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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2011

 

OR

 

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

 

For the transition period from                 to                

 

Commission File Number: 0-24081

 

EVOLVING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

84-1010843

(State or other jurisdiction of incorporation or organization)

 

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

 

9777 Pyramid Court, Suite 100 Englewood, Colorado

 

80112

(Address of principal executive offices)

 

(Zip Code)

 

(303) 802-1000

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if a smaller reporting company)

 

 

 

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

 

As of November 4, 2011 there were 11,094,932 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

 

 

 



Table of Contents

 

EVOLVING SYSTEMS, INC.

Quarterly Report on Form 10-Q

September 30, 2011

Table of Contents

 

PART I — FINANCIAL INFORMATION

Item 1

Financial Statements

 

Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010 (Unaudited)

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010 (Unaudited)

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) for the Nine Months Ended September 30, 2011 (Unaudited)

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (Unaudited)

 

Notes to Unaudited Condensed Consolidated Financial Statements

Item 2

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

Item 3

Quantitative and Qualitative Disclosures About Market Risk

Item 4

Controls and Procedures

 

 

PART II — OTHER INFORMATION

Item 1

Legal Proceedings

Item 1A

Risk Factors

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3

Defaults upon Senior Securities

Item 5

Other Information

Item 6

Exhibits

 

 

Signature

 

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

(unaudited)

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

29,589

 

$

10,801

 

Contract receivables, net of allowance for doubtful accounts of $22 and $520 at September 30, 2011 and December 31, 2010, respectively

 

2,975

 

5,502

 

Unbilled work-in-progress

 

2,000

 

1,519

 

Deferred income taxes

 

324

 

 

Prepaid and other current assets

 

1,542

 

1,251

 

Current assets of discontinued operations

 

 

7,374

 

Total current assets

 

36,430

 

26,447

 

Long-term investments

 

20,698

 

 

Property and equipment, net

 

443

 

625

 

Amortizable intangible assets, net

 

689

 

1,123

 

Goodwill

 

15,958

 

15,797

 

Long-term restricted cash

 

52

 

50

 

Long-term deferred income taxes

 

2,373

 

 

Other long-term assets

 

 

2

 

Long-term assets of discontinued operations

 

 

6,407

 

Total assets

 

$

76,643

 

$

50,451

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of capital lease obligations

 

$

15

 

$

13

 

Accounts payable and accrued liabilities

 

3,317

 

3,586

 

Income taxes payable

 

2,976

 

 

Dividends payable

 

552

 

532

 

Deferred income taxes

 

 

21

 

Unearned revenue

 

1,652

 

2,863

 

Current liabilities of discontinued operations

 

 

7,620

 

Total current liabilities

 

8,512

 

14,635

 

Long-term liabilities:

 

 

 

 

 

Capital lease obligations, net of current portion

 

 

4

 

Deferred income taxes

 

 

51

 

Long-term liabilities of discontinued operations

 

 

4

 

Total liabilities

 

8,512

 

14,694

 

 

 

 

 

 

 

Commitments and contingencies (Note 10)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued and outstanding as of September 30, 2011 and December 31, 2010

 

 

 

Common stock, $0.001 par value; 40,000,000 shares authorized; 11,072,498 shares issued and 10,905,500 outstanding as of September 30, 2011 and 10,651,431 shares issued and outstanding as of December 31, 2010

 

11

 

11

 

Additional paid-in capital

 

88,959

 

87,435

 

Treasury stock, 166,998 and 0 shares as of September 30, 2011 and December 31, 2010, respectively, at cost

 

(1,169

)

 

Accumulated other comprehensive loss

 

(4,496

)

(3,704

)

Accumulated deficit

 

(15,174

)

(47,985

)

Total stockholders’ equity

 

68,131

 

35,757

 

Total liabilities and stockholders’ equity

 

$

76,643

 

$

50,451

 

 

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

 

3



Table of Contents

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

REVENUE

 

 

 

 

 

 

 

 

 

License fees and services

 

$

1,921

 

$

3,350

 

$

7,179

 

$

11,616

 

Customer support

 

2,349

 

2,110

 

6,990

 

5,986

 

Total revenue

 

4,270

 

5,460

 

14,169

 

17,602

 

 

 

 

 

 

 

 

 

 

 

COSTS OF REVENUE AND OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Costs of license fees and services, excluding depreciation and amortization

 

1,090

 

1,402

 

3,517

 

4,539

 

Costs of customer support, excluding depreciation and amortization

 

420

 

621

 

1,839

 

1,890

 

Sales and marketing

 

1,604

 

1,517

 

4,913

 

4,844

 

General and administrative

 

855

 

1,083

 

2,815

 

3,524

 

Product development

 

629

 

675

 

1,863

 

1,884

 

Depreciation

 

87

 

86

 

261

 

258

 

Amortization

 

102

 

172

 

461

 

512

 

Restructuring

 

 

 

569

 

 

Total costs of revenue and operating expenses

 

4,787

 

5,556

 

16,238

 

17,451

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

(517

)

(96

)

(2,069

)

151

 

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

271

 

6

 

285

 

10

 

Interest expense

 

(1

)

(20

)

(14

)

(81

)

Foreign currency exchange gain (loss)

 

105

 

63

 

222

 

(86

)

Other income (expense), net

 

375

 

49

 

493

 

(157

)

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations before income taxes

 

(142

)

(47

)

(1,576

)

(6

)

Income tax expense (benefit)

 

378

 

(4

)

(1,722

)

2

 

Income (loss) from continuing operations

 

(520

)

(43

)

146

 

(8

)

Income from discontinued operations, net of tax

 

18,724

 

1,619

 

34,303

 

4,198

 

Net income

 

$

18,204

 

$

1,576

 

$

34,449

 

$

4,190

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per common share - continuing operations

 

$

(0.05

)

$

(0.00

)

$

0.01

 

$

(0.00

)

Diluted income (loss) per common share - continuing operations

 

$

(0.05

)

$

(0.00

)

$

0.01

 

$

(0.00

)

 

 

 

 

 

 

 

 

 

 

Basic income per common share - discontinued operations

 

$

1.72

 

$

0.16

 

$

3.17

 

$

0.42

 

Diluted income per common share - discontinued operations

 

$

1.68

 

$

0.15

 

$

3.07

 

$

0.39

 

 

 

 

 

 

 

 

 

 

 

Basic income per common share - net income

 

$

1.67

 

$

0.16

 

$

3.18

 

$

0.42

 

Diluted income per common share - net income

 

$

1.63

 

$

0.15

 

$

3.08

 

$

0.39

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared per common share

 

$

0.05

 

$

0.05

 

$

0.15

 

$

0.10

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic shares outstanding

 

10,877

 

10,157

 

10,821

 

10,067

 

