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

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

FORM 10-K

Commission File Number: 0-24081

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

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

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

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

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

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

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

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

PART I

Item 1. Business Overview

Introduction

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

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

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

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Recent Developments

Acquisition of CMS Communications, Inc.

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

Wireless Number Portability ("WNP")

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

Offshore Development

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

Management Changes

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

ServiceXpress Strategy

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

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

Industry Background

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

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

Operations Support Systems (OSS)

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

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

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Solutions for OSS

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

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

ServiceXpress Methodology and Toolkit

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

NumeriTrack Number Inventory and Assignment Solution

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

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

Network Assurance and Fulfillment Solutions

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

Custom Solutions and Integration

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

Business Structure and Strategy for Growth

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

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

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

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

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

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

Sales and Marketing

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

Product Development and Support

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

Competition

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

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

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

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

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

Intellectual Property

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

Backlog

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

Employees

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

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Risk Factors

Fluctuations in Quarterly Results of Operations

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

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the size of new contracts and when they are signed;



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our rate of progress under our contracts;



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



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our ability to effectively manage offshore software development in India;



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



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judicial or administrative actions about these laws or regulations;



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the nature and pace of enforcement of the Telecom Act;



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product lifecycles;



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the mix of products and services sold;



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changes in demand for our products and services;



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



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budgeting cycles of our customers;



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



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



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



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



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software defects and other product quality problems;



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changes in our strategy;



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the extent of industry consolidation; and



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general economic conditions.

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

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

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

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

Regulatory Uncertainties

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

Reliance on Significant Customers

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

Risks Associated with Offshore Development

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

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

Integration of CMS or Future Acquisitions

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

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



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



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



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



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



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



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



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



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



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



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



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



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

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

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

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

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

Lengthy Sales Cycle/Consolidations and Budget Cutbacks in the Industry

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

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

Fixed-Price Contracts

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

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

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

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

Mature Market for Number Portability Products

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

Risks Associated with Managing Expenses

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

Competition

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

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

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

•

how well we respond to our customers' needs;



•

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, could harm our business, financial condition, results of operations and cash flows. There can be no assurance that we will be able to compete successfully with existing or new competitors or that we will properly identify and address the demands of new markets. This is particularly true in new markets where standards are not yet established, such as in the wireless data area where we are participating in an industry forum to establish standards to manage the presence and availability of wireless communications. Our failure to adapt to emerging market demands, respond to regulatory and technological changes or compete successfully with existing and new competitors would materially harm our business, financial condition and results of operations.

Risks Associated with Recruiting and Retaining Personnel

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

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Product Liability

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

Protection of Intellectual Property; Risks of Infringement

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

International Operations

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

•

Compliance with international laws and regulatory requirements



•

The potential exchange and repatriation of foreign earnings



•

Foreign currency exchange rate fluctuations



•

Difficulties in staffing and managing Indian operations

Possible Volatility of Stock Price

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

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

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

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

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

Reporting Requirements

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

We Have Never Paid Dividends

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

Certain Anti-Takeover Provisions

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

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

15

classified board of directors, may have the effect of delaying or preventing changes in control of our management, which could adversely affect the market price of our common stock by discouraging or preventing takeover attempts that might result in the payment of a premium price to our stockholders.

Available Information

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

Item 2. Properties

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

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

Item 3. Legal Proceedings

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

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

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

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PART II

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

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

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

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

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

Item 6. Selected Financial Data

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

17

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

(1)

In 2003 we expensed $233,000 of in-process research and development associated with the acquisition of CMS Communications, Inc.

(2)

In 2002 we incurred $5.1 million in restructuring and other expenses related to our headcount reduction; headquarters lease restructure, satellite office closures and asset impairments. See Note 4 to the Consolidated Financial Statements.

(3)

In 2001 a full valuation allowance was recorded relating to our deferred tax asset. See Note 7 to the Consolidated Financial Statements.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

        This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about Evolving Systems' industry, management's beliefs, and certain assumptions made by management. Forward-looking statements include our expectations regarding product, services, and customer support revenue, our expectations associated with Evolving India, and short- and long-term cash needs. In some cases, words such as "anticipates", "expects", "intends", "plans", "believes", "estimates", variations of these words, and similar expressions are intended to identify forward-looking statements. The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10K. Our

18

actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in this section and in the section entitled "Risk Factors."

