UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

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)		(IRS 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)

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

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

As of November 14, 2005 there were 16,090,009 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

(unaudited)

	September 30, 2005			December 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	3,423		$	11,386
Restricted cash	100			100
Contract receivables, net of allowance of $44 at 2005 and 2004	4,989			11,296
Unbilled work-in-progress	1,489			1,323
Prepaid and other current assets	1,700			1,832
Total current assets	11,701			25,937
Property and equipment, net	2,015			2,563
Intangible assets, net	14,649			19,993
Goodwill	35,060			37,698
Restricted cash	300			300
Total assets	$	63,725		$	86,491

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of notes payable and long-term obligations	$	4,455		$	31
Short-term notes payable	—			4,880
Accounts payable and accrued liabilities	5,796			8,357
Payable to Tertio sellers	—			2,664
Deferred income taxes, foreign	98			265
Unearned revenue	7,822			13,083
Total current liabilities	18,171			29,280
Long-term liabilities
Long-term obligations	80			125
Notes payable, net of current portion	8,697			11,849
Deferred income taxes, foreign	3,346			4,642
Total liabilities	30,294			45,896

Commitments and contingencies (Note 11)

Series B convertible redeemable preferred stock; $.001 par value; 966,666 shares issued and outstanding at September 30, 2005 and December 31, 2004	11,281			11,281

Stockholders’ equity:
Common stock, $.001 par value; 25,000,000 shares authorized; 16,058,878 and 15,987,217 shares issued and outstanding as of September 30, 2005 and December 31, 2004, respectively	16			16
Additional paid-in capital	67,859			67,765
Accumulated other comprehensive income (loss)	(1,502		)	1,994
Accumulated deficit	(44,223		)	(40,461		)
Total stockholders’ equity	22,150			29,314
Total liabilities and stockholders’ equity	$	63,725		$	86,491

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

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,
	2005			2004		2005			2004
REVENUE
License fees and services	$	4,821		$	810	$	14,643		$	6,412
Customer support	4,749			4,929		14,691			10,354
Total revenue	9,570			5,739		29,334			16,766

COSTS OF REVENUE AND OPERATING EXPENSES
Costs of license fees and services, excluding depreciation and amortization	2,285			808		7,654			3,003
Costs of customer support, excluding depreciation and amortization	1,578			1,807		5,244			5,286
Sales and marketing	2,427			942		7,242			2,779
General and administrative	1,445			1,100		5,426			2,969
Product development	452			152		1,058			884
Depreciation	363			272		1,123			811
Amortization	1,354			213		4,170			645
Restructuring and other expenses (income)	4			—		(47		)	—
Total costs of revenue and operating expenses	9,908			5,294		31,870			16,377
Income (loss) from operations	(338		)	445		(2,536		)	389
Interest income (expense), net	(372		)	89		(1,130		)	213
Other income (expense), net	(99		)	3		(273		)	3
Income (loss) before income taxes	(809		)	537		(3,939		)	605
Income tax expense (benefit)	117			20		(177		)	12
Net income (loss)	$	(926	)	$	517	$	(3,762	)	$	593

Basic income (loss) per common share	$	(0.05	)	$	0.03	$	(0.20	)	$	0.04

Diluted income (loss) per common share	$	(0.05	)	$	0.03	$	(0.20	)	$	0.03

Weighted average basic shares outstanding	18,665			15,890		18,634			15,860
Weighted average diluted shares outstanding	18,665			16,906		18,634			17,378

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

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(3,762	)	$	593
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation	1,123			811
Amortization of intangible assets	4,170			646
Amortization of debt issuance costs	34			—
Interest expense added to debt principal	1,016			—
Gain on disposal of property and equipment	(12		)	(3		)
Bad debt recovery	—			(21		)
Foreign deferred income tax benefit	(1,251		)	—
Change in operating assets and liabilities:
Contract receivables	6,034			7,104
Unbilled work-in-progress	(103		)	591
Prepaid and other assets	73			(302		)
Accounts payable and accrued liabilities	(1,371		)	(304		)
Unearned revenue	(4,903		)	(5,707		)
Long-term obligations	(20		)	(27		)
Net cash provided by operating activities	1,028			3,381

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(656		)	(1,087		)
Proceeds from sale of property and equipment	18			5
Business combinations	(545		)	41
Net cash used in investing activities	(1,183		)	(1,041		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Capital lease payments	(23		)	(21		)
Principal payments on notes payable	(4,889		)	—
Payment of amount due to Tertio sellers	(2,617		)	—
Proceeds from issuance of stock	94			377
Net cash (used in) provided by financing activities	(7,435		)	356

Effect of foreign exchange rate changes on cash	(373		)	(3		)

Net increase (decrease) in cash and cash equivalents	(7,963		)	2,693
Cash and cash equivalents at beginning of period	11,386			17,999
Cash and cash equivalents at end of period	$	3,423		$	20,692

Supplemental disclosure of other cash and non-cash financing transactions:
Interest paid	$	155		$	12
Taxes paid	$	104		$	—

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

EVOLVING SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

Interim Consolidated Financial Statements. The accompanying unaudited condensed consolidated financial statements of Evolving Systems, Inc. (“Evolving Systems” or the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, management believes that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in management’s opinion, reflect all adjustments, which include normal recurring adjustments, necessary for a fair presentation in accordance with GAAP. The results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that the Company will have for any subsequent quarter or full fiscal year. These 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, 2004 included in the Company’s Annual Report on Form 10-K.

Use of Estimates. The preparation of financial statements in conformity with GAAP requires management 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. Estimates have been made by management with respect to revenue recognition, allowance for doubtful accounts, income taxes, intangible assets and goodwill, business combinations, and capitalization of internal software development costs. Actual results could differ from these estimates.

Foreign Currency Translation. The Company’s foreign subsidiaries' functional currency is generally the local currency of the countries in which they operate. Their assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Revenues, expenses, and cash flows are generally translated at the average rates of exchange prevailing during the period. Translation gains and losses are included in comprehensive income (loss) within stockholders’ equity. Realized and unrealized transaction gains and losses resulting from the remeasurement of non-functional currency financial instruments are included in the determination of net income (loss). For the three and nine months ended September 30, 2005 and 2004, net transaction losses were approximately $100,000 and $285,000, and $1,000 and $3,000, respectively.

Comprehensive Income. The Company’s comprehensive income (loss) is comprised of its net income (loss) and foreign currency translation adjustment. For the three and nine months ended September 30, total comprehensive income (loss) was approximately $(1.8) million and $(7.3) million, for 2005, and $517,000 and $586,000, for 2004, respectively.

Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany transactions and balances have been eliminated.

Reclassification. As a result of the significance of the intangible assets and the related amortization expense from the acquisitions of Tertio Telecoms Limited (“Tertio”) and Telecom Software Enterprises LLC (“TSE”), the Company is now reporting amortization expense as a separate line item on the statements of operations. In quarterly periods prior to December 31, 2004, amortization of intangibles was shown within costs of license fees and services and costs of customer support. Prior period balances have been reclassified to conform to the current period’s presentation.

Revenue Recognition. The Company recognizes revenue from two primary sources: license fees and services, and customer support, in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended and interpreted by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” provides further interpretive guidance for public companies on the recognition, presentation and disclosure of revenue in financial statements. In addition to the criteria described below, the Company recognizes revenue only when an agreement is signed, the fee is fixed or determinable and collectibility is reasonably assured.

The majority of the Company’s license fees and services revenue is generated from fixed-price contracts, which provide for licenses to its software products and services. Generally, when the services are determined to be essential to the functionality of the delivered software, revenue is recognized using the percentage-of-completion method of accounting, in accordance with SOP 97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.” The percentage of completion for each contract is estimated based on the ratio of direct labor hours incurred to total estimated direct labor hours. Since estimated direct labor hours and project costs, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and are reviewed by management regularly. Amounts billed in advance of services being performed are recorded as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected within 12 months.

The Company may encounter budget and schedule overruns on fixed price contracts caused by increased labor, overhead or material costs. Adjustments to cost estimates are made in the periods in which the facts requiring such revisions become known.

Estimated losses, if any, are recorded in the period in which current estimates of total contract revenue and contract costs indicate a loss.

In arrangements where the services are not essential to the functionality of the software, the Company recognizes license revenue upon delivery. To the extent that Vendor Specific Objective Evidence (“VSOE”) of the fair value of the undelivered elements exists, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered. If VSOE for the undelivered elements does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist on the undelivered elements or all of the elements have been delivered.

Services revenue from fixed-price contracts is generally recognized using the proportional performance method of accounting, which is similar to the percentage of completion method described above. Revenue from professional services provided pursuant to time-and-materials based contracts and training services are recognized as the services are performed, as that is when the Company’s obligation to its customers under such arrangements is fulfilled.

Customer support, including maintenance revenue, is generally recognized ratably over the service contract period. When maintenance or training services are bundled with the original license fee arrangement, their fair value, based upon VSOE, is deferred and recognized during the periods when services are provided.

(2) Business Combinations

Tertio

On November 2, 2004, the Company acquired all of the outstanding shares of privately-held, U.K.-based Tertio. Total consideration for Tertio’s net assets was approximately $40.2 million, consisting of $11.0 million in cash, approximately $15.9 million in seller-financed notes, of which $4.0 million was paid during the first half of 2005, 966,666 shares of Series B Preferred Stock with an estimated fair value of approximately $11.3 million and approximately $2.0 million in estimated transaction-related costs. Of the total purchase price, 10% was deposited in escrow with Wells Fargo Bank, N.A. as escrow agent to secure the sellers’ representations and warranties under the purchase agreement. Of the funds deposited in escrow, 80% will remain in escrow until November 2, 2005 and the remaining 20% will remain in escrow until November 2, 2007, unless sooner released to the Company in payment of indemnification claims. The acquisition was recorded as a purchase business combination and Tertio’s results of operations have been combined with Evolving Systems’ from the acquisition date.

Tertio’s activation and mediation solutions fit well with elements of the Company’s product portfolio, enabling it to provide activation solutions and strengthening its current network mediation offering. In addition, the acquisition provided the Company with global reach and a customer base that includes many of the world’s leading communications carriers. The purchase price for Tertio included goodwill because the Company concluded that increased scale may be achieved from a financial, customer and product perspective. In addition, Tertio brought a quality, experienced work force.

In January 2005, Tertio changed its name to Evolving Systems Limited and is sometimes referred to in this Form 10-Q as “Evolving Systems U.K.”

