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EVOLVING SYSTEMS, INC. Annual Report on Form 10-K December 31, 2003 Table of Contents
Item 7A. Quantitative and Qualitative Disclosure about Market Risk

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

FORM 10-K

Commission File Number: 0-24081

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

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

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, par value $0.001 per share
(Title of class)

        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

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

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

        The approximate aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the National Association of Securities Dealers Automated Quotation National Market System was approximately $46.3 million as of June 30, 2003.

        The number of shares of Common Stock outstanding was 15,859,360 as of March 10, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

        The information required by Part III (Items 10, 11, 12, 13 and 14) is incorporated by reference to portions of the registrant's definitive proxy statement for the 2004 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the 2003 year.

EVOLVING SYSTEMS, INC.
Annual Report on Form 10-K
December 31, 2003
Table of Contents

        Except for the historical information contained in this document, the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to those discussed in this section, in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors."

PART I

Item 1. Business Overview

Introduction

        Evolving Systems, Inc. ("we", "our", "us") is a provider of mission critical and cost-effective software solutions to tier one telecommunications companies. We maintain long-standing relationships with many of the largest wireline and wireless telecommunications providers in the United States. 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) and Network Support Systems (NSS). Our customers include four of the largest wireline carriers in North America, representing approximately 90 percent of U.S. access lines, and four wireless carriers, representing more than 20 percent of U.S. wireless subscribers. We offer software products and solutions that enable our customers to comply with government-mandated requirements regarding local number portability (LNP) for wireline, and wireless number portability (WNP). We also offer inventory and assignment software which supports carriers compliance with the government phone number conservation mandates. In addition, we offer a variety of network assurance and fulfillment solutions that were added to our portfolio when we acquired CMS Communications Inc., in November 2003. We are uniquely positioned as a provider of both OSS, NSS and comprehensive systems integration capabilities because these complementary competencies enable us to address and implement solutions across a customer's infrastructure.

        Founded in 1985, we initially focused on providing custom software development and professional services to a limited number of telecommunications companies. In 1996, concurrent with the passage of the Telecommunications Act of 1996 (the Telecom Act), we made a strategic decision to add software products to our established professional services offerings. Since that time we have built a strong product portfolio that includes, but is not limited to, LNP OSS software that enables carriers to meet Federal Communications Commission (FCC) requirements that consumers be permitted to retain their phone numbers when changing service providers; number inventory and conservation software that addresses FCC mandates to extend the life of the North American Numbering Plan; and a solution for collecting traffic data off of network elements which supports both service assurance requirements and network planning activities. Number portability is mandated and implemented for U.S. wireline carriers today and was implemented by all U.S. wireless carriers for top-tier markets on November 24, 2003, with all remaining markets scheduled for implementation on May 24, 2004. Number conservation, or number pooling, has been mandatory for all U.S. carriers since November 2002, and is implemented for both U.S. wireline and wireless carriers today.

        Historically, we have helped our customers integrate our products into their existing OSS environments. In 2002, we initiated a restructuring plan, which, in addition to significant operational cost reductions and greater leverage of offshore development, included the reengineering of our business model to a solutions strategy. The solutions business model reflects a more balanced mix of services and products, as well as integration and product enhancements for our customer's back office to meet the specific requirements of each customer. Solutions which include our intellectual property and extensions, enhancements and integration are typically licensed to our customers and supported by us. We branded the integration and development methodology that supports our new business strategy ServiceXpress™.

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Recent Developments

Acquisition of CMS Communications, Inc.

        In November 2003, we completed our acquisition of privately-held CMS Communications, Inc. ("CMS"). In acquiring CMS we added their licensed product, Traffic Data Management System ("TDMS") to our product base. TDMS is installed as the narrow band traffic collection data system in three of the nation's largest wireline carriers. We also added a workforce of approximately fifteen employees with experience working on complex tier one telecommunications solutions.

Wireless Number Portability ("WNP")

        In November 2003, the FCC mandated that wireless carriers in the top-tier markets implement number portability. As a result of this mandate wireless carriers are required to allow consumers the ability to retain their phone number when changing service providers. As of December 31, 2003, our WNP software is used by three wireless carriers and two service bureaus. Although major WNP deployments have been completed, there are additional revenue opportunities to provide upgrades and enhancements to the core WNP installations as well as ongoing maintenance and services opportunities.

Offshore Development

        In February 2004, we formed Evolving Systems Networks India Private Limited, a wholly owned subsidiary of Evolving Systems (Evolving Systems India). For several years, offshore development has been a key aspect of our low-cost, accelerated-deployment strategy. With the formation of Evolving Systems India we expect to have more control and flexibility and lower costs than our previous outsourced development approach using offshore third party contractors.

Management Changes

        Effective January 1, 2004, Stephen Gartside, formerly executive vice president of sales and operations, was appointed as our chief executive officer and as a member of the board of directors. Mr. Gartside succeeds former CEO George Hallenbeck, who remains with us as chief technology officer and as chairman of the board.