Introduction

        Evolving Systems ("we", "our", "us") is a provider of mission critical and cost-effective software solutions to tier one telecommunications companies. We maintain long-standing relationships with many of the largest wireline and wireless telecommunications providers in the United States. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (OSS) and enhanced services platforms.

        Historically, we have helped our customers integrate our products into their existing OSS environments. In 2002, we initiated a restructuring plan, which, in addition to significant operational cost reductions and greater leverage of offshore development, included the reengineering of our business model to a solutions strategy. The solutions business model reflects a more balanced mix of services and products, and a push for integration and enhancements of our customer's back office which meets the specific requirements of each customer. We branded the integration and development methodology that supports our new business strategy ServiceXpress. The implementation of the new solutions business model was followed by a transition to increased revenue and profitability in 2003.

Executive Summary

        During 2003, we recorded our first full year of profitability as a public company. Due to increased revenue and significantly lower expenses due to our restructuring plan in 2002, we had net income for the year ended December 31, 2003 of $6.9 million compared to a net loss of $12.4 million for the year ended December 31, 2002.

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

        We recorded increased revenues in license and services as well as customer support. The increase in license and services revenue is due to the transition to a solutions model which reflects a more balanced mix of services and products and the pursuit of follow on business with current customers which typically includes extensions or enhancements to our core products. The implementation of WNP in November 2003 did not have a material effect on our 2003 results but we believe there are continuing revenue opportunities to provide upgrade and enhancement services to meet the needs of our customers. Future challenges in license and services revenue include our high level of customer concentration as well as the maturity of the market related to our core products.

        Customer support revenues increased due to an increase in our installed licensed software base and the acquisition of CMS in November 2003 which contributed $370,000 in customer support revenue. Customer support agreements have historically been renewed annually. Customer pressures for quarterly maintenance renewals and lower maintenance fees could affect future customer support contracts.

        Total costs of revenue and operating expenses decreased by 40% or $14.3 million during 2003. The decrease is due to the restructuring that took place during 2002. The combination of higher revenues and significantly lower costs enabled us to more than double our cash during the year to $18.0 million and increase our working capital by $10.3 million.

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Critical Accounting Policies

        Management's Discussion and Analysis of Financial Condition and Results of Operations are 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. We have identified these policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to this policy on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements in Item 16 of this Annual Report on Form 10-K, beginning on page F-6.

•

Revenue recognition



•

Allowance for doubtful accounts



•

Income taxes



•

Goodwill and intangible assets

Revenue Recognition

        The Company derives revenue from two primary sources: license fees/services and customer support. We recognize revenue in accordance with Statements of Position, or 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." In addition we have adopted Staff Accounting Bulletin, or SAB, No. 104, "Revenue Recognition," which provides further interpretive guidance for public companies on the recognition, presentation and disclosure of revenue in financial statements.

        The majority of our license fees and services revenue is generated from fixed-price contracts that provide for both licenses and services. Revenue under these arrangements, where the services are essential to the functionality of the delivered software, is recognized using the percentage-of-completion method of accounting, in accordance with SOP 81-1, "Accounting for Long-Term Construction Type Contracts". The percentage of completion for each contract is determined based on the ratio of direct labor hours incurred to total estimated direct labor hours. Due to the fact that the estimated direct labor hours 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 and all such amounts are expected to be billed and collected during the succeeding 12 months.

        In arrangements where the services are not essential to the functionality of the delivered software, we recognize license revenue when a license agreement has been signed, delivery has occurred, the fee is fixed or determinable and collectibility is probable. Where applicable, fees from multiple element arrangements are unbundled and recorded as revenue as the elements are delivered to the extent that vendor specific objective evidence ("VSOE") of fair value exists. If VSOE does not exist, fees from such arrangements are deferred until the earlier of the date that VSOE does exist or all of the elements are delivered.