Weighted average diluted shares outstanding

 

11,149

 

10,807

 

11,191

 

10,717

 

 

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

 

4



Table of Contents

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Total

 

 

 

Common Stock

 

 

 

Paid-in

 

Treasury

 

Comprehensive

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Stock

 

Income (Loss)

 

(Deficit)

 

Equity

 

Balance at December 31, 2010

 

10,651,431

 

$

11

 

$

87,435

 

$

 

$

(3,704

)

$

(47,985

)

$

35,757

 

Stock option exercises

 

414,623

 

 

1,009

 

 

 

 

1,009

 

Common Stock issued pursuant to the Employee Stock Purchase Plan

 

5,037

 

 

32

 

 

 

 

32

 

Stock-based compensation expense

 

 

 

483

 

 

 

 

483

 

Restricted stock issuance, net of cancellations

 

1,407

 

 

 

 

 

 

 

Treasury stock

 

(166,998

)

 

 

(1,169

)

 

 

(1,169

)

Common stock cash dividends

 

 

 

 

 

 

(1,638

)

(1,638

)

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

34,449

 

 

 

Net unrealized losses on investments, net of tax

 

 

 

 

 

 

 

 

 

(748

)

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

(44

)

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

33,657

 

Balance at September 30, 2011

 

10,905,500

 

$

11

 

$

88,959

 

$

(1,169

)

$

(4,496

)

$

(15,174

)

$

68,131

 

 

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

 

5



Table of Contents

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2011

 

2010

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

34,449

 

$

4,190

 

Income from discontinued operations

 

34,303

 

4,198

 

Income (loss) from continuing operations

 

146

 

(8

)

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

261

 

258

 

Amortization of intangible assets

 

461

 

512

 

Amortization of debt issuance costs

 

11

 

64

 

Stock based compensation

 

464

 

707

 

Unrealized foreign currency transaction (gains) and losses, net

 

(222

)

86

 

Benefit from deferred income taxes

 

(2,794

)

(189

)

Change in operating assets and liabilities:

 

 

 

 

 

Contract receivables

 

2,717

 

1,867

 

Unbilled work-in-progress

 

(451

)

(1,452

)

Prepaid and other assets

 

(312

)

310

 

Accounts payable and accrued liabilities

 

(264

)

435

 

Unearned revenue

 

(1,276

)

(1,445

)

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

 

(1,259

)

1,145

 

Net cash provided by operating activities of discontinued operations

 

6,534

 

5,502

 

Net cash provided by operating activities

 

5,275

 

6,647

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of property and equipment

 

(85

)

(282

)

Proceeds from sale of business, net

 

37,509

 

 

Purchase of marketable securities

 

(21,445

)

 

Restricted cash

 

(2

)

 

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

 

15,977

 

(282

)

Net cash used in investing activities of discontinued operations

 

(588

)

(88

)

Net cash provided by (used in) investing activities

 

15,389

 

(370

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Capital lease payments

 

(3

)

(10

)

Principal payments on long-term debt

 

 

(1,811

)

Common stock cash dividends

 

(1,618

)

(502

)

Purchase of treasury stock

 

(1,169

)

 

Proceeds from the issuance of stock

 

1,042

 

1,323

 

Net cash used in financing activities of continuing operations

 

(1,748

)

(1,000

)

Net cash used in financing activities of discontinued operations

 

(4

)

(8

)

Net cash used in financing activities

 

(1,752

)

(1,008

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(124

)

63

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

18,788

 

5,332

 

Cash and cash equivalents at beginning of period

 

10,801

 

5,369

 

Cash and cash equivalents at end of period

 

$

29,589

 

$

10,701

 

 

 

 

 

 

 

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

 

 

 

 

 

Interest paid

 

$

3

 

$

19

 

Income taxes paid

 

93

 

290

 

Common stock dividend declared

 

552

 

506

 

 

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

 

6



Table of Contents

 

EVOLVING SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — BASIS OF PRESENTATION

 

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

 

Interim Consolidated Financial Statements — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in our opinion reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance with GAAP and SEC regulations for interim financial statements. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that we will have for any subsequent period.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2010 included in our Annual Report on Form 10-K.

 

Discontinued Operations - On April 21, 2011, we announced the execution of an Asset Purchase Agreement, dated as of April 21, 2011 (the “Purchase Agreement”), with NeuStar, Inc., a Delaware corporation (the “Buyer”).  Under the terms of the Purchase Agreement, we agreed to sell our Numbering Solutions Business (the “Numbering Business”) to the Buyer for $39 million in cash, subject to increase or decrease in accordance with a post-closing working capital adjustment and the assumption of certain liabilities related to the Numbering Business (the “Asset Sale”). The Asset Sale qualified for treatment as discontinued operations during the second quarter of 2011 upon receipt of shareholder approval at a special meeting of shareholders on June 23, 2011. On July 1, 2011, we completed the Asset Sale of the Numbering Business. There was no post-closing working capital adjustment. This divested business is reflected in these consolidated financial statements as discontinued operations and historical information related to the divested business has been reclassified accordingly. Refer to Note 9, Discontinued Operations, for more information regarding the Asset Sale.

 

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

 

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

 

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

 

Goodwill - Goodwill is the excess of acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested for impairment annually or whenever indicators of impairment exist. These indicators

 

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may include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. For purposes of the goodwill evaluation, we compare the fair value of each of our reporting units to its respective carrying amount. If the carrying value of a reporting unit were to exceed its fair value, we would then compare the fair value of the reporting unit’s goodwill to its carrying amount, and any excess of the carrying amount over the fair value would be charged to operations as an impairment loss. Goodwill recorded in conjunction with our purchases of CMS Communications, Inc. (“CMS”) and Telecom Software Enterprises, LLC (“TSE”) was sold as part of the Asset Sale of our Numbering Business and the related U.S. customer support goodwill was classified as long-term assets of discontinued operations in the December 31, 2010 Condensed Consolidated Balance Sheets.

 

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

 

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

 

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

 

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

 

·                  Significant negative industry or economic trends; and/or

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Cash, Cash Equivalents and Marketable Securities - All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. Our marketable debt securities have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the available-for-sale designations as of each balance sheet date. We classify our marketable debt securities as either short-term or long-term based on each instrument’s underlying contractual maturity date. Marketable debt securities with maturities of 12 months or less are classified as short-term and marketable debt securities with maturities greater than 12 months are classified as long-term.