ServiceXpress Strategy

        Our ServiceXpress strategy is designed to provide our customers with high quality solutions that meet their specific needs, as quickly as feasible, at a competitive price. We work with our customers using our domain knowledge of telecommunications OSS to identify precisely what they need. We minimize the cost and maximize the speed of delivery by using low-cost offshore development, incorporating our products and ServiceXpress tools into the solution, as well as third party products and tools. Our detailed ServiceXpress methodology defines a repeatable process for developing, delivering and supporting high quality solutions. Most of our solutions are provided for a fixed price that allows our customers to benefit from the savings we achieve while providing us with reasonable margins. We strive to be a premier low-cost provider of high-quality, mission-critical solutions for wireline and wireless telecommunications carriers. After we deliver a solution to one of our customers, we pursue follow-on business that includes software development, product upgrades and related integration, as well as customer support and product maintenance. Since the solutions we provide usually perform functions that are required for the operation of our customer's business, we expect the follow-on revenue to occur for several years after an initial core product sale. This allows us to expand our product portfolio and ServiceXpress tools to solve our customers' requirements.

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        Our ServiceXpress strategy is currently used in support of major solution and project implementations with several of our tier one carrier customers and we expect to follow this strategy going forward.

Industry Background

        Historically, telecommunications carriers have operated in a highly regulated environment. Deregulation and the widespread adoption of new telecommunications technologies, such as fiber optics, packet-data networks, digital wireless telephony and Internet-based services, have significantly increased the number of telecommunications carriers and created an increasingly competitive market. New entrants to the telecommunications service market include Competitive Local Exchange Carriers (CLECs), cable companies, Internet service providers (ISPs) and wireless service providers.

        The U.S. long distance market was opened to competition in the early 1970s. More recently, the Telecom Act provided for competition in local telephone service, allowing long distance, wireless and other carriers to enter local telephone markets. The Telecom Act, among other things, requires carriers to offer LNP, which allows customers to retain their local phone numbers regardless of the carrier providing local telephone service. While LNP is a key application for enabling such competition, the North American market saw the trend of new telecommunication carriers entering the market reverse in 2001. The North American wireline and wireless landscape today is dominated by a relatively small number of large carriers. Consolidation has played some role in creating the largest wireline and wireless carriers, a trend that appears to be continuing.

Operations Support Systems (OSS)

        OSS encompasses a broad array of software and systems that perform critical functions for telecommunications carriers, including but not limited to ordering, inventory, provisioning, service assurance, repair and billing. Ordering systems collect customer information, retrieve current service information, capture and validate new service requests, verify the availability of selected services and transmit completed orders to one or more provisioning OSS. Inventory systems maintain both physical and logical views of all the telecommunications assets required to turn up a service. Carriers use provisioning systems to install the services for new customers and to change or add services for existing customers. Service assurance systems allow carriers to perform the testing, monitoring and reporting necessary to maintain appropriate network availability and feed operational data to other business systems. Repair and dispatch systems set up, track and report on service conditions or outages for the large craft force that works for a carrier. Carriers use billing systems to collate, manage and report billing information to customers every month. OSS typically operate on a 24x7 basis to support the real-time communications network that is the backbone of the carriers' service offerings.

        Historically, as carriers have added new services, such as wireless or Internet-based services, they have developed multiple, distinct OSS. These legacy, proprietary OSS in place at all the U.S. tier one carriers often utilize incompatible hardware, operating systems, communications protocols, application software and other technologies, making operation among systems difficult. These OSS are further strained by the many incremental changes that have been made in order to accommodate new technologies, such as client/server technology and advancements in data networking to allow the proliferation of value-added services, such as call waiting, call forwarding and voice mail, broadband and to comply with federal mandates that in some cases change how systems and processes are required to work. Despite these difficulties, carriers are unable to completely replace existing OSS due to the large investment and vast amounts of historical data contained in these systems. As a result, carriers continue to make incremental modifications to these OSS, thereby further increasing their complexity and making it more difficult for them to operate with one another.

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Solutions for OSS

Local Number Portability Solutions for Wireline (LNP) and Wireless (WNP)

        Our LNP software solution enables carriers to comply with the LNP mandate in the Act and subsequent FCC regulations implementing LNP and WNP. For both the wireline and wireless industries, this requires service providers to allow customers the ability to retain, or "port", their phone numbers when changing from one service provider to another. Our LNP software for ordering, provisioning, reporting and exchanging information between carriers is widely used by wireline service providers and is involved in approximately 50 percent of all porting transactions in the United States each year. In addition, we developed the initial custom software currently used by all eight regional Number Portability Administration Centers (NPAC) in North America to control the porting process. This software receives ported telephone number information from carriers as changes occur and distributes the data to all subscribing carriers in the region. Our software was provided under contract to NeuStar, Inc., formerly a division of Lockheed Martin IMS. Over time, we have expanded our LNP product features and developed other LNP related OSS software products for the wireline and wireless markets. The emerging wireless communications industry's ongoing implementation of WNP represents a growth opportunity for us. Today, our WNP software is used by three wireless carriers and two service bureaus. It is estimated that approximately 30 percent of wireless customers change carriers at least once per year. Our full LNP solution comprises four distinct products: OrderPath® order entry; NumberManager® network provisioning; DataServer™ data warehousing; and PortExchange™ ICP pre-porting.