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

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

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

Allowance for Doubtful Accounts

        We make judgments related to our ability to collect outstanding accounts receivable. We provide allowances for receivables when their collection becomes doubtful by recording an expense. Generally, we determine the allowance based on our assessment of the realization of receivables using the historical information and current economic trends, including assessing the probability of collection from customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments owed to us, an increase in the allowance for doubtful accounts would be required. We evaluate the adequacy of the allowance regularly and make adjustments accordingly. Adjustments to the allowance for doubtful accounts could materially affect our results of operations.

Income Taxes

        We account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Significant judgment is required in determining our provision for income taxes. We assess the likelihood that our deferred tax asset will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we establish a valuation allowance. We consider future taxable income projections, historical results and ongoing tax planning strategies in assessing the recoverability of deferred tax assets. However, adjustments could be required in the future if we determine that the amount to be realized is less or greater than the amount that we recorded. Such adjustments, if any, could have a material impact on our results of our operations.

Goodwill and Intangible Assets

        We account for our purchase of an acquired company in accordance with SFAS No. 141, "Business Combinations." We allocate the cost of an acquired company to the tangible and identifiable intangible assets and liabilities acquired, with the remaining amount being recorded as goodwill. Certain intangible assets are amortized over their estimated lives, while in-process research and development is recorded as a one-time charge to product development expense in the statements of operations on the acquisition date.

        We assess the impairment of identifiable intangibles and goodwill, annually or more frequently if events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Factors that we consider important which could trigger an impairment review include the following:

•

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



•

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

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•

Significant negative industry or economic trends;



•

Significant decline in our stock price for a sustained period; and or



•

Our market capitalization relative to net book value

        If we determine that the carrying value of intangibles and/or long-lived assets may not be recoverable based on the existence of one or more of the above indicators of impairment, we measure any impairment based on the estimated discounted cash flows expected to result from the use of the asset and its eventual disposition and compare that to the asset's carrying amount. Any impairment loss recognized would represent the excess of the asset's carrying value over its estimated fair value.

Results of Operations

        The following table sets forth, for the periods indicated, our Consolidated Statements of Operations reflected as a percentage of total revenue.

        Beginning in the first quarter of 2003, we began to evaluate our business on a project basis, separately managing the delivery of new projects from recurring customer support projects. Revenue is comprised of license fees/services and customer support. Delivery projects include software license fees, custom development, integration and time and materials work. Customer support includes recurring maintenance fees, annual support fees and warranty maintenance. Warranty maintenance revenues are withheld from the percent complete calculation on a project and are recognized ratably over the warranty period. Prior to the first quarter of 2003, we classified license fees and those services directly related to the delivery of licensed product, along with warranty maintenance, as license fees and related services. Customer support and other services included the remaining revenue types. Beginning in the first quarter of 2003, all delivery projects are classified as license fees/services and all support projects are classified as customer support. This change has not impacted our revenue recognition policy.

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Accordingly, license fees/services and customer support revenues and the related costs of license fees/services and customer support for the years ended December 31, 2002 and 2001 have been reclassified to conform to our current presentation. This change had no effect on our financial position, total revenue, net income (loss) or cash flows for any of the periods presented.

Revenue

        Revenue is comprised of license fees/services and customer support. Total revenue was $28.0 million, $23.0 million and $34.1 million for the years ended December 31, 2003, 2002 and 2001, respectively.

License fees and services

        License fees and services revenues increased 20% to $14.6 million for the year ended December 31, 2003, from $12.1 million for the year ended December 31, 2002. The increase in 2003 is due to our transition to a solutions business model, which has increased the number of revenue generating projects, internal stabilization following the 2002 restructuring and improved customer confidence related to our improved financial condition.

        License fees and services revenues decreased 52% to $12.1 million for the year ended December 31, 2002, from $25.3 million for the year ended December 31, 2001. The decrease in 2002 is primarily due to an $11.8 million decrease in custom development services related to the poor economic condition in the telecommunications market.

        In addition, 2001 license fees and services revenue were further impacted by the termination of our revenue sharing ASP arrangement we had with Qwest Communications International Inc. ("Qwest"). This ASP arrangement was amended in response to Qwest's decision to discontinue its plans to offer certain of our products on a commercial ASP basis. We continue to provide software and services to Qwest for its internal operations; however, the impact of the new business relationship was a reduction in our fourth quarter 2001 revenue of $1.2 million.