 

Revenue Recognition - We recognize revenue when an agreement is signed, the fee is fixed or determinable and collectability is reasonably assured. We recognize revenue from two primary sources: license fees and services, and customer support.   The majority of our license fees and services revenue is generated from fixed-price contracts, which provide for licenses to our software products and services to customize such software to meet our customers’ use.   When the customization services are determined to be essential to the functionality of the delivered software, we recognize revenue using the percentage-of-completion method of accounting. In these types of arrangements, we do not typically have vendor specific objective evidence (“VSOE”) of fair value on the license fee/services portion (services are related to customizing the software) of the arrangement due to the large amount of customization required by our customers; however, we do have VSOE for the warranty/maintenance services based on the renewal rate of the first year of maintenance in the arrangement. The license/services portion is recognized using the percentage-of-completion method of accounting and the warranty/maintenance services are separated based on the renewal rate in the contract and recognized ratably over the warranty or maintenance period. We estimate the percentage-of-completion for each contract based on the ratio of direct labor hours incurred to total

 

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estimated direct labor hours and recognize revenue based on the percent complete multiplied by the contract amount allocated to the license fee/services.  Since estimated direct labor hours, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and we review them regularly. If the arrangement includes a customer acceptance provision, the hours to complete the acceptance testing are included in the total estimated direct labor hours; therefore, the related revenue is recognized as the acceptance testing is performed. Revenue is not recognized in full until the customer has provided proof of acceptance on the arrangement.  Generally, our contracts are accounted for individually. However, when certain criteria are met, it may be necessary to account for two or more contracts as one to reflect the substance of the group of contracts. We record amounts billed in advance of services being performed as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected within 12 months.

 

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

 

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

 

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

 

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

 

Stock-based Compensation - We account for stock-based compensation by applying a fair-value-based measurement method to account for share-based payment transactions with employees and directors. We record compensation costs associated with the vesting of unvested options on a straight-line basis over the vesting period.  Stock-based compensation is a non-cash expense because we settle these obligations by issuing shares of our common stock instead of settling such obligations with cash payments.    We use the Black-Scholes model to estimate the fair value of each option grant on the date of grant.  This model requires the use of estimates for expected term of the options and expected volatility of the price of our common stock.

 

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

 

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

 

We use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities.

 

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

 

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NOTE 2 — FINANCIAL INSTRUMENTS

 

All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. Marketable debt securities have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the available-for-sale designations as of each balance sheet date. We classify our marketable debt securities as either short-term or long-term based on each instrument’s underlying contractual maturity date. Marketable debt securities with maturities of 12 months or less are classified as short-term and marketable debt securities with maturities greater than 12 months are classified as long-term.

 

The following tables summarize our available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as long-term marketable securities as of September 30, 2011 (in thousands):

 

 

 

September 30, 2011

 

 

 

Adjusted

 

Unrealized

 

Unrealized

 

Fair

 

Long-term

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

Investments

 

Level:2

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

21,890

 

$

25

 

$

1,217

 

$

20,698

 

$

20,698

 

 

The net unrealized gains and losses as of September 30, 2011 are related to long-term corporate debt securities. We may sell certain corporate debt securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. We recognized no net realized gains or losses during the three and nine month periods ended September 30, 2011. The maturities of our long-term corporate debt securities range from five to eight years.

 

We consider the declines in market value of our corporate debt securities investment portfolio to be temporary in nature. Our investment policy requires investments to be rated B- or better. Fair values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. During the three and nine month periods ended September 30, 2011, we did not recognize any impairment charges. As of September 30, 2011, we do not consider any of our investments to be other-than-temporarily impaired.

 

As of September 30, 2011 approximately 77% of our corporate debt security investments are concentrated within the senior secured notes of a single issuer. These debt securities are approximately 7% of the issuer’s total debt offering. Any significant adverse developments in that issuer’s business, industry, operations or financial condition could have a disproportionately adverse impact on the value of our investment, our receipt of interest and principal payments under the notes, or our financial condition and operating results.

 

NOTE 3 — GOODWILL AND INTANGIBLE ASSETS

 

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

 

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

 

 

 

License and
Services

 

Customer
Support

 

Total

 

 

 

UK

 

UK

 

Goodwill

 

Balance as of December 31, 2010

 

$

7,066

 

$

8,731

 

$

15,797

 

Effects of changes in foreign currency exchange rates

 

72

 

89

 

161

 

Balance as of September 30, 2011

 

$

7,138

 

$

8,820

 

$

15,958

 

 

All U.S. goodwill, approximately $6.7 million, was sold as part of the Asset sale. The $6.7 million of U.S. goodwill was related to our acquisitions of TSE and CMS. On April 19, 2011, we entered into an agreement with Lisa Marie Maxson and Peter McGuire (collectively, the “TSE Sellers”) to amend certain terms and conditions of the Acquisition Agreement entered into by and among the parties on October 15, 2004 (“TSE Acquisition Agreement”), in which we acquired all of the issued and outstanding ownership interests of the TSE Sellers in TSE.  Under the terms of TSE Acquisition Agreement, the TSE Sellers were entitled to payment of up to $1 million (“NPAC Deferred Payment”) if we entered into certain dispositions or restrictions relative to the TSE software product referred to in the Acquisition Agreement as the “NPAC SMS Simulator.” The Asset Sale included certain assets of ours including the NPAC SMS

 

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Simulator. Under the terms of the agreement we agreed to pay the TSE Sellers $325,000 on or before May 2, 2011 and $325,000 upon closing of the Asset Sale.

 

We conducted our annual goodwill impairment test as of July 31, 2011, and we determined that goodwill was not impaired as of the test date. From July 31, 2011 through September 30, 2011, no events have occurred that we believe may have impaired goodwill.

 

We amortized identifiable intangible assets on a straight-line basis over estimated lives ranging from one to seven years and include the cumulative effects of foreign currency exchange rates.  As of September 30, 2011 and December 31, 2010, identifiable intangibles were as follows (in thousands):

 

 

 

September 30, 2011

 

December 31, 2010

 

Weighted-

 

 

 

(1)

 

 

 

Net

 

(1)

 

 

 

Net

 

Average

 

 

 

Gross

 

Accumulated

 

Carrying

 

Gross

 

Accumulated

 

Carrying

 

Amortization

 

 

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Amount

 

Period

 

Purchased software

 

$

1,391

 

$

1,391

 

$

 

$

1,672

 

$

1,534

 

$

138

 

4.6 yrs

 

Purchased licenses

 

 

 

 

227

 

227

 

 

2.3 yrs

 

Trademarks and tradenames

 

701

 

526

 

175

 

694

 

446

 

248

 

7.0 yrs

 

Business partnerships

 

114

 

114

 

 

113

 

102

 

11

 

5.0 yrs

 

Customer relationships

 

2,054

 

1,540

 

514

 

3,117

 

2,391

 

726

 

5.3 yrs

 

 

 

$

4,260

 

$

3,571

 

$

689

 

$

5,823

 

$

4,700

 

$

1,123

 

5.2 yrs

 

 


(1)  Changes in intangible gross values as of September 30, 2011 compared to December 31, 2010 are the direct result of the Asset Sale and changes in foreign currency exchange rates for the periods then ended.