ServiceXpress Methodology and Toolkit

        Our ServiceXpress methodology and toolkit was developed based on our domain knowledge of the telecommunication carriers' OSS and our tools and processes we developed to integrate our products, and enhancements to those products, into our customers' OSS. We believe our ServiceXpress methodology and toolkit reduces the cost and time required to integrate our solutions as well as other third party or legacy solutions into a carrier's environment. For example, before LNP went into effect, a customer's telephone number pointed to the geographic location of a carrier's particular physical telephone switch to which the customer's phone was attached. This allowed calls to be routed to the customer based only on the telephone number without any associated database lookup. Since most OSS were created before LNP, these systems assumed the telephone number could be used to identify a customer's service provider and to the switch which the customer's phone was attached. When LNP was implemented, the phone number had to be associated with a different switch each time the customer changed its service provider. Thus, when our customers deployed our LNP products, they also had to implement changes throughout many of their other OSS to deal with the impact that LNP had on their OSS. This, in turn, required new integration between the OSS so they could operate with one another. As a result of experience we gained helping our customers with this integration, we created our ServiceXpress methodology which we have used to solve LNP, WNP and number inventory and assignment integration efforts.

NumeriTrack Number Inventory and Assignment Solution

        We developed our NumeriTrack solution in response to the FCC mandated number conservation and number pooling regulations for both wireline and wireless carriers. These regulations, which resulted from the FCC's concern that the U.S. was running out of 10 digit telephone numbers, were designed to extend the life of the 10-digit numbering plan well into the 21^st century by changing the way phone numbers are allocated to carriers, specifying rules regarding the assignment and classification of those numbers, requiring regular utilization reporting by carriers and articulation of circumstances under which previously underutilized telephone numbers must be returned to the "pool" to be reallocated to other carriers. Our NumeriTrack solution, which has been sold to four major

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carriers, facilitates compliance with the FCC mandates for both wireline and wireless carriers, provides inventory management of phone numbers and other assets such as SIM cards, supports inventory assignments, and supports integration with carriers' existing back-office systems. The NumeriTrack solution contains features for future adaptability such as future support of assets that need inventory and assignment logic such as IP addresses. As is the case with our LNP and WNP solutions, the implementation of our NumeriTrack solutions has far-reaching implications for carriers' existing OSS environments and business processes. As described above, this presents another integration opportunity for our ServiceXpress methodology. The FCC's mandates for number conservation and pooling were implemented for wireline and wireless carriers in 2003.

Network Assurance and Fulfillment Solutions

        Communications service provider networks are complex and sophisticated, with unique processes and valuable information flowing from many systems and applications. How well service providers manage these networks and use their data is critical to customer retention and with telecommunications capital budgets under pressure, optimizing these networks and making them more efficient is a critical objective. We offer a variety of profit-enhancing network and service management solutions for fulfillment and assurance. These solutions, which are designed to automate key business processes and make valuable network data available to select employees in the enterprise, include Alarm and Fault Management, Capacity and Network Planning, Data Collection, Mediation, Performance Management, Service Activation, Service Design and Assignment, and Service Quality Analysis. The primary solution in the Evolving Systems portfolio in this space is Traffic Data Management System (TDMS). TDMS is installed as the narrow band traffic collection data system in three of the nation's largest wireline carriers. Evolving Systems is also working to extend this offering to broadband.

Custom Solutions and Integration

        Since inception we have developed and supported a variety of custom solutions for the OSS environment. Based on that experience, we have developed domain knowledge that continues to help us serve our customers. As an example, we still maintain and support a complex Cellular Digital Packet Data (CDPD) network element solution.

Business Structure and Strategy for Growth

        We have developed a solutions business model that leverages our strong U.S. presence (offices in Denver, Colorado and Columbus, Ohio) and telecommunications domain expertise with low-cost offshore development capabilities in India. We developed this model in response to the downturn in the telecommunications industry, and in 2002 we successfully completed a restructuring plan that resulted in dramatically improved financial results—revenue growth and solid profitability—for our year ended December 31, 2003.

        In January of 2004 we announced plans to launch Evolving Systems India, a wholly-owned subsidiary intended to replace our prior development partnership with India-based Infosys Technologies, Limited. In March 2004 we formally launched Evolving Systems India in the city of Bangalore, with an initial staffing of 15 employees. We expect Evolving Systems India to commence initial operations by the end of Q2 2004 with a target of 45 employees. We believe our captive development team in India will enable us to offer our customers even higher-quality, lower-cost solutions and a more consistent round-the-clock workday.