TSE

On October 15, 2004, the Company acquired all of the outstanding ownership interests in privately-held TSE. Total consideration for TSE approximated $2.4 million, consisting of $1.5 million in cash, a note payable of $889,000 and approximately $55,000 in transaction-related costs. The note payable was due and paid on March 31, 2005. Of the total purchase price, $250,000 was deposited in escrow for one year with Wells Fargo Bank, N.A. as escrow agent to secure the sellers’ representations and warranties under the purchase agreement. The Company agreed to pay additional consideration of up to $3.5 million contingent upon the achievement of certain specified revenue and gross margin results. Up to $2.5 million of the contingent consideration may be payable over a 24 month period from the closing date and additional contingent consideration of up to $1.0 million may be paid through the year 2011 if certain specified sales of TSE products occur. In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, the contingent consideration will not be recorded until the contingency is resolved and the additional consideration is distributable. During the three and nine months ended September 30, 2005, the Company recorded additional contingent consideration and resulting goodwill related to certain specified gross margin results achieved by the sale of TSE products during the period of approximately $99,000 and $330,000, respectively. The additional contingent consideration is paid within 45 days of the last day of the quarter in which it is earned. The acquisition was treated as a purchase business combination and the results of TSE’s operations have been combined with Evolving Systems’ from the acquisition date forward.

TSE’s products are sold to U.S. wireline and wireless carriers, and provide for simulation of the nation’s centralized Number Portability Administration Center (“NPAC”) and a testing environment for critical back office systems that carriers use for enabling number portability. Other products in the TSE portfolio are used for enhanced integration between back office Operational Support Systems (“OSS”). TSE has installed its products at many of the leading wireless and wireline carriers in North America. By acquiring TSE, the Company expanded its customer base and extended the set of Local Number Portability (“LNP”) solutions it offers its customers. The primary reason for a valuation which gives rise to goodwill is related to the value the Company placed on TSE’s solid reputation as a provider of LNP products, the Company’s expectation of new customers and the experienced employees acquired in the TSE acquisition.

Pro Forma Financial Information

The financial information in the table below summarizes the combined results of operations of Evolving Systems, Inc., TSE and Evolving Systems U.K. on a pro forma basis, as though the companies had been combined during the period presented below. The impact of the In-Process Research and Development (“IPR&D”) charges associated with the acquisitions has been excluded. This pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved had the acquisitions actually taken place as of the beginning of the period presented below. The following amounts are in thousands, except per share amounts.

	Three Months Ended September 30, 2004		Nine Months Ended September, 2004
Revenues	$	12,439	$	36,149
Net income	$	1,612	$	913
Basic earnings per share	$	0.10	$	0.05
Diluted earnings per share	$	0.08	$	0.05

(3) Goodwill and Intangible Assets

The Company has recorded goodwill and intangible assets from its acquisitions of CMS in 2003, and TSE and Tertio in 2004. In accordance with SFAS No. 142, goodwill is not amortized but is subject to an impairment test at least annually at the reporting unit level by applying a fair-value-based test. Changes in the carrying amounts of goodwill by reporting unit for the nine months ended September 30, 2005 are as follows:

Goodwill:	License and Services			Customer Support			Total Goodwill
Balance as of December 31, 2004	$	20,689		$	17,009		$	37,698
Adjustments to goodwill	145			(328		)	(183		)
Effects of foreign currency exchange rates	(1,518		)	(937		)	(2,455		)
Balance as of September 30, 2005	$	19,316		$	15,744		$	35,060

The Company recorded goodwill adjustments during the nine months ended September 30, 2005 related to the finalization of the Tertio purchase price and contingent consideration and resulting goodwill related to certain specified gross margin results achieved by the sale of TSE products during the period. The Company may have additional purchase price adjustments related to TSE as contingent consideration is earned.

The Company’s annual goodwill impairment test was conducted as of July 31, 2005, and it was determined that goodwill was not impaired as of the test date.

Identifiable intangibles are amortized over estimated finite lives of from one to seven years, and include the cumulative effects of changes in foreign currency exchange rates.

	September 30, 2005								December 31, 2004
Identifiable intangible assets:	Gross Amount		Accumulated Amortization			Net Carrying Amount			Gross Amount		Accumulated Amortization		Net Carrying Amount
Purchased software	$	8,835	$	1,999		$	6,836		$	9,180	$	326	$	8,854
Customer contracts	1,701		1,555			146			1,859		305		1,891
Purchased licenses	1,335		509			826			1,335		309		1,026
Trademarks and tradenames	1,094		167			927			1,196		33		1,163
Business partnerships	1,365		178			1,187			1,491		35		1,456
Customer relationships	6,411		1,684			4,727			6,740		800		5,603
	$	20,741	$		6,092	$		14,649	$	21,801	$	1,808	$	19,993

Amortization expense of identifiable intangible assets was $1.4 million and $4.2 million for the three and nine months ended September 30, 2005, respectively, and $214,000 and $646,000 for the three and nine months ended September 30, 2004, respectively.

(4) Earnings Per Common Share

Basic earnings per share (“EPS”) is computed 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, such as the Series B Convertible Redeemable Preferred Stock (“Series B Preferred Stock”). Diluted EPS is computed 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 and shares held in escrow. The following is the reconciliation of the numerators and denominators of the basic and diluted EPS computations (in thousands except per share data):

	Three Months Ended September 30,		Nine Months Ended September 30,
	2005	2004	2005	2004
Weighted average common shares outstanding	16,055	15,890	16,024	15,860
Participating securities	2,610	—	2,610	—
Basic weighted average common shares outstanding	18,665	15,890	18,634	15,860
Effect of dilutive securities	—	1,016	—	1,518
Diluted weighted average common shares outstanding	18,665	16,906	18,634	17,378

Weighted average options to purchase 779,000 and 1.2 million shares of common stock were excluded from the dilutive stock calculation for the three and nine months ended September 30, 2005, respectively, as their effect would have been anti-dilutive as a result of the net loss for the period. Weighted average options to purchase 2.6 million and 2.4 million shares of common stock were excluded from the dilutive stock calculation for the three and nine months ended September 30, 2005, respectively, because their exercise prices were greater than the average fair value of the Company’s stock for the period.

Weighted average options to purchase 442,000 and 409,000 shares of common stock were excluded from the dilutive stock calculation for the three and nine months ended September 30, 2004, because their exercise prices were greater than the average fair value of the Company’s stock for the period.

The participating securities reflect 966,666 shares of Series B Preferred Stock, convertible into 2.9 million shares of the Company’s common stock, less the 96,667 shares of Series B Preferred Stock, convertible into 290,000 shares of the Company’s common stock, that are held in escrow. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128 “Earnings Per Share”, shares that are contingently issuable are not included in the computation of basic EPS until all necessary conditions have been satisfied (in essence, when issuance of the shares are no longer contingent).

(5) Stock-Based Compensation

The Company applies the intrinsic-value-based method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for employee stock-based compensation arrangements. Non-employee stock compensation arrangements are accounted for under SFAS No. 123, “Accounting for Stock-Based Compensation” and Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees, or in Conjunction with Selling Goods or Services.”

SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123,” established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended. The following table illustrates the effect on net income (loss) if the fair-value-based method had been applied to all outstanding and unvested awards in each period (in thousands, except per share data):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2005			2004		2005			2004
Net income (loss), as reported	$	(926	)	$	517	$	(3,762	)	$	593
Stock-based compensation expense under the fair value method	407			513		1,632			1,487
Pro forma net income (loss)	$	(1,333	)	$	4	$	(5,394	)	$	(894	)

Earnings (loss) per common share, as reported:
Basic	$	(0.05	)	$	0.03	$	(0.20	)	$	0.04
Diluted	$	(0.05	)	$	0.03	$	(0.20	)	$	0.03
Pro forma loss per common share:
Basic	$	(0.07	)	$	0.00	$	(0.29	)	$	(0.06	)
Diluted	$	(0.07	)	$	0.00	$	(0.29	)	$	(0.05	)

(6) Concentration of Credit Risk

For the three and nine months ended September 30, 2005, the Company recognized 45% (20%, 13% and 12%) and 39% (12%, 13% and 14%), respectively, of total revenue from three significant customers (defined as contributing at least 10%), in the communications industry. For the three months ended September 30, 2004, the Company recognized 72% (47%, 14% and 11%) of total revenue from three significant customers, all in the communications industry. For the nine months ended September 30, 2004, the Company recognized 72% (24%, 18%, 17% and 13%) of total revenue from four significant customers, all in the communications industry.

As of September 30, 2005, three significant customers accounted for approximately 50% (25%, 13% and 12%) of contract receivables. At December 31, 2004, three significant customers accounted for approximately 58% (30%, 17% and 11%) of contract receivables.

The Company earns a significant portion of its revenue from a small number of customers in the communications industry. This has been mitigated somewhat by the expansion of the Company’s customer base through recent acquisitions. 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, however, could be materially harmful to the Company’s business, financial condition, results of operations and cash flows.

(7) Notes Payable

The Company’s notes payable consist of the following (in thousands):

	As of September 30,				As of December 31,
	2005				2004
Long-term seller financed notes payable (Tertio), interest at weighted average rate of 11.62%, due in varying quarterly principal installments beginning March 31, 2006, with final maturity on December 31, 2007	$	13,195			$		11,950
Short-term seller financed note payable (Tertio), interest at 5.50%, $2,000 due and paid March 31, 2005 and $2,000 due and paid June 30, 2005	—				4,000
Promissory notes payable to TSE sellers, interest at 5.00%, due and paid March 31, 2005	—				889
Debt issuance costs	(76			)	(110			)
Total notes payable	13,119				16,729
Less: current portion, net	(4,422			)	(4,880			)
Long-term debt, net of current portion	$		8,697		$	11,849

The Company entered into the long-term seller-financed notes payable (“Long-Term Notes”) on November 2, 2004, in conjunction with the acquisition of Tertio. From the acquisition date through November 2, 2006, the Long-Term Notes bear interest at 11.0% per annum. From November 2, 2006 through the maturity date of December 31, 2007, the notes will bear interest at 14.0% per annum. Interest is recognized using an effective rate of 11.62% for the term of the notes. Interest is accrued and added to the principal balance through December 31, 2005, and beginning March 31, 2006, interest is payable in cash on a quarterly basis in addition to the scheduled principal payments. Accrued interest of approximately $1.2 million has been added to the principal balance of the Long-Term Notes during the nine months ended September 30, 2005. The Long-Term Notes payable may be prepaid at any time without

penalty. Beginning in March 2005, if the Company’s quarterly cash balances exceed $7.0 million, the holder of the Long-Term Notes may require a prepayment on the note equal to the amount by which the quarterly cash balance exceeds $7.0 million. Based on its projections of cash balances, the Company believes that these additional payments will not be required through September 30, 2006. The scheduled principal payments on the Long-Term Notes are as follows (in thousands):

Principal Payment Date	Amount
March 31, 2006	$	1,340
June 30, 2006	3,110
December 31, 2006	1,430
March 31, 2007	1,870
June 30, 2007	3,110
December 31, 2007	2,335
	$	13,195

The notes are secured by substantially all of the assets of Evolving Systems and a pledge, subject to certain limitations, of the shares of its subsidiaries.