Customer Support

        Customer support revenues increased 24% to $13.4 million for the year ended December 31, 2003 from $10.8 million for the year ended December 31, 2002. The increase in 2003 is due to the increase in our installed licensed software base upon which support fees are charged and our acquisition of CMS, which provided $370,000 of customer support revenue from its acquisition date of November 3, 2003 through December 31, 2003.

        Customer support revenues increased 24% to $10.8 million for the year ended December 31, 2002 from $8.7 million for the year ended December 31, 2001. The increase in 2002 is due to the increase in our installed licensed software base upon which support fees are charged.

Costs of Revenue, Excluding Depreciation and Amortization

        Costs of revenue, excluding depreciation and amortization, consist primarily of personnel costs, offshore development subcontractor costs, facilities costs, the costs of third-party software and all other direct costs associated with this personnel. Total costs of revenue, excluding depreciation and amortization were $11.5 million, $17.0 million and $29.4 million for the years ended December 31, 2003, 2002 and 2001, respectively. Headcount reductions of 111 associated with our restructuring plan in 2002 were related to departments within costs of revenue.

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Costs of License Fees and Services, Excluding Depreciation and Amortization

        Costs of revenue for license fees and services, excluding depreciation and amortization, decreased 9% to $5.2 million for the year ended December 31, 2003 from $5.6 million for the year ended December 31, 2002. The decrease in 2003 is due to decreased employee and related expenses due to staff reductions, primarily in the first three quarters of 2002 and reduced facilities costs related to our restructuring plan. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 35% for the year ended December 31, 2003, from 46% for the year ended December 31, 2002. The decrease as a percentage of license fees and services revenue is primarily due to the 20% increase in license fees and services revenue during 2003.

        Costs of revenue for license fees and services, excluding depreciation and amortization, decreased 72% to $5.6 million for the year ended December 31, 2002 from $20.2 million for the year ended December 31, 2001. The decrease in 2002 is due to decreased employee and related expenses due to staff reductions in 2002 and reduced facilities costs related to our restructuring plan. As a percentage of license fees and services revenue, costs of license fees and services, excluding depreciation and amortization, decreased to 46% for the year ended December 31, 2002, from 80% for the year ended December 31, 2001. The decrease as a percentage of license fees and services revenue is due to the significant savings related to our restructuring plan which exceeded the 52% decrease in revenue.

Costs of Customer Support, Excluding Depreciation and Amortization

        Costs of revenue for customer support, excluding depreciation and amortization, decreased 44% to $6.3 million for the year ended December 31, 2003 from $11.4 million for the year ended December 31, 2002. The decrease in 2003 is due to decreased employee and related expenses due to staff reductions in 2002 and reduced facilities costs related to our restructuring plan. As a percentage of customer support revenue, costs of customer support, excluding depreciation and amortization, decreased to 47% for the year ended December 31, 2003, from 105% for the year ended December 31, 2002. The decrease as a percentage of customer support revenue is primarily due to decreased costs related to our restructuring plan and a 24% increase in customer support revenue.

        Costs of revenue for customer support, excluding depreciation and amortization, increased 23% to $11.4 million for the year ended December 31, 2002 from $9.2 million for the year ended December 31, 2001. The increase in 2002 is due to increased employee and related expenses related to the 24% increase in customer support revenue. As a percentage of customer support revenue, costs of customer support, excluding depreciation and amortization, decreased to 105% for the year ended December 31, 2002, from 106% for the year ended December 31, 2001. The decrease as a percentage of customer support revenue is due to larger increase in revenue than costs in 2002.

Sales and Marketing

        Sales and marketing expenses consist primarily of compensation costs, including bonuses and commissions, travel, public relations and occupancy expenses. Sales and marketing expenses were $2.9 million, $4.9 million and $8.2 million for the years ended December 31, 2003, 2002 and 2001, respectively. The decrease of 40% to $2.9 million for the year ended December 31, 2003 from $4.9 million for the year ended December 31, 2002 was due to a reduction of our sales and marketing staff throughout 2002, related to our restructuring plan as well as significant decreases in advertising and travel and entertainment costs which was partially offset by increased bonus expense. We eliminated 18 of the 24 positions in sales and marketing related to our restructuring plan in 2002. As a percentage of revenue, sales and marketing expenses decreased to 11% for the year ended December 31, 2003 from 21% for the year ended December 31, 2002. The decrease as a percentage of

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revenue is due to the aforementioned reduction in sales and marketing staff and related expenses in 2002 and a 22% increase in revenue during 2003.