        While the focus in 2003 was on achieving sustainable profitability from business operations using our solutions business model, in Q4 2003 we announced plans for extending the strategy to focus on profitable growth. The profitable growth is expected to come from organic growth from current operations combined with a selective acquisition strategy targeted to find new telecommunications

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software assets that fit our business model and that can extend the presence we have in our target tier one carrier market. An example of the strategy is the acquisition by Evolving Systems of CMS in November 2003. This acquisition brought us a new core product in the assurance and fulfillment area with a tier one installed base.

        The Company plans to integrate CMS completely into the current business model and operations and expects to fully integrate any potential future acquisition to maximize the revenue and cost synergies.

        We currently operate our business as two operating segments based on revenue type: license fees/services revenue and customer support revenue. For financial information by segment, please refer to Note 9 to the Consolidated Financial Statements.

Sales and Marketing

        The primary objective of our sales and marketing efforts is to educate existing and potential customers throughout the telecommunications industry about the depth and breadth of our capabilities, experience and product portfolio. We work with those customers through discovery, concept and business case to create solutions that reduce costs or allow compliance with Federal mandates. Our solutions sales efforts are lead by principals from our consulting practice who have strong industry and technical expertise and are supported by account executives and customer support managers. Our sales and marketing efforts include constant interaction with existing and target customers and prospects, participation in relevant industry bodies, a website presence, presentations at industry conferences and forums, news releases to the industry and other marketing initiatives. Our sales focus is to create solution opportunities that leverage our competencies with U.S. tier one carriers. The majority of sales efforts are conducted by the direct sales teams described above. Occasionally, we make sales through partners or application service providers ("ASP's") that address other segments of the communication market using solutions we have created.

Product Development and Support

        Our product development efforts are focused on identifying customer requirements and performing design and development functions for features to enhance specific applications or to build new applications for specific customer solutions. We make other investments in tools and product extensions to accelerate the development, implementation and integration process for customer solutions. We usually do not develop completely new products, major product enhancements or tools until we have at least one customer who has agreed to license what we develop.

Competition

        The market for telecommunications OSS and enhanced services software products is intensely competitive and is subject to rapid technological change, changing industry standards and regulatory developments. We face continuous demand for improved product performance, new product features and rapid integration capabilities, and reduced prices, as well as pressure to accelerate the release of new products and product enhancements. Our existing and potential competitors include many large domestic and international companies, off-shore development companies and certain of our customers' internal IT organizations, that have substantially greater financial, technological, marketing, distribution and other resources, larger installed customer bases and longer- standing relationships with telecommunications customers than we do. Although we concentrate on providing software and services for the telecommunications industry, the market for telecommunications software is extremely large and we currently hold only a small portion of the market share outside of the LNP/WNP, number pooling, and fulfillment and assurance segments. We differentiate ourselves from competitors through our

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combination of telecommunications domain knowledge, low-cost offshore development, products, services, integration capabilities and strong customer relationships.

        Our principal competitor in the LNP, WNP and Number Pooling markets is Telcordia Technologies, Inc. (formerly known as Bellcore). We expect competition to increase in the future from Telcordia Technologies, Inc. and other companies that may enter our existing or future markets with solutions which may be less costly, provide higher performance or additional features or be introduced earlier than our solutions.

        Many of our customers have large internal development organizations, which develop software solutions and provide services similar to our products and services. As a result, our customers often choose to implement their own solutions rather than choosing solutions we offer. In addition, other integration companies such as Accenture, Bearing Point and IBM, as well as off-shore companies such as Infosys, Tata and Wipro Technologies, compete with us for integration work.

        We believe that our ability to compete successfully depends on a wide range of factors. We plan to compete by offering quality low-cost solutions that are tailored specifically to the customer. Many of our customer relationships span 5 years or more with some extending beyond ten years. We believe these long relationships also help us compete.

Intellectual Property

        We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We presently have U.S. patents on elements of our principal LNP OSS products: NumberManager and OrderPath and have applied for patent protection on various elements of our OmniPresenceServer™ application. We have applied for patent protection on elements of our ServiceXpress test harness application.

Backlog

        The Company's backlog is defined as firm non-cancelable sales orders that are anticipated to be delivered over the next twelve months. As of December 31, 2003 and 2002, our backlog was approximately $11.0 million and $18.9 million, respectively. Our backlog at December 31, 2003 is comprised of license fees and services of $3.4 million and customer support of $7.6 million compared to license fees and services of $6.0 million and customer support of $12.9 million at December 31, 2002. The decrease at December 31, 2003 in customer support is mainly due to the timing of annual customer support renewals coupled with the conversion of certain customers from annual support plans to quarterly support plans. The decrease in license and services at December 31, 2003 is due to fewer core license and services projects in process.

Employees

        As of December 31, 2003, we employed 100 people, with 75% involved in product delivery, development, support and professional services, 12% in sales and marketing, and 13% in general administration. Additionally, we used the services of an offshore subcontractor who provided the equivalent of approximately 42 employees, primarily in the area of product delivery, development and support.

