based on the present authoritative guidance, the Company believes it will not incur any compensation charges for accounting purposes in connection with the program.

(7)    Restructuring and Other Expenses

        Due to the continued downturn in the telecommunications industry, the Company's sharp decline in revenue, the FCC's delay in ruling on wireless number portability and other factors in the first three quarters of 2002, management implemented a cost reduction plan. This plan included workforce reductions, restructuring of the Company's headquarters building lease and the closure of its satellite field offices. The Company incurred $310,000 and $5.0 million in restructuring and other expenses for the three and nine months ended September 30, 2002, respectively.

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        Work force reductions.    The Company reduced its staff by 148 people (41 in the first quarter, 78 in the second quarter and 29 in the third quarter) in the nine months ended September 30, 2002. All departments within the Company were impacted by the reductions. As a result, the Company recorded expenses associated with these reductions in staff of approximately $310,000 and $1.5 million in restructuring and other expenses for the three and nine months ended September 30, 2002, respectively. All payments for these employees were contractually defined, fixed, and communicated during the applicable quarter. At September 30, 2002 approximately $410,000 was remaining in accounts payable and accrued liabilities related to these workforce reductions as a result of cash payments of $190,000 and $1.1 million for the three and nine months ended September 30, 2002, respectively. This amount will be paid out over the terms of each employee's separation agreement, which do not extend beyond June 2003. We plan to further reduce our staff by approximately 28 employees in the fourth quarter of 2002. All employees who will be let go in the fourth quarter have been notified, and will receive a bonus equal to one months salary if they stay until the termination date set by management and they sign the appropriate releases. The bonus for these employees will be expensed during the period earned. Accordingly, the Company accrued $100,000 related to these bonuses in the third quarter of 2002, which is expected to be paid in the fourth quarter of 2002. Additionally, the Company expects to record expenses associated with these reductions in staff of approximately $100,000 during the fourth quarter of 2002.

        The following table summarizes the number of employee positions eliminated through September 30, 2002 in accordance with the restructuring plan:

        Restructure of headquarters lease.    In June 2002, the Company restructured and amended its lease agreement on its Englewood, Colorado headquarters lease and recorded a lease cancellation charge in restructuring and other expenses of $2.0 million. During the three months ended September 30, 2002, the Company paid its landlord $800,000, the only payments made year to date against this liability, with the remaining $1.2 million payable in $100,000 monthly installments through September 2003. As of September 30, 2002, $1.2 million was included in accounts payable and accrued liabilities related to this obligation. The payment of the lease cancellation charge is secured by the Company's contract receivables. In addition, as security for the amended lease obligation, the Company restricted $500,000 of its cash through the issuance of a letter of credit to its landlord in the third quarter.

        Closure of satellite offices.    The Company closed all of its satellite field offices during the six months ended June 30, 2002. Estimated costs to sublease or terminate the lease commitments of $467,000 were recorded for the six months ended June 30, 2002, as restructuring and other expenses. During the three and nine months ended September 30, 2002, the Company made cash payments of $168,000 and $277,000, respectively, related to these leases. At September 30, 2002, $190,000 was included in accounts payable and accrued liabilities related to these office closures, which will be paid over the remaining lease terms, ranging from 1 month to 43 months. The costs to sublease or terminate these lease commitments are based on estimates and as such, the Company may incur additional costs related to the satellite office closures.

        Impairment of assets.    The Company recorded a non-cash expense of $1.1 million for the impairment of assets in restructuring and other expenses during the three months ended June 30, 2002. The majority of this charge resulted from the abandonment of leasehold improvements relating to the restructuring of its headquarters lease in June 2002 and the remainder was due to the abandonment of

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furniture and equipment related to the Company's employee reductions. These assets were taken out of service in the second quarter and were disposed of during the third quarter of 2002.

(8)    Segment Information

        In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," the Company defines operating segments as components of an enterprise for which separate financial information is available. This information is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and to make operating decisions. The Company has identified its Chief Executive Officer and Chief Financial Officer as its chief operating decision makers. These chief operating decision makers review the revenues by segment and review overall results of operations.

        As a result of the downturn in the telecommunications industry, reductions in staff and changes in management, the Company re-evaluated how it looks at its business, and it no longer uses the segments reported prior to June 30, 2002 to evaluate performance and make operating decisions. The Company currently operates its business as three operating segments based on revenue type: product revenue, maintenance revenue and other services revenue. The Company provides products and services solely within the United States geographic area. Total assets and margins have not been specified because information is not available to the chief operating decision-making group. The Company will continue to review its internal reporting structure for future changes which may result in additional disclosures. Prior year balances have been reclassed to conform to the current year's presentation.

        Revenue information by segments is as follows (in thousands):

(9)    Recent Accounting Pronouncements

        In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which was effective January 1, 2002 and requires, among other things, the discontinuance of amortization related to goodwill and indefinite-lived intangible assets. The adoption of SFAS No. 142 had no impact on the Company's financial statements as it has no goodwill or other intangible assets.