The Long-Term Notes subject the Company to certain affirmative and negative covenants, including a financial covenant indexed to the Company’s computation of EBITDA, as defined. The Company was required to comply with such covenants beginning June 30, 2005 and has been in compliance since that date.

The notes issued in connection with the Tertio acquisition prohibit the Company from declaring dividends to its common stockholders during the term of the notes.

See also Note 13, Subsequent Events, for changes to the Company’s notes payable.

(8) Income Taxes

The Company recorded net income tax (expense) benefit of $(117,000) and $177,000 for the three and nine months ended September 30, 2005, respectively. The net (expense) benefit during the three and nine months ended September 30, 2005 consists of current income tax expense of approximately $419,000 and $1.0 million, respectively, and a deferred tax benefit of $302,000 and $1.2 million, respectively, both of which are related to the Company’s UK-based operations. The Company recorded current income tax expense of $20,000 and $12,000 for the three and nine months ended September 30, 2004, respectively, related primarily to U.S. state income taxes.

In conjunction with the acquisition of Tertio, certain identifiable intangible assets were recorded. Since the amortization of these identifiable intangibles is not deductible for income tax purposes, a long-term deferred tax liability of $4.6 million was established 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, 2005, this deferred tax liability was $3.3 million. This deferred tax liability is carried on the books of the Company’s United Kingdom subsidiary, and has no impact on the Company’s ability to recover its U.S.-based deferred tax assets.

In conjunction with the acquisition of Tertio, future revenue under contracts in existence at the acquisition dates was reduced to an amount equal to the Company’s estimated costs to fulfill its obligations under the contracts plus a reasonable profit margin on the Company’s estimated fulfillment effort. The resulting reduction of future revenue recorded for financial reporting purposes is not deductible for income tax purposes and thus, a current deferred tax liability of approximately $600,000 was established at the acquisition date. As of September 30, 2005, this deferred tax liability was $98,000. Both of the aforementioned deferred tax liabilities will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized and the contract revenue is recognized.

As of September 30, 2005 and December 31, 2004, the Company continued to maintain a full valuation allowance on its domestic net deferred tax asset, primarily consisting of certain net operating loss carryforwards. The Company’s assessment of this valuation allowance was made using all available evidence, both positive and negative. The Company considered its recent historical domestic losses, potential tax planning strategies, and projected future profitability; however, greater weight was given to historical results, as that evidence is more objectively verifiable. Given the weight of the evidence, the Company concluded that a full valuation allowance for its deferred tax asset was required. The Company is required to reassess its conclusions regarding its deferred tax asset valuation allowance at each financial reporting date. It is reasonably possible that future evaluation could result in a conclusion that all or a portion of the valuation allowance is no longer necessary, which could have a material impact on the Company’s results of operations and financial position.

(9) Restructuring and Other Expenses

In early 2002, management implemented a restructuring plan (the “Plan”) due to the downturn in the U.S. telecommunications industry, the Company’s sharp decline in revenue, the FCC’s delay in ruling on wireless number portability and other factors. The Plan included workforce reductions, restructuring of the Company’s headquarters building lease, the closure of its satellite field offices and the write down of certain fixed assets, all of which were executed in 2002.

At September 30, 2005 and December 31, 2004, the remaining accrual related to the closure of the satellite offices. Because the costs to sublease or terminate these lease commitments are based on estimates, the Company may incur additional costs related to the satellite office closures, disclosed as restructuring and other expenses (recovery) in the statements of operations. As of September 30, 2005 approximately $9,000 was included in accounts payable and accrued liabilities.

(10) Segment Information

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

The Company currently operates its business as two operating segments based on revenue type: license fees/services revenue and customer support revenue (as shown on the consolidated statements of operations). License fees and services revenue represents the fees received from the license of software products and those services directly related to the delivery of the licensed products, as well as fees for custom development, integration services and time and materials work. Customer support 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 and the related revenue, based on VSOE, is deferred and recognized ratably over the warranty period. Total assets by segment have not been specified because the information is not available to the chief operating decision-making group.

Segment information is as follows (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2005			2004		2005			2004
Revenue
License fees and services	$	4,821		$	810	$	14,643		$	6,412
Customer support	4,749			4,929		14,691			10,354
	$	9,570		$	5,739	$	29,334		$	16,766

Revenue less cost of revenue, excluding depreciation and amortization
License fees and services	$	2,536		$	2	$	6,989		$	3,409
Customer support	3,171			3,122		9,447			5,068
	5,707			3,124		16,436			8,477

Unallocated costs
Other operating expenses	4,324			2,194		13,726			6,632
Depreciation and amortization	1,717			485		5,293			1,456
Restructuring and other	4			—		(47		)	—
Income (loss) from operations	$	(338	)	$	445	$	(2,536	)	$	389

Geographic Regions

The Company, headquartered in Denver, Colorado, uses the customer locations as the basis of attributing revenues to individual countries. With the acquisition of London based Tertio, the Company now provides products and services on a global basis. Additionally, the Company’s personnel in Bangalore, India, provide support to the Company’s global operations. Financial information relating to the Company’s operations by geographic region is as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Revenue
United States	$	4,539	$	5,739	$	14,256	$	16,766
Europe, Middle East, Africa and Asia	5,031		—		15,078		—
Total Revenue	$	9,570	$	5,739	$	29,334	$	16,766

	As of September 30,		As of December 31,
	2005		2004
Long-lived assets, net
United States	$	1,108	$	1,563
Europe, Middle East, Africa and Asia	907		1,000
Total long-lived assets, net	$	2,015	$	2,563

(11) Commitments and Contingencies

As permitted under Delaware law, the Company has agreements with its officers and directors under which it agrees to indemnify them for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments the Company could be required to make under these indemnification agreements; however, the Company maintains Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable it to recover a portion of any future amounts paid. As a result of the Company’s insurance policy coverage, it believes the estimated fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2005 and December 31, 2004.

The Company enters into standard indemnification terms with its customers, as discussed below, in the ordinary course of business. Because the Company subcontracts some of the development of its deliverables under its customer contracts, the Company could be required to indemnify its customers for work performed by its subcontractors. Depending upon the nature of the customer indemnification, the potential amount of future payments the Company could be required to make under these indemnification agreements may be unlimited. The Company may be able to recover damages from a subcontractor if the indemnification to its customers results from the subcontractor’s failure to perform. To the extent the Company is unable to recover damages from its subcontractors, the Company could be required to reimburse the indemnified party for the full amount. The Company has never incurred costs to defend lawsuits or settle claims relating to indemnification arising out of its subcontractors’ failure to perform. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2005 and December 31, 2004.

The Company’s standard license agreements contain 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 warranty provisions require the Company to cure any defects through any reasonable means. To date, no formal claims under the warranty provisions have been brought to the Company’s attention. The Company believes the estimated fair value of the warranty provisions in the license agreements in place with its customers is minimal. Accordingly, the Company has not recorded liabilities for these warranty provisions as of September 30, 2005 and December 31, 2004.

The Company’s software arrangements generally include a product indemnification provision that the Company will indemnify and defend a client in actions brought against the client for claims that the Company’s products infringe upon a copyright, trade secret, or valid patent. Historically, the Company has not incurred any significant costs related to product indemnification claims. Accordingly, the Company has no liabilities recorded as of September 30, 2005 and December 31, 2004.

In relation to the acquisitions of Tertio, TSE and CMS, the Company agreed to indemnify certain parties of and from any losses, actions, claims, damages or liabilities (or actions in respect thereof) resulting from any claim raised by a third party. The Company does not believe that there will be any claims related to these indemnifications. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2005 and December 31, 2004.

From time to time the Company is involved in various legal proceedings arising in the normal course of business operations. We are not currently involved in any such proceedings.

(12) Recent Accounting Pronouncements

In May 2005, the FASB issued SFAS No. 154, “Accounting for Changes and Error Corrections – a Replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS 154). SFAS 154 requires retrospective application of voluntary changes in accounting principles, unless impracticable. SFAS 154 supersedes the guidance in APB Opinion No. 20 and SFAS No. 3, but does not change any transition provisions of existing pronouncements. Generally, elective accounting changes will no longer result in a cumulative effect of a change in accounting in the income statement, because the effects of any elective changes will be reflected as prior period adjustments to all periods presented. SFAS 154 will be effective beginning in fiscal 2006 and will affect any accounting changes that we elect to make thereafter.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (FIN 47). FIN 47 clarifies that conditional asset retirement obligations meet the definition of liabilities and should be recognized when incurred if their fair values can be reasonably estimated. The cumulative effect of

initially applying FIN 47 would be recognized as a change in accounting principle. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We do not expect FIN 47 to have a material impact on our financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 123(Revised), “Share-Based Payment.” This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Under the modified prospective method of adoption, SFAS No. 123(R) requires companies to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees and to record compensation cost for all stock awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. In addition, the Company is required to record compensation expense (as awards previously granted continue to vest) for the unvested portion of those awards that remain outstanding at the date of adoption. In accordance with adoption provisions released by the SEC, SFAS 123(R) will be effective for the Company on January 1, 2006. Management has not yet determined the impact that SFAS 123(R) will have on its financial position and results of operations, but expects that the stock incentive plans’ pro forma disclosure provides a reasonable measure of the expected annual impact.

(13) Subsequent Events

On November 14, 2005, the Company replaced its Long-Term Notes with the Tertio Sellers with a Subordinated Note, and entered into a Senior Term Note and a Senior Revolving Facility with a commercial finance company.

The $8.5 million Senior Term Note bears interest at LIBOR plus an applicable margin. The LIBOR rate varies, but can be no less than 3.75%. LIBOR was approximately 4.1% on November 14, 2005. The standard applicable margin of 6.25% may be reduced to 5.25% if the Company meets and maintains certain financial requirements. The Senior Term Note is secured by substantially all of the U.S. assets of Evolving Systems, Inc. The Senior Term Note subjects the Company to certain affirmative and negative covenants, including a financial covenant related to the Company’s EBITDA, as defined. The agreement restricts capital expenditures to specified limits and prohibits the Company from declaring dividends to its common stockholders. The Senior Term Note requires quarterly principal and monthly interest payments through October 2010.

The Company used the $8.5 million proceeds of the Senior Term Note to pay down a portion of the Long-Term Notes with the Tertio sellers. The Long-Term Notes were exchanged for unsecured Subordinated Notes of approximately $4.9 million, bearing interest at 11% through December 31, 2007, and 14% thereafter. The Subordinated Notes subject the Company to affirmative and negative covenants; however, certain covenants are not in effect until the Senior Term Note and Senior Revolving Facility are paid. The Senior Term Note and Senior Revolving Facility are senior to the Subordinated Notes. The Subordinated Notes are payable in full, including accrued interest, in May 2011.