 

All U.S. intangible assets were sold as part of the Asset Sale. Amortization expense of identifiable intangible assets was $0.1 million and $0.2 million for the three months ended September 30, 2011 and 2010, respectively, and $0.5 million for the nine months ended September 30, 2011 and 2010.  As Evolving Systems U.K. uses the British Pound Sterling as its functional currency, the amount of future amortization actually recorded will be based upon exchange rates in effect at that time. Expected future amortization expense related to identifiable intangibles based on our carrying amount as of September 30, 2011 was as follows (in thousands):

 

Twelve Months Ending September 30:

 

 

 

2012

 

$

394

 

2013

 

295

 

 

 

$

689

 

 

NOTE 4 — EARNINGS PER COMMON SHARE

 

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

 

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

 

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

 

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Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(520

)

$

(43

)

$

146

 

$

(8

)

Income from discontinued operations, net of tax

 

$

18,724

 

$

1,619

 

$

34,303

 

$

4,198

 

Net income

 

$

18,204

 

$

1,576

 

$

34,449

 

$

4,190

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

10,877

 

10,157

 

10,821

 

10,067

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.05

)

$

(0.00

)

$

0.01

 

$

(0.00

)

Discontinued operations

 

$

1.72

 

$

0.16

 

$

3.17

 

$

0.42

 

Net Income

 

$

1.67

 

$

0.16

 

$

3.18

 

$

0.42

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

(520

)

$

(43

)

$

146

 

$

(8

)

Income from discontinued operations, net of tax

 

$

18,724

 

$

1,619

 

$

34,303

 

$

4,198

 

Net income

 

$

18,204

 

$

1,576

 

$

34,449

 

$

4,190

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

10,877

 

10,157

 

10,821

 

10,067

 

Effect of dilutive securities - options

 

272

 

650

 

370

 

650

 

Diluted weighted average shares outstanding

 

11,149

 

10,807

 

11,191

 

10,717

 

 

 

 

 

 

 

 

 

 

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.05

)

$

(0.00

)

$

0.01

 

$

(0.00

)

Discontinued operations

 

$

1.68

 

$

0.15

 

$

3.07

 

$

0.39

 

Net Income

 

$

1.63

 

$

0.15

 

$

3.08

 

$

0.39

 

 

For the three months ended September 30, 2011 and 2010, 0.3 million and 0.4 million shares, respectively, of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

For the nine months ended September 30, 2011 and 2010, 0.3 million and 0.4 million shares, respectively, of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

NOTE 5 — SHARE-BASED COMPENSATION

 

We account for stock-based compensation by applying a fair-value-based measurement method to account for share-based payment transactions with employees and directors, and record compensation cost for all stock awards granted after January 1, 2006 and awards modified, repurchased, or cancelled after that date, using the modified prospective method. We record compensation costs associated with the vesting of unvested options on a straight-line basis over the vesting period. We recognized $0.1 million and $0.2 million of compensation expense in the consolidated statements of operations, with respect to our stock-based compensation plans for the three months ended September 30, 2011 and 2010, respectively, and $0.5 million and $0.7 million for the nine months ended September 30, 2011 and 2010, respectively.  The following table summarizes stock-based compensation expenses recorded in the consolidated statement of operations (in thousands):

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Cost of license fees and services, excluding depreciation and amortization

 

$

11

 

$

12

 

$

33

 

$

36

 

Cost of customer support, excluding depreciation and amortization

 

1

 

2

 

4

 

4

 

Sales and marketing

 

14

 

26

 

53

 

84

 

General and administrative

 

106

 

159

 

330

 

510

 

Product development

 

10

 

29

 

44

 

73

 

Share based compensation - continuing operations

 

142

 

228

 

464

 

707

 

Discontinued operations

 

 

13

 

19

 

30

 

Total share based compensation

 

$

142

 

$

241

 

$

483

 

$

737

 

 

Stock Incentive Plans

 

In January 1996, our stockholders approved an Amended and Restated Stock Option Plan (the “Option Plan”).  Under the Option Plan, as amended, 4,175,000 shares were reserved for issuance.  Options issued under the Option Plan were at the discretion of the Board

 

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of Directors, including the vesting provisions of each stock option granted. Options were granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant. The Option Plan terminated on January 18, 2006; options granted before that date were not affected by the plan termination.  At September 30, 2011 and December 31, 2010, 0.5 million and 1.1 million options remained outstanding under the Option Plan, respectively.

 

In March 2007, upon the hiring of our Vice President of World Wide Sales and Marketing, in accordance with then-NASDAQ Marketplace Rule 4350(i)(1)(a)(iv) (now Rule 5635(c)(iv)), the Board of Directors approved an inducement award under a stand-alone equity incentive plan.  We granted 50,000 non-qualified options to purchase shares of our common stock at an exercise price equal to the closing price of our common stock on the date of grant.  The options vest over four years and expire ten years from the date of grant. At September 30, 2011 and December 31, 2010, 50,000 options remained outstanding under this plan.

 

In June 2007, our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”) with a maximum of 1,000,000 shares reserved for issuance. In June 2010, our stockholders approved an amendment to the 2007 Stock Plan which increased the maximum shares that may be awarded under the plan to 1,250,000. Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years for employees and one year for directors and expire no more than ten years from the date of grant.  At September 30, 2011, there were approximately 0.2 million shares available for grant under the 2007 Stock Plan, as amended. At September 30, 2011 and December 31, 2010, 0.5 million and 0.7 million options were issued and outstanding under the 2007 Stock Plan as amended, respectively.

 

During the nine months ended September 30, 2011 and 2010, we awarded a total of 10,000 and 48,750 shares of restricted stock, respectively to members of our Board of Directors and senior management. There were no grants during the three months ended September 30, 2011 or 2010. During the three and nine months ended September 30, 2011, 9,000 and 28,000 shares of restricted stock vested, respectively. During the three and nine months ended September 30, 2010, 11,000 and 34,000 shares of restricted stock vested, respectively.  Approximately 2,000 and 9,000 shares of restricted stock were forfeited during the three and nine months ended September 30, 2011, respectively and none were forfeited during the three or nine months ended September 30, 2010. The fair market value of restricted shares for share-based compensation expensing is equal to the closing price of our common stock on the date of grant. Stock-based compensation expense includes $46,000 and $138,000 for the three and nine months ended September 30, 2011 and $51,000 and $0.2 million for the three and nine months ended September 30, 2010, respectively, of expense related to restricted stock grants. The restrictions on the stock awards are released quarterly, generally over four years for senior management and over one year for board members.