        Sales and marketing expenses decreased 40% to $4.9 million for the year ended December 31, 2002 from $8.2 million for the year ended December 31, 2001. The decrease was due to a reduction of our sales and marketing staff, related to our restructuring plan, lower commission expense due to a decline in sales, as well as decreases in travel and entertainment and advertising related costs. As a percentage of revenue, sales and marketing expenses decreased to 21% for the year ended December 31, 2002 from 24% for the year ended December 31, 2001. The decrease as a percentage of revenue is due the aforementioned reduction in sales and marketing staff and related expenses in 2002.

General and Administrative

        General and administrative expenses consist principally of compensation costs, which includes bonuses, for the following departments; facilities, finance, legal, human resources, and executive management. General and administrative expenses were $3.5 million, $5.4 million and $8.7 million for the years ended December 31, 2003, 2002 and 2001, respectively. The decrease of 36% to $3.5 million for the year ended December 31, 2003 from $5.4 million for the year ended December 31, 2002 was due to decreased salary expenses resulting from staff reductions throughout 2002, partially offset by increased bonus expense, and reduced facility costs related to our restructuring plan. We eliminated 16 of the 39 general and administrative positions as a result of the restructuring plan that took place in 2002. As a percentage of revenue, general and administrative expenses decreased to 13% for the year ended December 31, 2003 from 24% for the year ended December 31, 2002. The decrease as a percentage of revenue is due to the aforementioned headcount reductions and restructure of our headquarters lease in 2002 as well as a 22% increase in revenue in 2003.

        General and administrative expenses decreased 38% to $5.4 million for the year ended December 31, 2002 from $8.7 million for the year ended December 31, 2001. The decrease was due to decreased salary expenses resulting from staff reductions throughout 2002 and reduced facility costs related to our restructuring plan. As a percentage of revenue, general and administrative expenses decreased to 24% for the year ended December 31, 2002 from 26% for the year ended December 31, 2001. The decrease as a percentage of revenue is due to the aforementioned headcount reductions and restructure of our headquarters lease in 2002.

Product Development

        Product development expenses consist primarily of personnel, occupancy and offshore development subcontractor expenses. Product development expenses were $2.0 million, $1.2 million and $3.1 million for the years ended December 31, 2003, 2002 and 2001, respectively. The increase of 69% to $2.0 million for the year ended December 31, 2003 from $1.2 million for the year ended December 31, 2002 was due to our work on our ServiceXpress toolkit, WNP readiness and a $233,000 write-off of in-process research and development associated with our acquisition of CMS. As a percentage of revenue, product development costs increased to 7% for the year ended December 31, 2003 from 5% for the year ended December 31, 2002. The increase as a percentage of revenue is due to the work on ServiceXpress and the in-process research and development write-off related to the CMS acquisition.

        As part of our 2002 restructuring plan we focused our employee resources on developing specifically requested customer projects. The effects of our eliminating 20 product development positions, along with fewer staff being dedicated to product development in 2002 resulted in the decrease of $1.9 million or 61% compared with 2001. As a percentage of revenue, product development costs decreased to 5% for the year ended December 31, 2001 from 9% for the year ended December 31, 2001. The decrease as a percentage of revenue is due to the aforementioned headcount reductions in 2002.

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Restructuring and Other Expense

        In late 2001 and early 2002, management implemented a restructuring plan (the "Plan") due to the downturn in the telecommunications industry, the Company's sharp decline in revenue, the delay in ruling on WNP 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. The Company recorded an expense (benefit) of ($9,000) and $5.1 million in restructuring and other for the years ended December 31, 2003 and 2002, respectively.