The scheduled principal payments under the Senior Term Note and Subordinated Notes are as follows (in thousands):

Year ending December 31,	Amount
2006	$	1,000
2007	2,000
2008	2,500
2009	2,000
2010	1,000
Thereafter	4,900
	$	13,400

Additionally, the Company obtained a $4.5 million Senior Revolving Facility that bears interest at LIBOR plus 4.0%, and has an annual management fee of 0.05%. The LIBOR rate varies, but can be no less than 3.75%. Borrowings under the Senior Revolving Facility are limited to a multiple of the Company’s EBITDA, as defined, less the balance of the Senior Term Note. The multiple ranges from 2.50 in the first year to 1.75 in the fourth year. The agreement mandates an initial borrowing of $2.0 million. The Senior Revolving Facility is secured by substantially all of the assets of Evolving Systems U.K. and includes the same covenants and restrictions as the Senior Term Note. The Senior Revolving Facility requires monthly payments of interest and fees, with the unpaid balance due in October 2010.

If the Company is in compliance with all financial covenants of the Senior Term Note and Senior Revolving Facility, no events of default have occurred, and certain minimum liquidity conditions are met, early payment is allowed under those agreements.

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

OVERVIEW

Evolving Systems, Inc. (“we”, “our”, “us”) is a provider of mission critical software products and services to communications carriers. We maintain long-standing relationships with many of the largest wireline, wireless and cable communications carriers 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”) and Network Support Systems (“NSS”). Included among our more than 40 customers are four of the largest wireline carriers in North America, one of the largest cable companies in North America and three of the world’s 10 largest wireless carriers. We offer software products and solutions in three core areas — numbering solutions that enable carriers to comply with government-mandated requirements regarding phone number conservation and number portability; a service activation solution that is used to activate complex bundles of voice, video and data services; and mediation solutions supporting data collection for both service assurance and billing applications. Historically, our products have been used to support traditional telephony capabilities; however, today many communications carriers are using our products to support Voice over Internet Protocol (“VoIP”) offerings.

The core Evolving Systems portfolio that included ordering and provisioning solutions for Local Number Portability (“LNP”), as well as a number inventory and assignment platform, has recently been expanded, as a result of three acquisitions we made over a period of 12 months from November of 2003 to November of 2004. Through the acquisition of CMS Communications, Inc. (“CMS”) in November 2003 we acquired a network mediation and service assurance solution to add to our product portfolio. Additionally, with the acquisition of Telecom Software Enterprises, LLC (“TSE”) on October 15, 2004 we added LNP and Wireless Number Portability (“WNP”) number ordering and provisioning testing products which provide new OSS system integration capabilities. On November 2, 2004, we acquired Tertio Telecoms Ltd. (“Tertio”), a privately held supplier of OSS software solutions to communication carriers throughout Europe, the Middle East, Africa and Asia, expanding our markets beyond North America. Tertio’s leading activation solution, Provident™, now called Tertio™, and mediation solution Evident™, strengthen our overall product portfolio. Our significantly expanded product and service capabilities now enable us to address a larger portion of our customer’s application needs. Also, as a result of these acquisitions, we have become a company with global reach and a customer base that includes many of the world’s leading communications carriers. We are positioned as a provider of OSS, NSS and comprehensive systems integration capabilities. These complementary competencies enable us to address and implement solutions across much of a customer’s back office.

Company Background

Founded in 1985, we initially focused on providing custom software development and professional services to a limited number of telecommunications companies in the United States. 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, of which we are best known for our LNP and wireless service activation solutions.

Historically, we have helped our customers integrate our products into their existing business process and 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 customers’ back office to meet the specific requirements of each customer. Solutions which include our products, as well as product extensions and integration, are typically licensed to our customers and supported by us. In 2004, we expanded our direct sales reach to include indirect sales through partnerships with network equipment providers and system integrators, such as Siemens, Alcatel and Accenture. We anticipate these channel sales will extend our reach to new geographical regions as well as help us further penetrate our existing territories. We have also created packaged products with our channel partners, where we provide the underlying product and our partner provides some or most of the integration services.

Critical Accounting Policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require our judgment in its application. Our senior management has reviewed these critical accounting policies and related disclosures with our Audit Committee. We have identified policies in the areas listed below as critical to our business operations and the understanding of our results of operations.

• Revenue recognition

• Allowance for doubtful accounts

• Income taxes

• Intangible assets

• Business combinations

• Capitalization of internal software development costs

For a detailed discussion on the application of these accounting policies, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2004.

Recent Developments

Acquisition of TSE

In October 2004, we acquired TSE. TSE’s VeriPort™ and Verify™ products are sold to United States of America (“U.S.”) wireline and wireless carriers, and provide for simulation of the nation’s centralized Number Portability Administration Centers (“NPAC”) and a testing environment for critical back office systems that carriers use to enable number portability. Other products in the TSE portfolio are used for enhanced integration between back office OSS systems. TSE has installed its products at several of the leading wireless and wireline carriers in the U.S. By acquiring TSE, we have expanded our customer base and our numbering solutions products.

Acquisition of Tertio

In November 2004, we acquired Tertio and became a global company with a customer base that includes many of the world’s largest communication carriers. Tertio’s activation and mediation solutions, Provident and Evident, fit well with elements of our product portfolio, enabling us to provide activation solutions and strengthening our current mediation and service assurance offerings.

In January 2005, we changed Tertio’s name to Evolving Systems Limited (“Evolving Systems U.K.”). We also renamed the Provident activation product “Tertio”, to build on the strong recognition of the Tertio brand in the service activation market. The name changes are reflected in this filing where appropriate.

Expansion of Offshore Development Subsidiary

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, through a subcontractor, had been a key aspect of our low-cost, accelerated-deployment strategy. Having our own offshore subsidiary provides us with more control, flexibility and lower costs than we had using an offshore third party contractor. As of September 30, 2005, we had 83 employees in our India office with plans for further expansion as demand dictates.

Customer Support Revenue Deferral

During the first and second quarter of 2004, we deferred the recognition of customer support revenue for one of our largest customers. Under this maintenance arrangement, the customer purchased professional services, specified licensed software upgrades and support services. Since fair value of the undelivered specified licensed software upgrades did not exist, all of the revenue related to this contract was deferred until the specified licensed software upgrades were delivered and accepted by the customer. During the third quarter of 2004, we delivered and obtained acceptance of the specified licensed software upgrades. Since vendor specific objective evidence of fair value existed for all of the remaining undelivered elements in the arrangement, we recognized the residual amount of revenue for all delivered elements at that time. Accordingly, during the three and nine months ended September 30, 2004, we recognized approximately $1.1 million and $2.1 million, respectively of customer support revenue related to this contract. Our 2005 customer support contract with the same customer did not contain these additional accounting elements, and was not deferred.

Accelerated Filer Status

Companies considered accelerated filers under Securities Exchange Act Rule 12b-2, are required to comply with the internal control reporting and disclosure requirements of Section 404 of the Sarbanes-Oxley Act of 2002, for fiscal years ending on or after November 15, 2004. An accelerated filer is defined as a company that meets the following conditions as of the end of its fiscal year:

• Its common equity public float was $75 million or more as of the last business day of its most recently completed second fiscal quarter;

• The company has been subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act for a period of at least 12 calendar months;

• The company has previously filed at least one annual report pursuant to Section 13(a) or 15(d) of the Exchange Act; and

• The company is not eligible to use Forms 10-KSB and 10-QSB.

As of the last business day of our most recently completed second fiscal quarter, June 30, 2005, our common equity public float was less than $75 million, therefore we are not an accelerated filer, as defined in Securities Exchange Act Rule 12b-2, and are not required to comply with the management reporting on internal control over financial reporting for the year ending December 31, 2005. In September 2005, the SEC extended for one year the compliance dates regarding the internal control reporting requirements rules for companies that are not accelerated filers. If our filing status does not change as of June 30, 2006, the next measurement date, we must begin complying with the internal control reporting and disclosure requirements for our fiscal year ending December 31, 2007.

Cost Reductions

In July 2005, we undertook cost reduction measures that involved a 10% reduction in our workforce, including individuals at all levels of our U.S. and U.K. operations. The efforts around the cost reductions were also designed to better integrate our recent acquisitions. These reductions will save the Company more than $3.0 million annually, with the impact of the savings realized beginning in the fourth quarter of 2005. The Company paid related severance costs of $477,000 and $580,000, respectively, in the three and nine months ended September 30, 2005.

To meet our long-term goals, including revenue growth, we continue to make investments in our products. We are currently investing in both service activation and numbering solutions products to expand the number of products that we offer and achieve greater international sales of our existing numbering solutions products. These activities may cause research and development expenses to increase in future periods compared to prior periods.

Results of Operations

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
REVENUE
License fees and services	50	%	14	%	50	%	38	%
Customer support	50	%	86	%	50	%	62	%
Total revenue	100	%	100	%	100	%	100	%

COSTS OF REVENUE AND OPERATING EXPENSES
Costs of license fees and services, excluding depreciation and amortization	24	%	14	%	26	%	18	%
Costs of customer support, excluding depreciation and amortization	16	%	31	%	18	%	31	%
Sales and marketing	25	%	16	%	25	%	16	%
General and administrative	15	%	19	%	18	%	18	%
Product development	5	%	3	%	3	%	5	%
Depreciation	4	%	5	%	4	%	5	%
Amortization	14	%	4	%	14	%	4	%
Restructuring and other expenses (recovery)	—	%	—	%	—	%	—	%
Total costs of revenue and operating expenses	103	%	92	%	108	%	97	%
Income (loss) from operations	(3	)%	8	%	(8	)%	3	%
Interest income (expense), net	(4	)%	1	%	(4	)%	1	%
Other income (expense), net	(1	)%	—	%	(1	)%	—	%
Income (loss) before income taxes	(8	)%	9	%	(13	)%	4	%
Income tax (expense) benefit	(1	)%	—	%	—	%	—	%
Net income (loss)	(9	)%	9	%	(13	)%	4	%

The three and nine months ended September 30, 2005 compared to the three and nine months ended September 30, 2004

Revenue

Revenue is comprised of license fees/services and customer support. License fees and services revenue represent the fees we receive from the licensing of our software products and those services directly related to the delivery of the licensed product as well as integration services and time and materials work. Customer support revenue includes annual support, recurring maintenance, maintenance upgrades and warranty services. Warranty services consist of maintenance services and are typically bundled with a license sale and the related revenue, based on VSOE, is deferred and recognized ratably over the warranty period. The following table presents the Company’s approximate revenue by product group (in thousands).