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes model.  The Black-Scholes model uses four assumptions to calculate the fair value of each option grant.  The expected term of share options granted is derived using the simplified method, which we adopted in January 2008. The risk-free interest rate is based upon the rate currently available on zero-coupon U.S. Treasury instruments with a remaining term equal to the expected term of the stock options.  The expected volatility is based upon historical volatility of our common stock over a period equal to the expected term of the stock options.  The expected dividend yield is based upon historical and anticipated payment of dividends.  The weighted-average assumptions used in the fair value calculations are as follows:

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Expected term (years)

 

*

 

*

 

5.3

 

5.9

 

Risk-free interest rate

 

*

 

*

 

1.53

%

2.50

%

Expected volatility

 

*

 

*

 

66.35

%

73.80

%

Expected dividend yield

 

*

 

*

 

3.0

%

0.3

%

 


* - None granted

 

The following is a summary of stock option activity under the plans for the nine months ended September 30, 2011:

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Weighted-

 

Remaining

 

Aggregate

 

 

 

Number of

 

Average

 

Contractual

 

Intrinsic

 

 

 

Shares

 

Exercise

 

Term

 

Value

 

 

 

(in thousands)

 

Price

 

(Years)

 

(in thousands)

 

Options outstanding at December 31, 2010

 

1,799

 

$

6.08

 

 

 

$

5,939

 

Options granted

 

14

 

$

6.78

 

 

 

 

 

Less options forfeited

 

(319

)

$

7.83

 

 

 

 

 

Less options exercised

 

(415

)

$

2.43

 

 

 

 

 

Options outstanding at September 30, 2011

 

1,079

 

$

6.63

 

5.24

 

$

1,667

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at September 30, 2011

 

941

 

$

6.90

 

4.84

 

$

1,446

 

 

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There were no stock options granted during the three months ended September 30, 2011 or 2010. The weighted-average grant-date fair value of stock options granted during the nine months ended September 30, 2011 and 2010 was $3.12 and $3.89, respectively.

 

As of September 30, 2011, there was approximately $0.5 million of total unrecognized compensation costs related to unvested stock options.  These costs are expected to be recognized over a weighted average period of 1.8 years.

 

The total fair value of stock options vested during the three months ended September 30, 2011 and 2010 was $0.1 million and $0.2 million, respectively. The total fair value of stock options vested during the nine months ended September 30, 2011 and 2010 was $0.4 million and $0.5 million, respectively.

 

The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $8,000 and $15,000 for the three months ended September 30, 2011 and 2010, respectively. The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $30,000 and $45,000 for the nine months ended September 30, 2011 and 2010, respectively.

 

Cash received from stock option exercises for the three months ended September 30, 2011 and 2010 was $0.2 million and $0.7 million, respectively. Cash received from stock option exercises for the nine months ended September 30, 2011 and 2010 was $1.0 million and $1.3 million, respectively.

 

During the three months ended March 31, 2011, we had net settlement exercises of stock options, whereby the optionee did not pay cash for the options but instead received the number of shares equal to the difference between the exercise price and the market price on the date of exercise. Net settlement exercises during the three months ended March 31, 2011, resulted in approximately 91,000 shares issued and 120,000 options cancelled in settlement of shares issued.  There were no net settlement exercises during the three months ended September 30, 2011. There were no net settlement exercises during the three or nine months ended September 30, 2010.

 

Employee Stock Purchase Plan

 

Under the Employee Stock Purchase Plan (“ESPP”), we were previously authorized to issue up to 550,000 shares under the ESPP. Under the terms of the ESPP, employees may elect to have up to 15% of their gross compensation withheld through payroll deduction to purchase our common stock, capped at $25,000 annually and no more than 10,000 shares per offering period. The purchase price of the stock is 85% of the lower of the market price at the beginning or end of each three-month participation period. As of September 30, 2011, there were approximately 74,000 shares available for purchase.  For the three months ended September 30, 2011 and 2010, we recorded compensation expense of $400 and $3,000, respectively and $7,000 and $10,000 for the nine month periods ended September 30, 2011 and 2010, respectively, associated with grants under the ESPP which includes the fair value of the look-back feature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period primarily based on the level of employee participation.

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Expected term (years)

 

0.25

 

0.25

 

0.25

 

0.25

 

Risk-free interest rate

 

0.2

%

0.2

%

0.04

%

0.10

%

Expected volatility

 

30.2

%

60.1

%

34.2

%

62.3

%

Expected dividend yield

 

3.2

%

2.8

%

3.0

%

0.8

%

 

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Cash received from employee stock plan purchases for the three months ended September 30, 2011 and 2010 was $14,000 and $13,000, respectively.  Cash received from employee stock plan purchases for the nine months ended September 30, 2011 and 2010 was $32,000 and $40,000, respectively.

 

We issued shares related to the ESPP of approximately 2,000 for the three months ended September 30, 2011 and 2010. We issued shares related to the ESPP of approximately 5,000 and 7,000 for the nine months ended September 30, 2011 and 2010, respectively.

 

NOTE 6 — CONCENTRATION OF CREDIT RISK

 

For the three months ended September 30, 2011 and 2010, two significant customers (defined as contributing at least 10%) accounted for 21% (11% and 10%) and 25% (13% and 12%), respectively, of revenue from continuing operations.  For the three months ended September 30, 2011, these customers are 2 large telecommunications operators in Europe. For the three months ended September 30, 2010, these customers are large telecommunications operators in Europe and North America. For the nine months ended September 30, 2011, one significant customer accounted for 10% of revenue from continuing operations. This customer is a large telecommunications operator in Europe. For the nine months ended September 30, 2010, two significant customers accounted for 27% (14% and 13%) of revenue from continuing operations.  These customers are large telecommunications operators located in Asia and Europe.

 

As of September 30, 2011, one significant customer accounted for approximately 13% of contract receivables and unbilled work-in-progress.  This customer is a large telecommunications operator in Asia.  At December 31, 2010, one significant customer accounted for approximately 12% of contract receivables and unbilled work-in-progress.  This customer is a large telecommunications operator located in Asia.

 

As of September 30, 2011 approximately 77% of our corporate debt security investments are concentrated within one issuer. These debt securities are senior secured and our holdings are approximately 7% of the issuer’s total debt offering.