        Work force reductions.    We reduced our staff by 165 people (41 in the first quarter, 78 in the second quarter, 29 in the third quarter and 17 in the fourth quarter) in 2002. All departments within the Company were impacted by the reductions. As a result, we recorded expenses associated with these reductions in staff of approximately $1.5 million in restructuring and other expenses for the year ended December 31, 2002. In 2003, we reduced our work force reductions accrual related to the settlement of severance benefits, which resulted in a benefit of $80,000 for the year ended December 31, 2003. We made cash payments of $57,000 and $1.4 million for the years ended December 31, 2003 and 2002, respectively, related to the work force reductions. All payments for these employees were contractually defined and fixed. At December 31, 2003 there was no remaining liability related to these workforce reductions.

        Restructure of headquarters lease.    In June 2002, we restructured and amended our lease agreement on our Englewood, Colorado headquarters lease and recorded a lease cancellation charge and related liability of $2.0 million in restructuring and other expenses less a net benefit of approximately $200,000 of rent escalation liabilities that were reversed and building improvement costs that we assumed. The amended lease decreased the overall leased square footage and decreased the lease term from February 2016 to May 2007. During 2002, we paid our landlord $1.1 million, with the remaining $900,000 paid in 2003. As of December 31, 2003, there was no remaining liability related to this obligation. In addition, as security for the amended lease obligation, we restricted $500,000 of cash through the issuance of a letter of credit to our landlord in the third quarter of 2002. The restricted cash requirement will expire by $100,000 in December 2004, $100,000 in December 2005 and the remainder in May 2007 as long as our account is in good standing.

        Closure of satellite offices.    We closed all of our satellite field offices during the six months ended June 30, 2002. Estimated costs to sublease or terminate the lease commitments of $84,000 and $484,000 were recorded for the years ended December 31, 2003 and 2002, respectively. During the years ended December 31, 2003 and 2002, we made cash payments of $66,000 and $327,000, respectively. The cash payments are net of sublease income of $108,000 and $29,000 for the years ended December 31, 2003 and 2002 respectively. At December 31, 2003, $128,000 was included in accounts payable and accrued liabilities, and an additional $47,000 was included in long-term obligations related to these office closures, which will be paid over the remaining lease terms. The lease terms range from 10 months to 28 months. The costs to sublease or terminate these lease commitments are based on estimates and as such, we may incur additional costs related to the satellite office closures.

        Impairment of assets.    We recorded a non-cash expense of $1.1 million for the impairment of assets in restructuring and other expenses during the year ended December 31, 2002. The majority of this charge resulted from the abandonment of leasehold improvements relating to the restructuring of our headquarters lease in June 2002 and the remainder was due to the abandonment of furniture and equipment related to employee reductions. These assets were taken out of service in the second quarter and were disposed of during the third quarter of 2002.

        Other Costs.    We recorded an expense of $106,000 related to other assets that we would no longer be utilize as a result of the restructuring.

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Other income (expense)

        Other income (expense) includes interest expense on our capital leases, interest income on cash and cash equivalents and gains or losses on the disposal of assets. Other income (expense) was $191,000, $35,000 and $256,000 for the years ended December 31, 2003, 2002 and 2001, respectively, and resulted in net other income for each of the years. The increase for the year ended December 31, 2003 compared to 2002 is due to increased interest income from higher cash balances and losses on disposal of certain assets that occurred in 2002. The decrease for the year ended December 31, 2002 compared to 2001 is due to decreased interest income from reduced interest rates and from reduced cash balances.

Provision for income taxes

        We recorded income taxes expense of $167,000 during 2003 related primarily to our alternative minimum tax ("AMT") liability. The expense is a result of the net operating loss carryforward for AMT purposes that may only be used to offset 90% of our alternative minimum taxable income.

        A full valuation allowance is recorded as of December 31, 2003, due to uncertainties related to the ability to utilize our deferred tax assets, primarily consisting of certain net operating loss carryforwards, before they expire. Our assessment of this valuation allowance was made using all available evidence. In particular, we considered both its historical results and its projections of profitability for only the reasonably foreseeable future periods. Our realization of the recorded net deferred tax assets is dependent on future taxable income and, therefore, we are not assured that such benefits will be realized.

Quarterly Financial Information

        The following table sets forth certain unaudited information for each of our last eight quarters. This data has been derived from unaudited consolidated financial statements that have been prepared on the same basis as the annual audited consolidated financial statements and, in our opinion, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such information. Fourth quarter 2003 results include the acquisition of CMS from the acquisition date of November 3, 2003 to December 31, 2003.