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Numbering solutions	$	4,000	$	4,900	$	11,700	$	14,300
Mediation	900		800		3,800		2,500
Activation	4,700		—		13,800		—
	$	9,600	$	5,700	$	29,300	$	16,800

License Fees and Services

License fees and services revenue increased 495% to $4.8 million for the three months ended September 30, 2005, from $810,000 for the three months ended September 30, 2004. License fees and services revenue increased 128% to $14.6 million for the nine months ended September 30, 2005, from $6.4 million for the nine months ended September 30, 2004. The increase in license fees and services revenue is due to activation sales related to products acquired in the Tertio acquisition, offset by lower revenue from our number solutions products. The decline in number solutions products is due to industry consolidation and smaller overall license sales, which is reflective of the maturity of the narrowband numbering solutions market in the U.S.

Customer Support

Customer support revenue decreased 4% to $4.7 million for the three months ended September 30, 2005, from $4.9 million for the three months ended September 30, 2004. Third quarter numbering solutions revenue was lower in 2005, compared to 2004, because of the recognition in the third quarter of 2004 of a previously deferred, large customer support contract for approximately $1.1 million. This decrease in customer support revenue during the third quarter of 2005 was offset by increased revenue related to the support of activation products acquired in the Tertio acquisition.

Customer support revenue increased 42% to $14.7 million for the nine months ended September 30, 2005, from $10.4 million for the nine months ended September 30, 2004. The increase in customer support revenue during the first nine months of 2005 is due to increased revenue related to the support of activation products acquired in the Tertio acquisition, partially offset by price reductions in certain customer support contracts.

Costs of Revenue, Excluding Depreciation and Amortization

Costs of revenue, excluding depreciation and amortization, consist primarily of personnel costs, facilities costs, the costs of third-party software and all other direct costs associated with these personnel. Total costs of revenue, excluding depreciation and amortization, were $3.9 million and $2.6 million for the three months ended September 30, 2005 and 2004, respectively and $12.9 million and $8.3 million for the nine months ended September 30, 2005 and 2004, respectively. These costs are discussed further, below.

Costs of License Fees and Services, Excluding Depreciation and Amortization

Costs of license fees and services, excluding depreciation and amortization, were $2.3 million and $808,000 for the three months ended September 30, 2005 and 2004, respectively. The increase of $1.5 million, or 183%, is due to more projects in delivery as a result of the Tertio acquisition. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 47% for the three months ended September 30, 2005 from 99% for the three months ended September 30, 2004. The decrease as a percentage of license fees and services revenue was due to certain fixed costs being applied to a low level of revenue in 2004.

Costs of license fees and services, excluding depreciation and amortization, were $7.7 million and $3.0 million for the nine months ended September 30, 2005 and 2004, respectively. The increase of $4.7 million, or 155%, is due to more projects in delivery as a result of the Tertio acquisition, as well as additional costs incurred in the first half of the year related to transitioning from using third-party consultants for U.K. development to utilizing Evolving Systems personnel in India, via our offshore development model. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, increased to 52% for the nine months ended September 30, 2005 from 47% for the nine months ended September 30, 2004. The increase as a percentage of

license fees and services revenues was due to the aforementioned additional costs in the first half of the year related to the U.K. development transition to our offshore development model, including some duplicate operations during the transition, offset by savings from our offshore development model and certain fixed costs being applied to a higher level of revenue in 2005.

Costs of Customer Support, Excluding Depreciation and Amortization

Costs of customer support, excluding depreciation and amortization, were $1.6 million and $1.8 million for the three months ended September 30, 2005 and 2004, respectively. The decrease of $229,000, or 13%, is due to savings from transitioning to using Evolving Systems India personnel, offset by additional projects from the Tertio and TSE acquisitions. As a percentage of customer support revenue, costs of customer support revenue, excluding depreciation and amortization, decreased to 33% for the three months ended September 30, 2005 from 37% for the three months ended September 30, 2004. The decrease as a percentage of customer support revenue was due to the higher level of revenue in the third quarter of 2004 arising from the large customer support contract described above, as well as the savings from transitioning to using Evolving Systems India personnel.

Costs of customer support, excluding depreciation and amortization, were $5.2 million and $5.3 million for the nine months ended September 30, 2005 and 2004, respectively. The decrease of $100,000, or 1%, is due to decreased fees for third party software maintenance and savings from transitioning to using Evolving Systems India personnel, offset by additional projects from the Tertio and TSE acquisitions and the cost in the first half of the year to transition to using Evolving Systems India personnel. As a percentage of customer support revenue, costs of customer support revenue, excluding depreciation and amortization, decreased to 36% for the nine months ended September 30, 2005 from 51% for the nine months ended September 30, 2004. The decrease as a percentage of customer support revenue was due to savings from our offshore development model, decreased fees for third party software maintenance, and certain fixed costs being applied to a higher level of revenue in 2005, offset by the aforementioned additional costs in the first half of the year related to transitioning to our offshore development model.

Sales and Marketing

Sales and marketing expenses primarily consist of compensation costs, including bonuses and commissions, travel expenses, advertising and occupancy expenses. Sales and marketing expenses were $2.4 million and $942,000 for the three months ended September 30, 2005 and 2004, respectively. The increase of $1.5 million, or 158%, is due to additional costs from Evolving Systems U.K. and TSE, expenses in the U.S. related to increased headcount for sales initiatives designed to penetrate new markets, as well as a new company marketing campaign. As a percentage of total revenue, sales and marketing expenses for the three months ended September 30, 2005 and 2004, increased to 25% from 16%, respectively. The increase as a percentage of revenue is due to the combination of increased expenses from Evolving Systems U.K. and the increased expenses in the U.S., which exceeded the increase in revenue during the period.

Sales and marketing expenses were $7.2 million and $2.8 million for the nine months ended September 30, 2005 and 2004, respectively. The increase of $4.5 million, or 161%, is due to additional costs from Evolving Systems U.K. and TSE, increased expenses in the U.S. related to increased headcount for sales initiatives designed to penetrate new markets, and a new company marketing campaign. As a percentage of total revenue, sales and marketing expenses for the nine months ended September 30, 2005 and 2004, increased to 25% from 16%, respectively. The increase as a percentage of revenue is due to the combination of increased expenses from Evolving Systems U.K. and TSE, and the increased expenses in the U.S., which exceeded the increase in revenue during the period.

General and Administrative

General and administrative expenses consist principally of employee related costs and professional fees for the following departments: facilities, finance, legal, human resources, and executive management. General and administrative expenses were $1.4 million and $1.1 million for the three months ended September 30, 2005 and 2004, respectively. The increase of $344,000, or 31%, is primarily due to costs from Evolving Systems U.K. As a percentage of total revenue, general and administrative expenses for the three months ended September 30, 2005 and 2004, decreased to 15% from 19%, respectively. The decrease as a percentage of revenue is due to the increase in revenue from Evolving Systems U.K. and TSE, partially offset by the combination of increased expenses from Evolving Systems U.K..

General and administrative expenses were $5.4 million and $3.0 million for the nine months ended September 30, 2005 and 2004, respectively. The increase of $2.4 million, or 83%, is primarily due to costs related to the integration of Tertio, expenses from Evolving Systems U.K., and increased expenses in the U.S. related to significantly higher levels of professional fees. As a percentage of total revenue, general and administrative expenses for the nine months ended September 30, 2005 and 2004, was 18%. The expense as a percentage of revenue held steady due to the combination of increased expenses from Evolving Systems U.K. and increased professional fees in the U.S., which was matched by the increase in revenue during the period.

Product Development

Product development expenses consist primarily of employee related costs, offshore development subcontractor expenses and costs to start up our offshore Indian facility. Product development expenses were $452,000 and $152,000 for the three months ended September 30, 2005 and 2004, respectively. The increase of $300,000, or 198%, is due to costs related to development work on international numbering solutions products and additional work on our activation products, such as Tertio Content Connector. As a percentage of revenue, product development expenses for the three months ended September 30, 2005 and 2004, increased to 5% from

3%, respectively. The increase in costs as a percentage of revenue is due to additional research and development efforts in the third quarter of 2005 that have not yet resulted in an increase in revenue during the quarter.

Product development expenses were $1.1 million and $884,000 for the nine months ended September 30, 2005 and 2004, respectively. The increase of $174,000, or 20%, is due to costs related to development work on new activation and billing mediation products and features, and international numbering solutions products. As a percentage of revenue, product development expenses for the nine months ended September 30, 2005 and 2004, decreased to 3% from 5%, respectively. The decrease as a percentage of revenue is primarily due to the increased revenue during 2005 compared to 2004, partially offset by additional research and development efforts in the second and third quarters of 2005 that have not yet resulted in an increase in revenue.

Amortization

Amortization expense consists of amortization of identifiable intangibles from our acquisitions of CMS, TSE and Tertio. Amortization expense was $1.4 million and $213,000 for the three months ended September 30, 2005 and 2004, respectively. The increase in amortization expense of $1.1 million, or 534%, is due to amortization related to identifiable intangibles from the acquisitions of Tertio and TSE. As a percentage of revenue, amortization expense for the three months ended September 30, 2005 and 2004, increased to 14% from 4%, respectively. The increase as a percentage of revenue is due to the aforementioned increase in expenses, which was greater than the increase in revenue during the period.

Amortization expense was $4.2 million and $646,000 for the nine months ended September 30, 2005 and 2004, respectively. The increase in amortization expense of $3.5 million, or 546%, is due to amortization related to identifiable intangibles from the acquisitions of Tertio and TSE. As a percentage of revenue amortization expense for the nine months ended September 30, 2005 and 2004, increased to 14% from 4%. The increase as a percentage of revenue is due to the aforementioned increase in expenses, which was greater than the increase in revenue during the period.

Restructuring and Other Expenses (Income)

We closed all of our satellite field offices during 2002. Because the costs to sublease or terminate these lease commitments are based on estimates, we may incur additional costs related to the satellite office closures. During the three months ended September 30, 2005 we recorded a net expense of $4,000, related to a lease deposit withholding of $7,000 and a recovery of $3,000. During the nine months ended September 30, 2005, we recorded a net recovery of $48,000 related to the closure of the satellite offices, as the actual costs to close these facilities were less than our original estimate. As of September 30, 2005 approximately $9,000 was included in accounts payable and accrued liabilities related to the closure of the satellite offices.

Interest Income (Expense), Net

Interest income (expense), net was ($372,000) and $89,000 for the three months ended September 30, 2005. Interest income (expense), net was ($1.1 million) and $213,000 for the nine months ended September 30, 2005. The changes for the three and nine month periods of $461,000 and $1.3 million, respectively, were due primarily to the interest expense on the notes payable associated with the acquisition of Tertio and TSE.

Other Income (Expense), Net

Other income (expense), net, was ($99,000) and $3,000 for the three months ended September 30, 2005 and 2004, respectively. Other income (expense), net, was ($273,000) and $3,000 for the nine months ended September 30, 2005 and 2004, respectively. The changes for the three and nine month periods of $102,000 and $276,000, respectively, related to foreign currency transaction losses not present before the acquisition of Tertio in the fourth quarter of 2004.