 

NOTE 7 — INCOME TAXES

 

We recorded net income tax expense (benefit) of $0.4 million and ($4,000) for the three months ended September 30, 2011 and 2010, respectively.  The net expense during the three months ended September 30, 2011 consisted of current income tax expense of $0.2 million and a deferred tax expense of $0.2 million. The current tax expense consists primarily of income tax from our U.K.-based operations and income taxes related to our operations in India. Most of the U.K. income tax expense was related to placing a valuation allowance on foreign tax credits in the U.K. The tax credits are typically used to offset our income tax liability. The valuation allowance was placed on the tax credits, since we are not certain we will have enough taxable income to utilize the tax credits. The deferred tax expense was from an adjustment of the allocation between continuing and discontinued operations of the tax benefit related to the release of our valuation allowance on our domestic deferred tax asset of approximately $0.3 million, which occurred in the second quarter of 2011. The deferred tax expense was net of a tax benefit primarily related to intangible assets from our U.K.-based operations. The net benefit during the three months ended September 30, 2010 consisted of a current income tax expense of $59,000 and a deferred tax benefit of $63,000. The current tax expense consists of income tax from our U.K.-based operations, Alternative Minimum Tax (“AMT”) and unrecoverable foreign withholding tax in the U.S. and Minimum Alternative Tax (“MAT”) from our Indian operations. The deferred tax benefit was related to intangible assets from our U.K.-based operations.

 

We recorded net income tax expense (benefit) of ($1.7 million) and $2,000 for the nine months ended September 30, 2011 and 2010, respectively.  The net benefit during the nine months ended September 30, 2011 consisted of current income tax expense of $0.4 million and a deferred tax benefit of $2.1 million. The current tax expense consists primarily of income tax from our U.K.-based operations, income taxes related to our operations in India and AMT and state income taxes in the U.S. The majority of the U.K. income tax expense was related to placing a valuation allowance on foreign tax credits in the U.K. The tax credits are typically used to offset our income tax liability. The valuation allowance was placed on the tax credits, since we are not certain we will have enough taxable income to utilize the tax credits. The deferred tax benefit was related primarily to the release of our valuation allowance on our domestic deferred tax asset during the second quarter of 2011. The deferred tax asset was primarily from NOL’s of approximately $45 million. We also had a deferred tax benefit related to the release of our valuation allowance on our tax asset from our Indian operations as we will begin to utilize MAT payments made during our tax holiday, which can be applied toward future taxes payable since the tax holiday expired on March 31, 2011. We also had a tax benefit related to intangible assets from our U.K.-based operations. The net expense of $2,000 during the nine months ended September 30, 2010 consisted of income tax expense of $0.2 million and a deferred tax benefit of $0.2 million. The current tax expense consists of income tax from our U.K.-based operations, AMT and unrecoverable foreign withholding tax in the U.S. and MAT from our Indian operations. The deferred tax benefit was related to intangible assets from our U.K.-based operations.

 

In conjunction with the acquisition of Evolving Systems U.K., we recorded certain identifiable intangible assets.  Since the amortization of these identifiable intangibles is not deductible for income tax purposes, we established a long-term deferred tax

 

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liability of $4.6 million at the acquisition date for the expected difference between what would be expensed for financial reporting purposes and what would be deductible for income tax purposes. As of September 30, 2011 and December 31, 2010, this component of the deferred tax liability was $0.2 million and $0.3 million, respectively.  This deferred tax liability relates to Evolving Systems U.K., and has no impact on our ability to recover U.S.-based deferred tax assets.  This deferred tax liability will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized.

 

As of September 30, 2011, we removed the majority of the valuation allowance on our domestic net deferred tax asset as we have determined it is more likely than not that we will realize our domestic deferred tax assets.  Such assets primarily consist of certain net operating loss carryforwards.  We assessed the realizability of our domestic deferred tax assets using all available evidence.  In particular, we considered the projected gain on the sale of our Numbering Business and both historical results and projections of profitability for the reasonably foreseeable future periods. We maintained a valuation allowance on some deferred tax assets related to certain state NOL’s as we believe it is more likely than not that we will not be able to utilize those deferred tax assets. The effect of the removal of the valuation allowance was a benefit of $15.4 million, of which $13.8 million was allocated to discontinued operations. This allocation was based on projecting how much of the NOL’s would be used by our continuing operations, with the remaining value allocated to discontinued operations. The $2.7 million of deferred tax assets as of September 30, 2011, were comprised of the following:

 

Deferred tax assets:

 

 

 

Net operating loss carryforwards

 

$

2,958

 

Research & Development Credits

 

841

 

AMT/MAT credit

 

1,084

 

Stock Compensation

 

698

 

Unrealized losses on investments

 

445

 

Depreciable assets

 

143

 

Accrued liabilities and reserves

 

147

 

Total deferred tax assets

 

6,316

 

 

 

 

 

Deferred tax liabilities

 

 

 

Undistributed Foreign Earnings

 

$

(1,048

)

Intangibles

 

(179

)

Total deferred tax liability

 

(1,227

)

 

 

 

 

Net deferred tax assets, before valuation allowance

 

$

5,089

 

Valuation allowance

 

(2,392

)

Net deferred tax assets

 

$

2,697

 

 

As of September 30, 2011 and December 31, 2010, we had no liability for unrecognized tax benefits.  We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

 

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

 

NOTE 8 — RESTRUCTURING

 

During the second quarter of 2011, we undertook a reduction in workforce involving the termination of employees resulting in an expense of $0.6 million primarily related to severance for the affected employees. The reduction in workforce was related to the Asset Sale. There were no additional restructuring expenses during the three months ended September 30, 2011.

 

We expensed $0.6 million during the nine months ended September 30, 2011 in connection with our restructuring. As of September 30, 2011, $0.4 million remains as an accrued liability which will be fully paid by the third quarter of 2012.

 

NOTE 9 — DISCONTINUED OPERATIONS

 

On July 1, 2011, we completed the Asset Sale related to our Numbering Business. The Asset Sale qualified for treatment as discontinued operations during the second quarter of 2011 upon receipt of stockholder approval at a special meeting of stockholders on June 23, 2011. Summary results of operations of the Numbering Business for the three months and nine months ended September 30, 2011 and 2010, respectively, and components of the net gain on the transaction were as follows (in thousands):

 

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Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Revenues

 

$

 

$

3,784

 

$

6,490

 

$

11,101

 

 

 

 

 

 

 

 

 

 

 

Income before income tax

 

$

 

$

1,745

 

$

2,724

 

$

4,884

 

Income tax expense

 

 

126

 

21

 

686

 

Gain on sale of discontinued operations, net of income tax

 

18,724

 

 

31,600

 

 

Income from discontinued operations, net of income tax

 

$

18,724

 

$

1,619

 

$

34,303

 

$

4,198

 

 

The cash proceeds received from the Asset Sale amounted to approximately $39.4 million. Transaction costs were approximately $1.9 million. The net proceeds less transaction costs were $37.5 million. The sale is taxable for federal and state income tax purposes. Much of the federal income tax expense was absorbed by our NOL’s and we will owe AMT for federal tax purposes plus state taxes. We estimate federal and state income taxes owed related to the Asset Sale to be approximately $3.0 million. These are accrued on our balance sheet as of September 30, 2011.