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Risk Factors

Fluctuations in Quarterly Results of Operations

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

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the size of new contracts and when they are signed;



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our rate of progress under our contracts;



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the timing of customer and market acceptance of our products and service offerings;



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our ability to effectively manage offshore software development in India;



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actual or anticipated changes in government laws and regulations related to the telecommunications market, including, but not limited to, the effect of wireless number portability on our business;



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judicial or administrative actions about these laws or regulations;



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the nature and pace of enforcement of the Telecom Act;



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product lifecycles;



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the mix of products and services sold;



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changes in demand for our products and services;



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



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budgeting cycles of our customers;



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



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



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competition by existing and emerging competitors in the telecommunications software markets;



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our success in developing and selling new products, controlling cost, attracting and retaining qualified personnel and expanding our sales and customer focused programs;



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software defects and other product quality problems;



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changes in our strategy;



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the extent of industry consolidation; and



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general economic conditions.

        In the past, and currently, we earn a significant portion of our revenue from a small number of customers. We expect this will continue. As a result, the loss of any significant customer, delays in delivery or acceptance of any of our products by a customer, delays in the performance of services for a customer, or delays in collection of customer receivables could be materially harmful to our business, financial condition, results of operations, and cash flows.

        Our expense levels are based in significant part on our expectations regarding future revenue. Our revenue is difficult to forecast as the market for our products and services is rapidly changing, and our sales cycle and the size and timing of significant contracts vary substantially among customers. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenue. Any significant shortfall from anticipated levels of demand for our

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products and services could have a material adverse effect on our business, financial condition and results of operations.

        Furthermore, based on these factors, we believe our future quarterly operating results may vary significantly from quarter to quarter. As a result, quarter-to-quarter comparisons of operating results are not necessarily meaningful nor do they indicate what our future performance will be. Furthermore, we believe that in some future quarter our operating results may be below the expectations of public market analysts or investors. If that occurs, it is possible that the market price of our common stock could go down.

Regulatory Uncertainties

        The market for our traditional OSS products was created and has primarily been driven by the adoption of regulations under the Telecom Act requiring Regional Bell Operating Companies (RBOCs) to implement LNP as a condition to being permitted to provide long distance services. Therefore, any changes to these regulations, or the adoption of new regulations by federal or state regulatory authorities under the Telecom Act, or any legal challenges to the Telecom Act, could hurt the market for our products and services. For example, when the FCC delayed implementation of the Telecom Act with respect to wireless carriers until November 2003, these delays had an impact on our revenue from our WNP products and services. Likewise, in mid-2001 when Verizon Wireless petitioned the FCC requesting forbearance from this requirement, we saw our wireless customers delay making decisions to purchase wireless number portability products. WNP went into effect in November, 2003. However, any invalidation, repeal or modification in the requirements imposed by the Telecom Act or the FCC, could materially harm our business, financial condition and results of operations. In addition, customers may require, or we may find it necessary or advisable, to modify our products or services to address actual or anticipated changes in regulations affecting our customers. This could also materially harm our business, financial condition, results of operations, and cash flows.

Reliance on Significant Customers

        Historically, a substantial portion of our revenue came from a limited number of customers, all in the telecommunications industry. During 2003 and 2002, we recognized approximately 61% and 66%, respectively, of our total revenue from three significant customers, who each were responsible for more than 10% of our total revenue (Significant Customers). In 2001 approximately 67% of our revenue came from four Significant Customers. It is likely that we will continue to depend on large contracts with a small number of Significant Customers. This can cause our revenue and earnings to fluctuate between quarters based on the timing of contracts and when our customers install our products. None of our major customers have any obligation to purchase additional products or services beyond annual support contracts that they may or may not renew each year. As a result, our failure to maintain relationships with our existing customers or to develop relationships with significant new customers could materially harm our business, financial condition and results of operations.

Risks Associated with Offshore Development

        Several years ago, in response to pressure from our customers for lower cost solutions, we entered into a contract with Infosys to provide a dedicated team of software developers to provide software development services and maintenance services. In February 2004, we formed Evolving Systems India and we are currently in the process of staffing the Indian company and transitioning our projects from Infosys. Any failure by us to manage this transition properly could negatively affect our margins. In addition, if Infosys or Evolving Systems India fails to provide quality software in a timely fashion during or after this transition, this could negatively affect our ability to satisfy our customer contracts. Furthermore, political changes and uncertainties in India could negatively impact the business climate

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there. As a result, we may be unable to satisfactorily perform our customer contracts and our business, financial condition and results of operations could be materially harmed.