Income Taxes

The Company recorded net income tax (expense) benefit of $(117,000) and $177,000 for the three and nine months ended September 30, 2005, respectively. The net benefit during the three and nine months ended September 30, 2005 consists of current income tax expense of approximately $419,000 and $1.0 million, respectively and a deferred tax benefit of $302,000 and $1.2 million, respectively, both of which are related to the Company’s UK-based operations.

In conjunction with the acquisition of Tertio, certain identifiable intangible assets were recorded. Since the identifiable intangible amortization is not deductible for income tax purposes, a long-term deferred tax liability of $4.6 million was established 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, 2005, this deferred tax liability was $3.3 million. This deferred tax liability is carried on the books of the Company’s United Kingdom subsidiary, and has no impact on the Company’s ability to recover its U.S.-based deferred tax assets.

In conjunction with the acquisition of Tertio, future revenue under contracts in existence at the acquisition dates was reduced to an amount equal to the Company’s estimated costs to fulfill its obligations under the contracts plus a reasonable profit margin on the Company’s estimated fulfillment effort. The resulting reduction of future revenue recorded for financial reporting purposes is not deductible for income tax purposes and, thus, a current deferred tax liability of approximately $600,000 was established at the acquisition date. As of September 30, 2005, this deferred tax liability was $98,000. Both of the aforementioned deferred tax liabilities will be recognized as a reduction of deferred income tax expense as the identifiable intangibles are amortized and the contract revenue is recognized.

Liquidity and Capital Resources

We have historically financed operations through cash flows from operations and equity transactions. At September 30, 2005, our principal source of liquidity was $3.4 million in cash and cash equivalents.

	Nine months ended September 30,
	2005			2004
Cash provided (used) by:
Operating activities	$	1,028		$	3,381
Investing activities	(1,183		)	(1,041		)
Financing activities	(7,435		)	356
Effect of exchange rates	(373		)	(3		)
Net cash provided (used)	$	(7,963	)	$	2,693

Net cash provided by operating activities consists primarily of our net income (loss), adjusted for non-cash charges (including depreciation, amortization, interest expense and deferred taxes) and changes in working capital. Our net income (loss) for the nine months ended September 30, 2005 and 2004, was $(3.8) million and $593,000, respectively, while our non-cash charges were net sources of $5.1 million and $1.4 million, respectively. For the nine months ended September 30, 2005 and 2004, the primary working capital factors were contract receivables (a source of $6.0 million and $7.1 million, respectively) and unearned revenue (a use of $4.9 million and $5.7 million, respectively).

Net cash used by investing activities during the nine months ended September 30, 2005 and 2004, was for capital expenditures of $656,000 and $1.1 million, respectively, primarily for domestic internal hardware that improved performance and reliability of our product development environment, as well as servers and computers for Evolving Systems India, as well as net cash outflows of $545,000 in 2005 related to the TSE acquisitions.

Financing activities in the nine months ended September 30, 2005, consisted primarily of principal payments on notes payable of $4.9 million, and payments to the Tertio sellers of $2.6 million. Cash provided by financing activities for the nine months ended September 30, 2005 and 2004, related to proceeds from the issuance of stock of $94,000 and $377,000, respectively.

Working capital (deficit) at September 30, 2005 was ($6.5) million compared to ($3.3) million at December 31, 2004. As previously mentioned, we acquired two companies, TSE and Tertio, during the fourth quarter of 2004. We made net payments of approximately $8.1 million during the nine months ended September 30, 2005 related to notes payable, an acquired dividend obligation assumed, and contingent consideration related to the TSE and Tertio acquisitions. The acquisition of Tertio also included the issuance of long-term seller-financed notes (“Long-Term Notes”) of approximately $11.9 million of which $4.5 million is due within the next twelve months. We believe that our current cash and cash equivalents, together with anticipated cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. In making this assessment we considered the following:

• Our cash and cash equivalents balance at September 30, 2005 of $3.4 million.

• Our ability to generate positive cash flows from operations. During 2003, 2004 and the nine months ended September 30, 2005 we generated cash flows from operations of $6.9 million, $4.3 million and $1.0 million, respectively.

• Our backlog of approximately $13.8 million, including $4.6 million in license fees and services and $9.2 million in customer support at September 30, 2005.

• In July 2005, we took steps to reduce our cost structure by reducing our workforce in the U.S. and U.K. by 10%. This will allow us to save approximately $3.0 million annually.

• Notwithstanding Long-Term Notes restructuring, our cash forecast indicates that we will have sufficient liquidity to cover anticipated operating costs as well as debt service payments.

To the extent we are unable to invoice and collect in a timely manner under our customer revenue arrangements, it could have a material adverse impact on our ability to meet our intended business objectives. Management believes that we have the ability to further reduce operating expenses, if necessary, such that current working capital (exclusive of deferred revenue) and cash flows from operations will be adequate to meet our cash needs through the next twelve months.

Notwithstanding these assessments, if the timing of cash generated from operations is insufficient to satisfy our liquidity requirements, or an unexpected adverse event, or combination of events, occurs, we may require access to additional funds to support our business objectives through debt restructuring, a credit facility or possibly the issuance of additional equity. There can be no assurance that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to

us and would not be dilutive.

On November 14, 2005, we replaced our Long-Term Notes with the Tertio Sellers with a Subordinated Note, and entered into a Senior Term Note and a Senior Revolving Facility with a commercial finance company. The new debt agreements improve our liquidity position by extending our principal payments and providing additional borrowing capacity.

We used the $8.5 million proceeds of the Senior Term Note to pay down a portion of our Long-Term Notes with the Tertio sellers. The Long-Term Notes were exchanged for unsecured Subordinated Notes of approximately $4.9 million, bearing interest at 11% through December 31, 2007, and 14% thereafter. The Subordinated Notes are payable in full, including accrued interest, in May 2011.

A comparison of the scheduled principal payments under our new and old notes is as follows (in thousands):

Year ending December 31,	New Amount		Old Amount
2006	$	1,000	$	5,900
2007	2,000		7,500
2008	2,500		—
2009	2,000		—
2010	1,000		—
Thereafter	4,900		—
	$	13,400	$	13,400

Additionally, we obtained a $4.5 million Senior Revolving Facility that bears interest at LIBOR plus 4.0%, and has an annual management fee of 0.05%. The LIBOR rate varies, but can be no less than 3.75%. Borrowings under the Senior Revolving Facility are limited to a multiple of our EBITDA, as defined, less the balance of the Senior Term Note. The multiple ranges from 2.50 in the first year to 1.75 in the fourth year. The agreement mandates an initial borrowing of $2.0 million. The Senior Revolving Facility requires monthly payments of interest and fees, with the unpaid balance due in October 2010.

Factors That Might Affect Operating Results

These results should be read in conjunction with the risk factors defined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Statements contained in this Quarterly Report with respect to future revenue and expenses are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ. Among the factors that could cause actual results to differ are those described below and in more detail in our Annual Report on Form 10-K.

Risks related to Tertio Acquisition

We are subject to financial and operating risks associated with international sales and services.

Historically sales of our products have been limited to customers in the United States. Prior to our acquisition of Tertio, our only international operational experience was with our Indian offshore activities. The acquisition of Tertio resulted in the addition of significant sales and operations outside the United States, including Europe, Asia and Africa. If we are unable to manage our sales and operations on a global basis, our financial condition or results of operations could be materially adversely affected. Our international business is subject to financial and operating risks including:

• unexpected changes in, or impositions of, legislative or regulatory requirements;

• difficulties in maintaining effective controls over financial reporting across geographically dispersed entities, including those related to different business practices in foreign countries;

• internal control-related risks of running a foreign subsidiary;

• changes in the demand for our products and services due to the perception that we are an “American” company in countries where the United States’ foreign policy is not viewed favorably;

• fluctuating exchange rates, tariffs, currency repatriation restrictions and other barriers;

• difficulties in staffing and managing foreign subsidiary operations;

• import or export restrictions;

• greater difficulties in accounts receivable collection and longer payment cycles;

• potentially adverse tax consequences and additional tax considerations such as foreign withholding taxes and payment of value added tax (VAT);

• potential hostilities and changes in diplomatic and trade relationships;

• changes in a country’s economic or political conditions; and

• differing customer and/or technology standards requirements.

Our stockholders will be diluted by the conversion of outstanding Series B Redeemable Convertible Preferred Stock.

In consideration for our acquisition of Tertio, we made a cash payment of $11.0 million, issued 966,666 shares of Series B Redeemable Convertible Preferred Stock (the Series B Preferred Stock), issued a short-term secured note with a principal amount of $4.0 million bearing interest at 5.5% per annum and issued long-term secured notes with an aggregate principal amount of approximately $11.9 million bearing interest initially at 11% per annum (increasing to 14% on the second anniversary). Each share of Series B Preferred Stock is initially convertible into three shares of our common stock which could result in the issuance of up to 2,899,998 shares of our common stock.

Prior to our acquisition of Tertio, only one of our stockholders reported beneficial ownership in excess of 5% of our common stock. If the shares of Series B Preferred Stock are exchanged for shares of our common stock, such stockholders would beneficially own approximately 15.3% of our issued and outstanding shares of common stock (after giving effect to such conversions). The sale by such holders of one or more large blocks of our common stock could have a negative impact on the market price of our common stock. Additionally, such ownership interests could effectively deter a third party from making an offer to buy us, which might involve a premium over our current stock price or other benefits for our stockholders, or otherwise prevent changes in the control or management of Evolving Systems. In addition, there are no restrictions, in the form of a standstill agreement or other agreements with such stockholders, on their ability or their affiliates to purchase additional shares of our common stock and thereby further increase their ownership interests.

The holders of the Series B Preferred Stock are entitled to vote on any matters presented to our stockholders together with the holders of common stock. While each share of Series B Preferred Stock initially converts into three shares of the Company’s common stock, each such share of Series B Preferred Stock is only entitled to approximately 2.26 votes in order to comply with certain voting rights rules promulgated by NASDAQ relating to the fact that the Series B Preferred Stock was issued at a discount to market on the date of issuance. As of the date hereof, the holders of the Series B Preferred Stock were entitled to an aggregate of approximately 2,184,665 votes on all matters presented to the holders of common stock based on their ownership of the Series B Preferred Stock. The Series B Preferred Stock is voluntarily convertible into our common stock at anytime at the option of the holders thereof, at which time each such share of common stock will be entitled to one vote per share.