 

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

 

The income tax benefit of $13.4 million previously shown for the three months ended June 30, 2011, was comprised of a tax benefit of $13.6 million related to the release of our valuation allowance on our deferred tax assets and an expense of $0.2 million related to the Numbering Business. The $13.4 million related to the release of our valuation allowance is now shown within the gain on sale of discontinued operations, net of tax as the valuation allowance was used to offset income related to the Asset Sale. The income tax expense of $21,000 for the nine months ended September 30, 2011, was comprised of a tax expense related to the Numbering Business.

 

The carrying amounts of major classes of assets and liabilities of the Numbering Business were as follows (in thousands):

 

 

 

July 1,

 

December 31,

 

 

 

2011

 

2010

 

Contract receivables, net

 

$

946

 

$

6,571

 

Unbilled work-in-progress

 

645

 

726

 

Prepaid and other current assets

 

153

 

77

 

Current assets of discontinued operations

 

$

1,744

 

$

7,374

 

 

 

 

 

 

 

Property and equipment, net

 

$

292

 

$

374

 

Goodwill

 

6,682

 

6,033

 

Long-term assets of discontinued operations

 

$

6,974

 

$

6,407

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

264

 

$

185

 

Unearned revenue

 

5,502

 

7,435

 

Current liabilities of discontinued operations

 

$

5,766

 

$

7,620

 

 

 

 

 

 

 

Capital lease obligations, net of current portion

 

$

 

$

4

 

Other long-term obligations

 

$

 

$

4

 

 

NOTE 10 — STOCKHOLDERS’ EQUITY

 

Common Stock Dividend

 

Our Board of Directors declared a third quarter cash dividend of $.05 per share, payable October 15, 2011, to stockholders of record September 10, 2011. The dividend was accrued as of September 30, 2011 for $0.5 million and paid on October 15, 2011. Previously, our Board of Directors declared a first and second quarter cash dividend of $.05 per share, payable April 15, 2011 and July 15, 2011, respectively.

 

Any determination to declare a future quarterly dividend, as well as the amount of any cash dividend which may be declared,

 

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will be based on our financial position, earnings, earnings outlook and other relevant factors at that time.

 

Treasury Stock

 

Beginning on May 20, 2011, and continuing through December 31, 2011, we intend to make re-purchases of our common stock at prevailing market prices either in the open market or through privately negotiated transactions up to $5.0 million.  The size and timing of such purchases, if any, will be based on market and business conditions as well as other factors.  The Company is not obligated to purchase any shares.  Purchases under the program can be discontinued at any time the Company determines additional purchases are not warranted.

 

From the inception of the plan through September 30, 2011, we purchased 166,998 shares of our common stock for $1.2 million or an average price of $6.97 per share. These shares are currently being held in treasury.

 

Certain Anti-Takeover Provisions/Agreements with Stockholders

 

Our restated certificate of incorporation allows the board of directors to issue up to 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Issuance of preferred stock, while providing desired flexibility in connection with possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire a majority of our outstanding voting stock. As of September 30, 2011 and December 31, 2010, no shares of preferred stock were outstanding.

 

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

 

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

 

NOTE 11 — SEGMENT INFORMATION

 

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

 

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

 

Segment information is as follows (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Revenue

 

 

 

 

 

 

 

 

 

License fees and services

 

$

1,921

 

$

3,350

 

$

7,179

 

$

11,616

 

Customer support

 

2,349

 

2,110

 

6,990

 

5,986

 

Total revenue

 

4,270

 

5,460

 

14,169

 

17,602

 

 

 

 

 

 

 

 

 

 

 

Revenue less costs of revenue, excluding depreciation and amortization

 

 

 

 

 

 

 

 

 

License fees and services

 

831

 

1,948

 

3,662

 

7,077

 

Customer support

 

1,929

 

1,489

 

5,151

 

4,096

 

 

 

2,760

 

3,437

 

8,813

 

11,173

 

Unallocated Costs

 

 

 

 

 

 

 

 

 

Other operating expenses

 

3,088

 

3,275

 

9,591

 

10,252

 

Depreciation and amortization

 

189

 

258

 

722

 

770

 

Restructuring

 

0

 

0

 

569

 

0

 

Interest income

 

(271

)

(6

)

(285

)

(10

)

Interest expense

 

1

 

20

 

14

 

81

 

Foreign currency exchange (gain) loss

 

(105

)

(63

)

(222

)

86

 

Income (loss) from continuing operations before income taxes

 

$

(142

)

$

(47

)

$

(1,576

)

$

(6

)

 

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Table of Contents

 

Geographic Regions

 

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

 

 

 

Three Months Ended September 30,

 

 

 

2011

 

2010

 

 

 

L&S

 

CS

 

Total

 

L&S

 

CS

 

Total

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

United Kingdom

 

$

253

 

$

545

 

$

798

 

$

626

 

$

501

 

$

1,127

 

Canada

 

 

 

 

674

 

 

674

 

Greece

 

61

 

104

 

165

 

237

 

98

 

335

 

Indonesia

 

62

 

165

 

227

 

 

155

 

155

 

South Africa

 

58

 

174

 

232

 

164

 

141

 

305

 

Other

 

1,487

 

1,361

 

2,848

 

1,649

 

1,215

 

2,864

 

Total revenues

 

$

1,921

 

$

2,349

 

$

4,270

 

$

3,350

 

$

2,110

 

$

5,460

 

 

 

 

Nine Months Ended September 30,

 

 

 

2011

 

2010

 

 

 

L&S

 

CS

 

Total

 

L&S

 

CS

 

Total

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

United Kingdom

 

$

811

 

$

1,658

 

$

2,469

 

$

2,008

 

$

1,500

 

$

3,508

 

Canada

 

395

 

 

395

 

674

 

 

674

 

Greece

 

396

 

354

 

750

 

1,512

 

289

 

1,801

 

Indonesia

 

756

 

491

 

1,247

 

2,193

 

279

 

2,472

 

South Africa

 

782

 

470

 

1,252

 

318

 

455

 

773

 

Other

 

4,039

 

4,017

 

8,056

 

4,911

 

3,463

 

8,374

 

Total revenues

 

$

7,179

 

$

6,990

 

$

14,169

 

$

11,616

 

$

5,986

 

$

17,602

 

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

Long-lived assets, net

 

 

 

 

 

United States

 

$

104

 

$

139

 

United Kingdom

 

16,873

 

17,240

 

Other

 

113

 

166

 

 

 

$

17,090

 

$

17,545

 

 

NOTE 12 — COMMITMENTS AND CONTINGENCIES

 

(a)           Other Commitments

 

As permitted under Delaware law, we have agreements with officers and directors under which we agree to indemnify them for certain events or occurrences while the officer or director is, or was, serving at our request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments we could be required to make under these indemnification agreements; however, we maintain Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2011 or December 31, 2010.