Integration of CMS or Future Acquisitions

        The integration of CMS or future acquisitions may present risks and we may be unable to achieve the product, financial or strategic goals intended at the time of any acquisition. The risks we may encounter in such transactions include but are not limited to:

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we may have difficulty assimilating the operations and personnel of the acquired company;



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we may have difficulty effectively integrating the acquired technologies or products with our current products and technologies;



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we may have difficulty in maintaining controls, procedures and policies during the transition and integration;



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customers of the acquired company may decide not to renew their contracts with the combined entity and other ongoing business may be disrupted by transition and integration issues;



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the financial and strategic goals for the acquired and combined businesses may not be achieved;



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due diligence processes may fail to identify significant issues with product quality, intellectual property ownership, product architecture, legal and financial contingencies, and product development;



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significant exit charges may be sustained if products acquired in business combinations are unsuccessful;



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acquisitions require considerable time and commitment of management, which can distract management from day-to day operations and result in additional costs which reduce profits;



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we do not know if we will be able to identify and purchase assets and/or companies that will complement our business;



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we do not know if we will be able to finance future acquisitions;



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certain management and other employees of CMS, or future acquisitions, may be critical to the success of the acquired company, and we do not know if we will be successful in retaining these individuals in the combined companies;



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we may incur impairment charges in the future related to our goodwill and intangible assets if we do not achieve our expected cash flows or growth rates;



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the price of our stock may go down as stockholders receiving stock in connection with the CMS transaction, or any future transaction, elect to sell their shares, or the marketplace does not favorably view the transaction.

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

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Lengthy Implementation Process; Customer Acceptance of Our Solutions; Risk of Software Defects

        Implementing our solutions can be a relatively complex and lengthy process since we typically customize these solutions for each customer's unique environment. Often our customers may also require rapid deployment of our software solutions, resulting in pressure on us to meet demanding delivery and implementation schedules. Delays in implementation may result in customer dissatisfaction and/or damage our reputation. This could materially harm our business, financial condition, results of operations, and cash flows.

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

Lengthy Sales Cycle/Consolidations and Budget Cutbacks in the Industry

        Large telecommunications solutions used for enterprise-wide, mission-critical purposes, involve significant capital expenditures and lengthy implementation plans. Prospective customers typically commit significant resources to the technical evaluation of our products and services and require us to spend substantial time, effort and money providing education regarding our solutions. This evaluation process often results in an extensive and lengthy sales cycle, typically ranging between three and twelve months, making it difficult for us to forecast the timing and magnitude of sales contracts. Delays associated with customers' internal approval and contracting procedures, procurement practices, and testing and acceptance processes are common. For example, customers' budgetary constraints and internal acceptance reviews may cause potential customers to delay or forego a purchase. The delay or failure to complete one or more large contracts could materially harm our business, financial condition, results of operations and cash flows and cause our operating results to vary significantly from quarter to quarter.

        The telecommunications industry has recently experienced significant reorganization and consolidation. This may continue. Mergers and acquisitions of large telecommunications companies, as well as the formation of new alliances, have resulted in a constantly changing marketplace for our products and services. Delays associated with these changes are common. These consolidations have caused us to lose customers and it is possible that we could lose additional customers as a result of more consolidations. In addition, due to a major downturn in the telecommunications industry which began in the second half of 2000 (and continues to the present), many of the companies in the telecommunications industry reduced their capital expenditures in response to changes in the telecommunications marketplace; some companies have declared bankruptcy, cancelled contracts, delayed payments to their suppliers or delayed additional purchases. It is difficult to determine how long this downturn will continue. The delay or failure to complete one or more large contracts, or the loss of a significant customer, could materially harm our business, financial condition, results of operations, or cash flows, and cause our operating results to vary significantly from quarter to quarter.

Fixed-Price Contracts

        Currently, a large portion of our revenue is from contracts that are on a fixed-price basis. We anticipate that customers will continue to request we provide software and integration services as a total solution on a fixed-price basis. These contracts specify certain obligations and deliverables we must meet regardless of the actual costs we incur. Projects done on a fixed-price basis are subject to

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budget overruns. On occasion, in the past, we have experienced budget overruns, resulting in lower than anticipated margins. We can give no assurance we will not incur similar budget overruns in the future. If we incur budget overruns, our margins and results of operations may be materially harmed.

Rapid Technological Change; Risks Associated with New Versions and New Products

        The market for our products and services is subject to rapid technological changes, evolving industry standards, changes in carrier requirements and preferences and frequent new product introductions and enhancements. The introduction of products that incorporate new technologies and emergence of new industry standards can make existing products obsolete and unmarketable. To compete successfully, we must continue to design, develop and sell enhancements to existing products and new products that provide higher levels of performance and reliability in a timely manner, take advantage of technological advancements and changes in industry standards and respond to new customer requirements. As a result of the complexities inherent in software development, major new product enhancements and new products can require long development and testing periods before they are commercially released and delays in planned delivery dates may occur. There can be no assurance we will successfully identify new product opportunities or will achieve market acceptance of new products brought to market. In addition, products developed by others may cause our products to become obsolete or noncompetitive. If we fail to anticipate or respond adequately to changes in technology and customer preferences, or if our products do not perform satisfactorily, or if we have delays in product development, our business, financial condition and results of operations could be materially harmed.