On May 16, 2005, the Company sought the approval of its stockholders to exchange the $11.9 million long-term notes issued in connection with our acquisition of Tertio into convertible notes. While the note exchange proposal received the requisite number of votes for approval, a required amendment to the Company’s certificate of incorporation to increase the number of authorized shares of common stock to effectuate any such conversions did not receive enough votes, which therefore caused the note exchange proposal to fail. As a result, the long-term notes will remain outstanding in accordance with their terms. The Company may, but is not obligated to, resubmit such proposals to its stockholders in the future for their reconsideration. Accordingly, if the exchange of all or any portion of the long-term notes to convertible notes is eventually approved or otherwise authorized, the Company’s stockholders would experience additional dilution of their ownership interests and voting rights.

The holders of our Series B Preferred Stock have preferential rights that may be adverse to holders of our common stock.

The holders of the Series B Preferred Stock have preferential rights with respect to distributions upon a liquidation of Evolving Systems, including certain business combinations deemed to be a liquidation. Accordingly, no distributions upon liquidation may be made to the holders of common stock until the holders of the Series B Preferred Stock have been paid their liquidation preference of $3.89 per share (on an as converted common stock basis), subject to adjustment. As a result, it is possible that, on liquidation, all amounts available for the holders of equity of Evolving Systems would be paid to the holders of the Series B Preferred Stock, and that the holders of common stock would not receive any payment. Additionally, in connection with the Tertio acquisition we are obligated to file and keep effective a registration statement providing for the resale of the shares of our common stock issuable upon the conversion of the Series B Preferred Stock. If we fail to keep the registration statement effective, the holders of the Series B Preferred Stock will have the right to cause us to repurchase for cash the shares of the Series B Preferred Stock for $3.89 per share (on an as converted basis), or approximately $11.3 million. If we are required to make this payment, it would have a significant adverse impact on our liquidity and could cause us to incur additional indebtedness.

Additionally, the Series B Preferred Stock contains certain weighted average price based anti-dilution protections that, as long as they remain outstanding, would be triggered if we issued shares of our common stock (subject to certain adjustments and

standard exclusions relating to Company options) below $3.89 per share. However, such anti-dilution adjustments are capped to prohibit the Series B Preferred Stock from converting into 20% or more of our outstanding common stock.

In the event that we issued shares below this threshold, the holders of our common stock would be diluted to an unknown degree. Furthermore, the mere existence of such anti-dilution protections could make it difficult for us to issue any common stock below $3.89 per share, if at all. In the event the anti-dilution adjustments of the Series B Preferred Stock are triggered, such adjustments would result in a deemed dividend to the Series B Preferred Stock holders that would reduce income available to common stockholders. The charge would be equal to the number of additional shares issuable as a result of the anti-dilution calculation, multiplied by the fair value of the common stock on the date of the issuance of the Series B Preferred Stock, which was $4.64 per share. The deemed dividend charge could negatively affect the price of our common stock.

The indebtedness incurred in connection with the Tertio acquisition may limit our ability to grow and could adversely affect our financial condition.

The indebtedness incurred with respect to the long-term secured notes and, possibly, the redemption of the Series B Preferred Stock, is material in relation to our current level of indebtedness. No assurance can be given that sufficient funds will be available to meet our operating needs, to pay the interest due on the long-term secured notes or, if required, to redeem the Series B Preferred Stock. The notes are secured by a general lien on all of our assets. If we are unable to pay the notes as they become due, the holders of the notes could foreclose on all of our assets. The increased level of our indebtedness, among other things, could:

• make it difficult for us to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes;

• limit our flexibility in planning for, or reacting to changes in, our business; and

• make us more vulnerable in the event of a downturn in our business.

If we incur new indebtedness in the future, the related risks that we now face could intensify. Whether we are able to make required payments on our outstanding indebtedness and to satisfy any other future debt obligations will depend on our future operating performance and our ability to obtain additional debt or equity financing.

The terms and conditions of the Series B Preferred Stock may have an adverse impact on our results of operations and financial performance.

The inability to keep the registration of the Series B Preferred Stock effective could result in the Series B Preferred Stock becoming mandatorily redeemable. Currently, the Series B Preferred Stock is classified as non-permanent equity since the events that would require its redemption have not occurred. If we fail to maintain the effectiveness of the related registration statement, the Series B Preferred Stock will become mandatorily redeemable at the option of the holders and the instrument will be reclassified as a liability. Upon reclassification, the Series B Preferred Stock will be re-measured at its then current fair value and the difference between its fair value and redemption price will be charged to additional paid-in capital. Such a charge to equity may negatively impact the price of our common stock. Subsequent changes to the fair value of this instrument would be recognized in earnings, as a charge or income, and such amounts could be significant and unpredictable.

Certain provisions of the notes payable issued in conjunction with the Tertio acquisition call for the acceleration of payments if certain covenants are breached or cash balance thresholds are achieved.

The notes issued in conjunction with the Tertio acquisition contain certain affirmative and negative covenants that, if breached, could result in such notes becoming immediately due and payable. The covenants include the Company’s agreement to do the following:

• comply with applicable laws and licensing requirements;

• file and pay all applicable taxes as they become due; and

• operate in the ordinary course of business.

• The covenants also include the Company’s agreement not to do any of the following (except as specifically authorized in such notes):

• liquidate, dissolve or wind-up operations;

• pay any dividends or make prepayments on any indebtedness;

• acquire any other businesses or entities or make investments in third parties;

• sell or transfer a substantial portion of the Company’s assets;

• incur additional indebtedness or permit any liens on the Company’s assets;

• make capital expenditures beyond established thresholds; or

• take certain other operational actions.

The covenants may limit the Company’s flexibility in planning for, or reacting to changes in, its business. Failure to comply with such covenants, if not waived, could result in the acceleration of the notes. If the Company is required to pay the notes on an accelerated basis, it would have a significant adverse impact on the Company’s liquidity and financial condition and could cause us to incur additional indebtedness.

Additionally, the notes issued in conjunction with the Tertio acquisition require us to offer the note holders a prepayment on such notes in the amount that our closing cash balance exceeds $7.0 million at the end of any fiscal quarter beginning with the quarter ended March 31, 2005. Such a requirement will restrict our liquidity and cash management flexibility. Until the notes are repaid, our ability to engage in transactions or to enter into agreements requiring significant cash investments may be adversely affected.

Risks Related to Our Business

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

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

• the size of new contracts and when the related revenue is recognized;

• our rate of progress under our contracts;

• acquisition and integration costs;

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

• our ability to effectively manage offshore software development in India;

• actual or anticipated changes in government laws and regulations related to the telecommunications market;

• judicial or administrative actions about these laws or regulations;

• the nature and pace of enforcement of the Telecom Act as well as other similar foreign statutes, regulations and acts;

• product lifecycles;

• the mix of products and services sold;

• changes in demand for our products and services;

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

• budgeting cycles of our customers;

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

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

• competition by existing and emerging competitors in the communications software markets;

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

• software defects and other product quality problems;

• changes in our strategy;

• the extent of industry consolidation;

• foreign exchange fluctuations; and

• general economic conditions.

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

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

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

Our cash forecast indicates that we will have sufficient liquidity to cover anticipated operating costs as well as debt service payments for at least the next twelve months, but to the extent we are unable to invoice and collect in a timely manner under our customer revenue arrangements, or an unexpected adverse event, or combination of events occurs, it could have an adverse impact on our ability to meet our intended business objectives. Therefore, if the timing of cash generated from operations is insufficient to satisfy our liquidity requirements, we may require access to additional funds to support our business objectives through debt restructuring, a credit facility or possibly the issuance of additional equity. There can be no assurance that additional financing will be available at all or that if available, such financing will be obtainable on terms favorable to us and would not be dilutive.

Our international operations pose complex foreign currency, economic, regulatory and tax risks, which may have a material adverse effect on our business, financial condition and results of operations.

For the three and nine months ended September 30, 2005, we generated revenue of approximately $5.0 million and $15.1 million, respectively, from our foreign subsidiaries, representing 53% and 51%, respectively, of our total consolidated revenue. We anticipate that international revenue will continue to account for a significant percentage of our total revenue. Our international operations are subject to the risk factors inherent in the conduct of international business, including:

• unexpected changes in regulatory requirements;

• tariffs and other barriers;

• political and economic instability;

• limited intellectual property protection;

• difficulties in staffing and managing foreign operations; and

• potentially adverse tax consequences in connection with repatriating funds.

We may not be able to sustain or increase our international revenue or repatriate cash without incurring substantial risks involving floating currency exchange rates and income tax expenses. Any of the foregoing factors may have a material adverse effect on our international operations and, therefore, our business, financial condition and results of operations.

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

The market for our traditional North American 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 WNP products. WNP went into effect in November 2003. 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. Additionally, with our acquisition of Tertio, we are now subject to numerous regulatory requirements of foreign jurisdictions. Any compliance failures or changes in such regulations could also materially harm our business, financial condition, results of operations and cash flows.

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

In the past, and currently, we earn a significant portion of our revenue from a small number of customers in the communications industry. This has been mitigated somewhat by the expansion of our customer base through our recent acquisitions. However, 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.

The integration of entities that we have recently acquired may not achieve the expected results and may result in unexpected liabilities and costs

The integration of Tertio and TSE 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:

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

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

•		we may incur unanticipated liabilities that are not covered by our indemnification rights under the applicable acquisition agreements;

•		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;

•		we may not be successful in cross-selling products between Evolving Systems’ and the acquired companies’ customer bases;

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

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

•		significant impairment charges may be recorded if intangible assets, including goodwill, acquired in business combinations are determined to be unrecoverable or impaired;

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

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

•		our stockholders may experience additional dilution of their interests in Evolving Systems as a result of the issuance of convertible preferred stock, other convertible instruments and/or common stock in connection with our acquisitions;

•		certain management and other employees of Tertio and TSE, 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; and

•		the price of our stock may go down as stockholders who received stock in prior acquisitions, 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 and year to year. As a result, quarter-to-quarter and year-to-year comparisons of operating results are not necessarily meaningful or indicative of future performance.

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

Implementing our solutions can be a relatively complex and lengthy process since we typically customize these solutions for each customer’s unique environment. Often our customers may also require rapid deployment of our software solutions, resulting in pressure on us to meet demanding delivery and implementation schedules. 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, delayed payments, and deferral of revenue recognition. In addition, if our software contains defects or we otherwise fail to satisfy acceptance criteria within prescribed times, the customer may be entitled to 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.

Our products typically require significant review and internal approval processes by our customers over an extended period of time. Interruptions in such process due to economic downturns, consolidations or otherwise could result in the loss of our sales and adversely affect our financial performance.

Large communications 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 our contracts. 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 and year to year.

Mergers and acquisitions of large communications companies, as well as the formation of new alliances, have resulted in a constantly changing marketplace for our products and services. 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, the U.S. communications industry is still recovering from an industry downturn which began in 2000, and many of the companies in the communications industry have kept capital expenditures at historically low levels in response to changes in the communications marketplace; some companies have declared bankruptcy, cancelled contracts, delayed payments to their suppliers or delayed additional purchases. The delay or failure to complete one or more large contracts, or the loss of a significant customer, could materially harm our business, financial condition, results of operations, or cash flows, and cause our operating results to vary significantly from quarter to quarter and year to year.