 

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We enter into standard indemnification terms with customers and suppliers, in the ordinary course of business, for third party claims arising under our contracts. In addition, as we may subcontract the development of deliverables under customer contracts, we could be required to indemnify customers for work performed by subcontractors. Depending upon the nature of the indemnification, the potential amount of future payments we could be required to make under these indemnification agreements may be unlimited. We may be able to recover damages from a subcontractor or other supplier if the indemnification results from the subcontractor’s or supplier’s failure to perform. To the extent we are unable to recover damages from a subcontractor or other supplier, we could be required to reimburse the indemnified party for the full amount. We have never incurred costs to defend lawsuits or settle claims relating to an indemnification. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2011 or December 31, 2010.

 

Our standard license agreements contain product warranties that the software will be free of material defects and will operate in accordance with the stated requirements for a limited period of time.  The product warranty provisions require us to cure any defects through any reasonable means.  We believe the estimated fair value of the product warranty provisions in the license agreements in place with our customers is minimal.  Accordingly, there were no liabilities recorded for these product warranty provisions as of September 30, 2011 or December 31, 2010.

 

Our software arrangements generally include a product indemnification provision whereby we will indemnify and defend a customer in actions brought against the customer for claims that our products infringe upon a copyright, trade secret, or valid patent of a third party. We have not historically incurred any significant costs related to product indemnification claims. Accordingly, there were no liabilities recorded for these indemnification provisions as of September 30, 2011 or December 31, 2010.

 

In relation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreed to indemnify certain parties from any losses, actions, claims, damages or liabilities (or actions in respect thereof) resulting from any claim raised by a third party.  We do not believe that there will be any claims related to these indemnifications. Accordingly, there were no liabilities recorded for these agreements as of September 30, 2011 or December 31, 2010.

 

(b)           Litigation

 

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

 

NOTE 13 — RELATED PARTY TRANSACTIONS

 

Effective October 15, 2009, George A. Hallenbeck resigned from our Board of Directors and we entered into a consulting agreement with him to provide consulting services. Mr. Hallenbeck is one of the founders of the Company. Under the consulting agreement, we will pay Mr. Hallenbeck an annual fee of $10,000 for his services through May 31, 2012. We had current obligations in the consolidated balance sheets under the agreement of $2,500 and $2,500 as of September 30, 2011 and December 31, 2010, respectively. We recorded $2,500 and $7,500 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three and nine months ended September 30, 2011 and 2010, respectively.

 

In connection with the restructuring of our business after the sale of the Numbering Business, we eliminated the position of Sr. Vice President and General Counsel held by Anita T. Moseley, effective July 1, 2011. We entered into a consulting agreement with Ms. Moseley to provide consulting services to the Company through December 31, 2011, on an as-needed basis. We recorded approximately $2,000 of general and administrative expense in the consolidated statements of operations, related to this agreement, for the three and nine months ended September 30, 2011. We had no obligations in the consolidated balance sheets as of September 30, 2011 and December 31, 2010 under this agreement.

 

NOTE 14 — SUBSEQUENT EVENTS

 

On November 10, 2011, our Board of Directors declared a special cash dividend of $2.00 per share or approximately $22.0 million in total, payable January 3, 2012, to stockholders of record December 12, 2011.

 

Through November 10, 2011, we sold long-term investments which were held on our Condensed Consolidated Balance Sheets as of September 30, 2011 at approximately $3.9 million. The investments were sold for approximately $4.1 million and we will record the related gain on sale in the fourth quarter of 2011.

 

We evaluated our September 30, 2011 financial statements for subsequent events. We are not aware of any additional subsequent events which would require recognition or disclosure in the interim consolidated financial statements.

 

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

 

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are based on current expectations, estimates,

 

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and projections about Evolving Systems’ industry, management’s beliefs, and certain assumptions made by management.  Forward-looking statements include our expectations regarding product, services, and maintenance revenue, annual savings associated with the organizational changes effected in prior years, and short- and long-term cash needs.  In some cases, words such as “anticipates”, “expects”, “intends”, “plans”, “believes”, “estimates”, variations of these words, and similar expressions are intended to identify forward-looking statements.  The statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any forward-looking statements.  Risks and uncertainties of our business include those set forth in our Annual Report on Form 10-K for the year ended December 31, 2010 under “Item 1A. Risk Factors” as well as additional risks described in this Form 10-Q.  Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.  However, readers should carefully review the risk factors set forth in other reports or documents we file from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

 

OVERVIEW

 

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

 

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

 

RECENT DEVELOPMENTS

 

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

 

Consolidated revenue decreased to $4.3 million and $14.2 million from $5.5 million and $17.6 million for three and nine months ended September 30, 2011 and 2010, respectively. The decrease in revenue for both periods is due to lower license and services revenue from both DSA and TSA, partially offset by higher customer support revenue.

 

Our twelve month backlog increased to $10.3 million as of September 30, 2011, compared to $7.5 million as of September 30, 2010.

 

We have operations in foreign countries where the local currency is used to prepare the financial statements which are translated into our reporting currency, U.S. Dollars. Changes in the exchange rates between these currencies and our reporting currency are partially responsible for some of the changes from period to period in our financial statement amounts. The chart below summarizes how our revenue and expenses would change had they been reported on a constant currency basis. The constant currency basis assumes that the exchange rate was constant for the periods presented (in thousands).

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011 vs. 2010

 

2011 vs. 2010

 

Revenue

 

$

190

 

$

586

 

Costs of revenue and operating expenses

 

154

 

601

 

Operating income (loss)

 

$

36

 

$

(15

)

 

The net effect of our foreign currency translations for the three months ended September 30, 2011 was a $0.2 million increase in revenue and a $0.2 million increase in operating expenses versus the three months ended September 30, 2010. The net effect of our foreign currency translations for the nine months ended September 30, 2011 was a $0.6 million increase in revenue and a $0.6 million increase in operating expenses versus the nine months ended September 30, 2010.

 

RESULTS OF OPERATIONS

 

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

 

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Three Months Ended

September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

REVENUE

 

 

 

 

 

 

 

 

 

License fees and services

 

45

%

61

%

51

%

66

%

Customer support

 

55

%

39

%

49

%

34

%

Total revenue

 

100

%

100

%

100

%

100

%

 

 

 

 

 

 

 

 

 

 

COSTS OF REVENUE AND OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Costs of license fees and services, excluding depreciation and amortization

 

25

%

26

%

25

%

25

%

Costs of customer support, excluding depreciation and amortization

 

10

%

11

%

13

%

11

%

Sales and marketing

 

38

%

28

%

35

%

28

%

General and administrative

 

20

%

20

%

20

%

20

%

Product development

 

15

%

12

%

13

%

11

%

Depreciation

 

2

%

2

%

2

%

1

%

Amortization