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        These consolidated unaudited quarterly results should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. The results of operations for any quarter are not necessarily indicative of the results for any future period.

(1)

For the three months ended September 30, 2002 and December 31, 2002, we decreased total estimated hours on a significant fixed price project that resulted in an increase in revenue of approximately $700,000 and $1.0 million, respectively.

(2)

For the three months ended March 31, 2003, we had $1.6 million of license fees and services revenue related to a large LNP project completed in the quarter.

(3)

For the three months ended December 31, 2002, we had a benefit of $138,000 due to a decrease in the allowance for doubtful accounts. The decrease in the allowance for doubtful accounts was due to collections from customers.

(4)

For the three months ended September 30, 2003 and December 31, 2003, we recorded income tax expense of $126,000 and $41,000, respectively, to record our estimated alternative minimum tax liability.

(5)

During the three months ended December 31, 2003, we had product development expense of $233,000 for in-process research and development costs associated with our acquisition of CMS.

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Liquidity and Capital Resources

        We have historically financed operations through a combination of cash flow from operations and equity transactions. At December 31, 2003, our principal source of liquidity was $13.8 million in working capital. There is no debt outstanding at December 31, 2003, except for property and equipment financed under a capital lease and the remaining lease obligations on offices that were closed during our 2002 restructuring.

        Net cash provided by operating activities was $6.9 million in the year ended December 31, 2003 compared to cash used in operating activities of $2.5 million in the year ended December 31, 2002. The main factors in the cash provided by operating activities for the year ended December 31, 2003 were net income of $6.9 million, a decrease in accounts receivables of $3.5 million and depreciation and amortization of $1.3 million. Offsetting increases to cash flows from operating activities for the year ended December 31, 2003 were accounts payable and accrued liabilities of $1.5 million, unearned income of $3.2 million, and unbilled work-in-process of $493,000.

        Net cash used by investing activities during the year ended December 31, 2003 was $9,000 compared to cash used by investing activities during the year ended December 31, 2002 of $180,000. During 2003, we purchased $367,000 in property and equipment to support operations. The acquisition of CMS provided a net cash inflow of $352,000.

        Financing activities provided $2.5 million in cash for the year ended December 31, 2003 compared to cash used by financing activities of $521,000 in the year ended December 31, 2002. During 2003, we received proceeds from the issuance of common stock under our stock option and employee stock purchase plans of $2.6 million which was partially offset by repayments of capital lease obligations of $29,000.

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        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 December 31, 2003 of $18.0 million.



•

Our working capital balance at December 31, 2003 of $13.8 million.



•

Our profitability in each of the prior six quarters and anticipated profitability in 2004.



•

Our backlog of approximately $11.0 million at December 31, 2003.

        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 and cash flows from operations will be adequate to meet our cash needs through next year.

Off-Balance Sheet Arrangements

        As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2003, we are not involved in any unconsolidated SPE or off-balance sheet arrangements.

Contractual Obligations and Commercial Commitments

        The following summarizes our significant contractual obligations, net of estimated rental income under non-cancelable subleases, which are comprised of a capital lease and operating leases (in thousands).

Impact of Inflation

        Inflation has not had a significant effect on our operations during the three years ended December 31, 2003.

Accounting Estimates

        On an on-going basis, we evaluate our estimates, including those related to project completion, customer programs and incentives, bad debts, income taxes, warranty maintenance, cancellation costs, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from these estimates under different assumptions or conditions.

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Business Combination

        On November 3, 2003, we acquired privately-held CMS for 732,773 shares of Evolving Systems Inc. common stock, of which 10% will be held in escrow for up to one year. The stock escrow was established to provide a means whereby the Company may make claims (within 1 year of closing) if certain representations and warranties made by CMS are determined to be materially different than represented during the merger. There was also a cash escrow account of $62,000 that was put in place by CMS to ensure that net cash position of CMS was positive as of the acquisition date. If the net cash position of CMS is negative as of the acquisition date and the cash escrow is to be distributed to Evolving Systems, then a purchase price adjustment will be reflected in the period in which the cash is received. Net cash is defined as the sum of all cash, cash equivalents, prepaid expenses and net accounts receivable less the sum of all accounts payable, accrued liabilities and deferred revenue. The acquisition was treated as a business combination and the results of operations were combined from the purchase date forward.