Mature Market for Number Portability Products

        The market for our number portability products is mature and we may not be able to successfully identify new product opportunities or achieve market acceptance of new products brought to the market. Although wireless number portability was only recently mandated, many of the wireless carriers selected solutions from our competitors and it is unclear how many new opportunities there will be with these carriers. If we are unable to identify new product opportunities, our business, financial condition, results of operations or cash flows could be materially harmed.

Risks Associated with Managing Expenses

        In response to the downturn in the telecommunications industry, we have taken steps to reduce our expenses, such as reductions in staff, closing of our satellite facilities, reductions in employee benefits and general cost control measures. If we fail to anticipate and respond adequately to balance expenses against revenue, or if our fixed costs cannot be reduced enough, our financial condition could be materially harmed. Likewise, cutbacks in staff may have an impact on our ability to generate future revenue.

Competition

        Our primary markets are intensely competitive and are subject to rapid technological changes, evolving industry standards and regulatory developments. We face continuous demand for improved product performance, new product features and reduced prices, as well as intense pressure to accelerate the release of new products and product enhancements. Our existing and potential competitors include many large domestic and international companies, including some competitors that have substantially greater financial, manufacturing, technological, marketing, distribution and other resources, larger installed customer bases and longer-standing relationships with customers than we do. Our principal competitors in the LNP and WNP market include Telcordia Technologies, Inc., TSI Telecommunications, Inc., Accenture Ltd., Tekelec and NeuStar, Inc. There also can be no assurance that customers will not offer competitive products or services in the future since customers who have

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

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

•

how well we respond to our customers' needs;



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the quality and reliability of our products and services and our competitors' products and services;



•

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



•

how well we manage our projects;



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our technical subject matter expertise;



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the quality of our customer service and support;



•

the emergence of new industry standards;



•

the development of technical innovations;



•

our ability to attract and retain qualified personnel;



•

regulatory changes; and



•

general market and economic conditions.

        Some of these factors are within our control, and others are not. A variety of potential actions by our competitors, including a reduction of product prices or increased promotion, announcement or accelerated introduction of new or enhanced products, or cooperative relationships among competitors, could harm our business, financial condition, results of operations and cash flows. There can be no assurance that we will be able to compete successfully with existing or new competitors or that we will properly identify and address the demands of new markets. This is particularly true in new markets where standards are not yet established, such as in the wireless data area where we are participating in an industry forum to establish standards to manage the presence and availability of wireless communications. Our failure to adapt to emerging market demands, respond to regulatory and technological changes or compete successfully with existing and new competitors would materially harm our business, financial condition and results of operations.

Risks Associated with Recruiting and Retaining Personnel

        Our ability to manage future expansion, if any, effectively will require us to attract, train, motivate and manage new employees successfully, to integrate new management and employees into our overall operations and to continue to improve our operations, financial and management systems. There can be no assurance that we will be able to retain personnel or to hire additional personnel on a timely basis, if at all. Because of the complexity of our software solutions, a significant time lag exists between the hiring date of technical and sales personnel and the time when they become fully productive. We have at times experienced difficulty in recruiting and retaining such personnel. Our failure to retain personnel or to hire qualified personnel on a timely basis could materially harm our business, financial condition and results of operations.

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Product Liability

        Our agreements with our customers typically contain provisions designed to limit our exposure to potential liability for damages arising out of the use of or defects in our products. These limitations, however, tend to vary from customer to customer and it is possible that these limitations of liability provisions may not be effective. We currently have errors and omissions insurance, which, subject to customary exclusions, covers claims resulting from failure of our software products or services to perform the function or to serve the purpose intended. To the extent that any successful product liability claim is not covered by this insurance, we may be required to pay for a claim. This could be expensive, particularly since our software products may be used in critical business applications. Defending such a suit, regardless of its merits, could be expensive and require the time and attention of key management personnel, either of which could materially harm our business, financial condition and results of operations. In addition, our business reputation could be harmed by product liability claims, regardless of their merit or the eventual outcome of these claims.

Protection of Intellectual Property; Risks of Infringement

        Our success and ability to compete are dependent to a significant degree on our proprietary technology. We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We have U.S. patents on elements of our LNP products, NumberManager and OrderPath, and elements of our OmniPresenceServer application and have applied for patent protection on various other elements of our OmniPresenceServer application and our ServiceXpress Test Harness application. In addition, we have registered or filed for registration of certain of our trademarks. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization or to develop similar technology independently through reverse engineering or other means. In addition, the laws of some foreign countries may not adequately protect our proprietary rights. There can be no assurance that our means of protecting our proprietary rights in the U.S. or abroad will be adequate or that others will not independently develop technologies that are similar or superior to our technology, duplicate our technology or design around any of our patents. It is also possible that we will inadvertently infringe upon the intellectual property rights of a third party. Litigation may also be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of management time and resources and could materially harm our business, financial condition and results of operations.