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which was effective for fiscal years beginning after June 15, 2002. SFAS No. 143 requires, among other things, that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company anticipates that the adoption of SFAS No. 143 as of January 1, 2003 will have no impact on its financial statements.

        In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which was effective January 1, 2002. SFAS 144 provides guidance on measuring and recording impairment of assets, other than goodwill, and provides clarifications on measurement of cash flow information and other variables to be used to measure impairment. The adoption of SFAS No. 144 on January 1, 2002 had no impact on the Company's financial statements.

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        In May 2002, the FASB issued SFAS No. 145, Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002, which was effective for certain transactions occurring after May 15, 2002 and for financial statements issued on or after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS No. 145 amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The adoption of SFAS No. 145 had no impact on the Company's financial statements.

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit of Disposal Activities." This statement addresses the recognition, measurement, and reporting of costs associated with exit and disposal activities. SFAS No. 146 is applicable to restructuring activities and costs related to terminating a contract that is not a capital lease and one time benefit arrangements received by employees who are involuntarily terminated. SFAS 146 supercedes EITF 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring.)" Under SFAS No. 146 the cost associated with an exit or disposal activity is recognized in the periods in which it is incurred rather than at the date the Company committed to the exit plan. This statement is effective for exit or disposal activities initiated after December 13, 2002 with earlier adoption encouraged. The provisions of EITF 94-3 shall continue to apply for exit plans initiated prior to the adoption of SFAS No. 146. The Company will adopt SFAS No. 146 as of January 1, 2003 and does not anticipate it having a material impact on the Company's financial statements.

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

OVERVIEW

        This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about Evolving Systems' industry, management's beliefs, and certain assumptions made by management. Forward-looking statements include our expectations regarding product, services, and maintenance revenue, annual savings associated with the organizational changes effected in 2001 and 2002, 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. Risk and uncertainties of our business include those set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2001 under "Risk Factors" on pages 8 through 13. 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 the Company files from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Report on Form 8-K.

        Evolving Systems, Inc. ("we", "our", "us") provides innovative software solutions for operations, enhanced services and systems integration to many of the largest communications companies in the United States. Taken together our products and integration work provide a solution that is intended to satisfy our customer's needs. Our product sales routinely include significant integration work. After an initial sale is made, we usually provide enhancements, integration and support for our solutions to satisfy the changing needs of our customers. We also offer integration services which are not associated with our products.

        We are a leading provider of local number portability solutions. We offer software solutions that enable carriers to comply with the Federal Communication Commission's ("FCC") number conservation mandates intended to extend the life of the North American Numbering Plan. Our competency as a supplier of operations support systems ("OSS") and enhanced services solutions allows our customers to realize benefits such as reduced costs or increased revenues.

        From our inception in 1985, we have provided custom software development services to a limited number of telecommunications companies. Beginning in 1996, we made a decision to expand our focus to include development of Local Number Portability ("LNP") software solutions. Our LNP software solutions enable carriers to meet the FCC requirement that customers be permitted to retain their local phone numbers when changing service providers. Our LNP software solutions are used in the wireline industry to support the ordering and provisioning process for over 60% of the telephone numbers ported each month in North America. Over time, we have expanded our LNP solution features and developed other LNP related OSS software solutions for the wireline market. We also offer a suite of solutions that satisfy the same number portability requirement for the wireless industry. The wireless industry in the United States is currently under a mandate from the FCC to implement number portability on November 24, 2003.

        We developed the software currently in use by all regional Number Portability Administration Centers ("NPACs") in the United States and Canada. The software receives ported telephone number information from carriers as changes occur and distributes the data to all subscribing carriers in the region. This software was provided under contract to NeuStar, Inc., formerly a division of Lockheed

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Martin IMS. This software has been expanded and enhanced to support the FCC's wireless number portability mandate.

        In 2001, we began expanding our solution portfolio for the recently mandated number conservation market. The FCC's decision to alter the method of allocating telephone numbers to wireline and wireless carriers and to impose revised administration and reporting requirements on those carriers presented a unique opportunity. Our NumeriTrack™ solution has been sold to four major carriers and facilitates compliance with the FCC mandates for both wireline and wireless carriers, supports integration with carriers' existing back-office systems and contains features for future adaptability.

        During 2002 we began to execute a plan to reduce expenses in order to address the decline in our revenues from the downturn in the telecommunications industry. We reduced our work force during the first three quarters by 148 people, renegotiated our Englewood, Colorado headquarters lease, reduced our number of sub-contractors, eliminated certain employee benefits, closed all of our remaining satellite offices, and are carefully monitoring fixed asset purchases and general expenditures throughout all levels of the organization.

        In addition, we plan to continue to leverage the success we have had over the past two years developing software with a combined staff of our employees and sub-contractors from India. We believe this approach will allow us to deliver high quality products and services at a lower cost.

RESULTS OF OPERATIONS

        The following table presents the Company's statements of operations reflected as a percentage of total revenue.