Many of our products and services are sold on a fixed-price basis. If we incur budget overruns, our margins and results of operations may be materially harmed.

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 budget overruns. On occasion, 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, including overruns that result in losses on these contracts. If we incur budget overruns, our margins and results of operations may be materially harmed.

The industry in which we compete is subject to rapid technological change, if we fail to develop or introduce new, reliable and competitive products in a timely fashion, our business may suffer.

The market for our products and services is subject to rapid technological changes, evolving industry standards, changes in carrier requirements and preferences and frequent new product introductions and enhancements. The introduction of products that incorporate new technologies and the emergence of new industry standards can make existing products obsolete and unmarketable. To compete successfully, we must continue to design, develop and sell enhancements to existing products and new products that provide higher levels of performance and reliability in a timely manner, take advantage of technological advancements and changes in industry standards and respond to new customer requirements. 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, results of operations may be materially harmed.

The market for our number portability products is mature and we may not be able to successfully develop new products to remain competitive.

The market for our number portability products is mature in the U.S and we may not be able to successfully identify new product opportunities in the U.S. or abroad or achieve market acceptance of new products brought to the market. Although wireless number portability was only recently mandated in the U.S., 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 in the U.S. or abroad, our business, financial condition, results of operations or cash flows could be materially harmed.

The steps that we have taken to reduce costs may have a negative impact on our ability to grow and generate future revenue.

We have taken steps to reduce our expenses, such as reductions in staff and general cost control measures. If, as a result of such cost reductions, we have not adequately responded 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.

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

In February 2004, we formed Evolving Systems India, a wholly owned subsidiary of Evolving Systems, to transfer the services provided by our Indian subcontractor, Infosys, to Evolving Systems India. If we are unable to effectively manage the Evolving India development staff and/or we experience high levels of staff turnover, we may fail to provide quality software in a timely fashion, which could negatively affect our ability to satisfy our customer contracts. Furthermore, political changes and uncertainties in India could negatively impact the business climate there. As a result, we may be unable to satisfactorily perform our customer contracts and our business, financial condition and results of operations could be materially harmed.

The communications industry is highly competitive and if our products do not satisfy customer demand for performance or price, our customers could purchase products and services from our competitors.

Our primary markets are intensely competitive and 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., Syniverse Technologies and Tekelec. Our principal competitors in activation are Metasolv and Comptel. In mediation, we compete with many different companies with no single dominant competitor. There also can be no assurance that customers will not offer competitive products or services in the future since customers who have purchased solutions from us are not precluded from competing with us. Many telecommunications companies have large internal development organizations, which develop software solutions and provide services similar to the products and services we provide. We also expect competition may increase in the future from Application Service Providers, existing competitors and from other companies that may enter our existing or future markets with solutions which may be less costly, provide higher performance or additional features or be introduced earlier than our solutions.

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

• how well we respond to our customers’ needs;

• 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;

• our technical subject matter expertise;

• 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 and their strategic partners, 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. Our failure to adapt to emerging market demands, respond to regulatory and technological changes or compete successfully with existing and new competitors would materially harm our business, financial condition, results of operations and cash flows.

Our failure to attract and retain qualified personnel on a timely basis could materially harm our business.

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. In addition, our stock option plan terminates on January 19, 2006 and under Nasdaq rules we will be required to obtain stockholder approval to establish a new equity compensation plan. If we are unsuccessful in obtaining this approval, our ability to attract or retain employee may be harmed. Our failure to retain personnel or to hire qualified personnel on a timely basis could materially harm our business, financial condition, results of operations and cash flows.

Our products are complex and may have errors that are not detected until deployment, and litigation related to warranty and product liability claims could be expensive and could negatively affect our reputation and profitability.

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.

There can be no assurances that our measures to protect our proprietary technology and other intellectual property rights are adequate and if we fail to protect those rights, our business would be harmed.

Our success and ability to compete are dependent to a significant degree on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We have 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.

In the event that we are infringing upon the proprietary rights of others or violating licenses, we may become subject to infringement claims that may prevent us from selling certain products and we may incur significant expenses in resolving these claims.

It is also possible that our business activities may infringe upon the proprietary rights of others, or that other parties may assert infringement claims against us. If we become liable to any third party for infringing its intellectual property rights, we could be required to pay substantial damage awards and to develop non-infringing technology, obtain licenses, or to cease selling the applications that contain the infringing intellectual property. Litigation is subject to inherent uncertainties, and any outcome unfavorable to us could materially harm our business. Furthermore, we could incur substantial costs in defending against any intellectual property litigation, and these costs could increase significantly if any dispute were to go to trial. Our defense of any litigation, regardless of the merits of the complaint, likely would be time-consuming, costly, and a distraction to our management personnel. Adverse publicity related to any intellectual property litigation also could harm the sale of our products and damage our competitive position.

Certain software developed or used by Evolving Systems, as well as certain software acquired in our acquisitions of TSE or Tertio, may include or be derived from software that is made available under an open source software license.

• Such open source software may be made available under a license such as the GNU General Public License (“GPL”) or

GNU Lesser General Public License (“LGPL”) which imposes certain obligations on us in the event we were to distribute derivative works based on the open source software. These obligations may require us to make source code for these derivative works available to the public or license the derivative works under a particular type of open source software license, rather than the license terms we customarily use to protect our software.

• There is little or no legal precedent for interpreting the terms of certain of these open source licenses, including the terms addressing the extent to which a derivative work based on open source software may be subject to these licenses. We believe we have complied with our obligations under the various applicable open source licenses. However, if the owner of any open source software were to successfully establish that we had not complied with the terms of an open source license for a particular derivative work based on that open source software, we may be forced to release the source code for that derivative work to the public or cease distribution of that work.

• We generally prohibit the combination of our proprietary software with open source software. Despite these restrictions, parties may combine our proprietary software with open source software without our authorization, in which case such parties could be forced to release to the public the source code of our proprietary software.

Disruptions from terrorist activities or military actions may have an adverse effect on our business.

The continued threat of terrorism within the U.S. and throughout the world and acts of war may cause significant disruption to commerce throughout the world. Our business and results of operations could be materially and adversely affected to the extent that such disruptions result in delays or cancellations of customer orders, delays in collecting cash, a general decrease in corporate spending on information technology, or our inability to effectively market, manufacture or ship our products. We are unable to predict whether war and the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have any long-term material adverse effect on our business, results of operations, financial condition or cash flows.

The trading price of our stock has been subject to wide fluctuations and may continue to experience volatility in the future.

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, merger and acquisition activity, changes in financial estimates by securities analysts, the operating and stock 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.

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

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

We are subject to certain rules and regulations of federal, state and financial market exchange entities, the compliance of which requires substantial amounts of management time and company resources.

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 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. Our compliance with certain of these rules, such as Section 404 of the Sarbanes-Oxley Act, is likely to require the commitment of significant managerial resources. We are currently reviewing our material internal control systems, processes and procedures for compliance with the requirements of Section 404. There can be no assurance that such a review will not result in the identification of significant deficiencies or material weaknesses in our internal controls.

We have never paid dividends and do not anticipate paying cash dividends on our common stock in the foreseeable future.

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. In addition, the notes issued in connection with the Tertio acquisition prohibit us from declaring dividends to our common stockholders during the term of the notes. Accordingly, we do not anticipate paying cash dividends on our common stock in the foreseeable future.

Certain provisions of our charter document, employment arrangements and Delaware law may discourage or prevent takeover attempts that could result in the payment of a premium price to our stockholders.

Our restated certificate of incorporation allows our 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. In 1999, our Board of directors designated 250,000 shares of Series A Junior Participating Preferred Stock that contain “poison pill” provisions. In connection with the Tertio acquisition, we issued 966,666 shares of Series B Preferred Stock. We have no current plans to issue additional 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 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.

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

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

We are very limited in our ability to issue additional shares of common stock.

As of the date hereof, we have less than 50,000 authorized and unreserved shares of common stock available for issuance. We are, therefore, limited in our ability to issue shares of common stock which may hinder our ability to raise capital, use our common stock as currency for future acquisitions or increase the number of shares of common stock available for issuance under our stock option plan. To increase our authorized shares of common stock requires the approval of the stockholders owning a majority of our then issued and outstanding shares of common stock. Our last two attempts to obtain stockholder approval to increase the number of our authorized shares of common stock have been unsuccessful due to lower than required stockholder participation. There can be no assurances that our stockholders will in the future approve an increase in our authorized shares of common stock.

General risk statement.

Based on all of the foregoing, we believe it is possible for future revenue, expenses and operating results to vary significantly from quarter to quarter. 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 would likely go down.

ITEM 3. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES

For additional information about Evolving Systems’ risk factors see the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Foreign Exchange Risk

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

The Company has assets and liabilities, including a substantial portion of its intangible assets and its cash balances, in its United Kingdom subsidiary, denominated in the British Pound. To the extent that the exchange rate between the US Dollar and the British pound fluctuates, such fluctuation will have an impact on the Company’s comprehensive income in the form of translation adjustments, and could have an impact on the Company’s liquidity position in that the Company’s UK cash balances are maintained in British Pounds.

We transact business in various foreign currencies. As we continue to expand our international business, we are subject to increasing exposure from adverse movements in foreign exchange rates. At the present time, we do not hedge our foreign currency exposure, nor do we use derivative financial instruments for speculative trading purposes.

Interest Rate Risk

In the ordinary course of business we are exposed to the risk of changes in interest rates. Our cash balances are subject to interest rate fluctuations and as such, interest income amounts may fluctuate from current levels.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. As of September 30, 2005, the end of the period covered by this report, we evaluated, under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.

(b) Changes in internal controls. There has not been any change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the period covered by this report, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time we are involved in various legal proceedings arising in the normal course of business operations. We are currently not aware of any legal proceedings that would have a material effect on our business, financial condition or results of operations.

ITEM 6. EXHIBITS

(a) Exhibits

Exhibit 31.1 - Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 - Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 - Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 - Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

PART I – FINANCIAL INFORMATION
Item 1	Financial Statements
	Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2005 and December 31, 2004
	Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 2005 and 2004
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2005 and 2004
	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 Market Risk Disclosures
Item 4	Controls and Procedures
PART II – OTHER INFORMATION
Item 1	Legal Proceedings
Item 6	Exhibits
Signatures

Date: November 14, 2005	/s/ BRIAN R. ERVINE
	Brian R. Ervine
	Executive Vice President, Chief
	Financial and Administrative Officer,
	Treasurer and Assistant Secretary
	(Principal Financial and Accounting Officer)