International Operations

        Our operations in India subject us to various risks associated with growth outside the United States including:

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Compliance with international laws and regulatory requirements



•

The potential exchange and repatriation of foreign earnings



•

Foreign currency exchange rate fluctuations



•

Difficulties in staffing and managing Indian operations

Possible Volatility of Stock Price

        The trading price of our common stock has been subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by us or our competitors, changes in financial estimates by securities analysts, the operating and stock

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price performance of other companies that investors may deem comparable to us, general stock market and economic considerations and other events or factors. This may continue in the future.

        In addition, the stock market has experienced volatility that has particularly affected the market prices of stock of many technology companies and often has been unrelated to the operating performance of these companies. These broad market fluctuations may negatively impact the trading price of our common stock. As a result of the foregoing factors, we cannot assure our investors that our common stock will trade at or higher than its current price.

Effects of Future Sales of Our Common Stock in the Public Market

        If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. The perception among investors that such sales will occur could also produce this effect. These factors also could make it more difficult to raise funds through future offerings of common stock.

Reporting Requirements

        Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC and the NASDAQ, have recently issued new requirements and regulations and are currently developing additional regulations and requirements in response to recent laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. As certain rules are not yet finalized, we do not know the level of resources we will have to commit in order to be in compliance. Our compliance with current and proposed rules, such as Section 404 of the Sarbanes-Oxley Act of 2002, is likely to require the commitment of significant managerial resources. We are currently reviewing our internal control systems, processes and procedures to ensure compliance with the requirements of Section 404. While we expect that this review will show that we are in compliance, there can be no assurance that such a review will not result in the identification of significant control deficiencies or that our auditors will be able to attest as to the adequacy of our internal controls.

We Have Never Paid Dividends

        We have never paid cash dividends on our common stock. We currently intend to retain all future earnings, if any, for use in the operation of our business. Accordingly, we do not anticipate paying cash dividends on our common stock in the foreseeable future.

Certain Anti-Takeover Provisions

        Our restated certificate of incorporation allows our board of directors to issue up to 2,000,000 shares of Series A 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. We have no current plans to issue shares of preferred stock.

        In addition, we are subject to the anti-takeover provisions of Section 203 of Delaware General Corporation Law, which prohibit us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in the prescribed manner. The application of Section 203 and certain provisions of our restated certificate of incorporation, including a

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classified board of directors, 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.

Available Information

        You can find out more information about us at our Internet website located at www.evolving.com. Our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, and our Current Reports on Form 8-K and any amendments to those reports are available free of charge on our Internet website as soon as reasonably practicable after we electronically file such material with the SEC.

Item 2. Properties

        During 2003, we leased office space at five locations. The only office spaces currently being utilized are the Englewood, Colorado location, which was renegotiated in 2002 to reduce the square footage as well as the lease term, (see Note 4 to the Consolidated Financial Statements) and the space in Columbus, OH, which was acquired as part of the CMS acquisition. We closed all of our other offices in 2002. Any remaining lease obligations associated with the closed offices were accrued as restructuring and other expenses, net of estimated sublease income (see Note 4 to the Consolidated Financial Statements). We currently have sublease agreements on the California, Virginia and New Jersey locations. Our leases are shown below:

        In March 2004, we entered into a lease agreement for office space in Bangalore India. This office space is needed due to the formation of Evolving Systems India, which was incorporated in February 2004. The Bangalore office is approximately 7,488 square feet and the lease expiration date is March 7, 2005.

Item 3. Legal Proceedings

        From time to time we are involved in various legal proceedings arising in the normal course of business operations.

Item 4. Submission of Matters to a Vote of Security Holders

        In March 2004, Donald R. Dixon and Robert J. Loarie resigned from the Board of Directors. The Board appointed David J. Nicol to fill the position vacated by Mr. Dixon.

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

        Our common stock began trading publicly through the NASDAQ National Market under the symbol "EVOL" on May 12, 1998. Prior to that date, there was no public market for the common stock. We transferred from the NASDAQ National Market to the NASDAQ SmallCap Market on August 28, 2002. The closing price of our common stock as reported on the NASDAQ SmallCap Market as of March 10, 2004 was $9.14 per share. The following table sets forth for the periods indicated the high and low closing sale quotations for the common stock as reported on the NASDAQ National and SmallCap Markets. The prices reported do not include retail mark-ups, markdowns or commissions.

        As of March 10, 2004, there were approximately 135 holders of record of our common stock.

        We have not declared or paid a cash dividend on our common stock. We currently intend to retain any future earnings, if any, to finance the growth and development of our business and, therefore, do not anticipate paying cash dividends in the foreseeable future.

        As shown in the table below, as of December 31, 2003, we reserved 2,934,314 shares of common stock for future issuance upon exercise of outstanding options under equity compensation plans.

Item 6. Selected Financial Data

        The selected financial data set forth below for each of the years in the five-year period ended December 31, 2003, has been derived from our consolidated financial statements. The following selected financial data should be read in conjunction with "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations", the consolidated financial statements and the notes thereto and other financial information included elsewhere in this Annual Report on

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Form 10-K. 2003 results include amounts related to the acquisition of CMS Communications, Inc. from the purchase date of November 3, 2003 to December 31, 2003.