        CMS is a provider of network management operations support software for major telecommunications carriers. In addition to adding complementary products and sharing many common customers, CMS brings a workforce that is familiar with complex tier one telecommunications solutions. We believe that CMS's network management products will fit our solutions business model and provide us with additional opportunities with our tier one customers.

        The aggregate purchase price of approximately $11.2 million includes the issuance of 732,773 shares of Evolving Systems, Inc. common stock in exchange for all outstanding shares of CMS. The fair value of our common stock was determined using an average price of approximately $14.98 in accordance with EITF 99-12, "Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination," which was the average closing price a few days before and after the merger agreement.

        In accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations," we allocated the purchase price to tangible assets, liabilities and intangible assets acquired, as well as in-process research and development, based on their estimated fair values. The excess purchase price over the fair values was recognized as goodwill. The fair value assigned to intangible assets acquired was based on estimates and assumptions determined by management. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill will not be amortized but will be reviewed annually for impairment. Purchased intangibles with finite lives are amortized on a straight-line basis over their respective useful lives. The total purchase price has been allocated as follows (in thousands):

        The Company hired an independent firm to assist in performing the purchase price allocation. The purchase price allocation analysis included, the future use of the acquired assets, analyses of historical performance and estimates of future performance of CMS' products. The fair value of intangible assets

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was primarily based on the income approach. The rates utilized to discount the net cash flows to their present values were based on our weighted average cost of capital. Amortization of identifiable intangibles will be expensed as "costs of license fees and services, excluding depreciation and amortization" and "costs of customer support, excluding depreciation and amortization". At December 31, 2003, identifiable intangible assets purchased in the CMS acquisition consist of the following (in thousands, except for useful life):

        Expected future amortization expense related to identifiable intangibles as of December 31, 2003 is as follows (in thousands):

        In-process research and development ("IPR&D") of $233,000 was expensed as "Product development" in the accompanying statements of operations because the purchased research and development had no alternative uses and had not reached technological feasibility. The value assigned to IPR&D was determined using the income approach by segregating cash flow projections related to in process projects. The stage of each in process project was estimated to determine the discount rate to be applied to the valuation of the in process technology.

Recent Accounting Pronouncements

        In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 addresses consolidation of business enterprises of variable interest entities which have certain characteristics. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies, in the first fiscal year beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of FIN 46 has not had, nor does the Company believe it will have, a material impact on its current or prospective consolidated financial statements.

        In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ("SFAS 150"). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 shall be effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The FASB

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issued FASB Staff Position ("FSP") 150-3 on November 7, 2003 to defer the effective date for applying the provisions of SPAS No. 150 for certain mandatorily redeemable non-controlling interests. The Company does not expect the provisions of this statement to have a significant impact on its current or prospective consolidated financial statements.

        In December 2003, the SEC issued SAB 104, Revenue Recognition, ("SAB 104") which rescinds and updates SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosure about Market 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.

        Our cash balances are subject to interest rate fluctuations and as such, interest income amounts may fluctuate from current levels.

Item 8. Consolidated Financial Statements and Supplementary Data

        The consolidated financial statements required pursuant to this item are included in Item 15 of this Annual Report on Form 10-K and are presented beginning on page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        Not Applicable.

Item 9A. Controls and Procedures

        Evaluation of disclosure controls and procedures.    We maintain "disclosure controls and procedures," as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act"), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

        Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material

33

information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Annual Report on Form 10-K was being prepared.

        Changes in internal control over financial reporting.    There was no change in our internal control over financial reporting that occurred during the fourth quarter of the period covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. During the first quarter of 2003, we implemented new accounting software. The implementation has increased our access to detailed project information.

PART III

Item 10. Directors and Executive Officers of the Registrant

        Incorporated by reference to the section of Evolving Systems, Inc. 2004 Proxy Statement, anticipated to be filed within 120 days of December 31, 2003, entitled "Proposal 1—Election of Directors," and the section entitled "Management."

Item 11. Executive Compensation

        Incorporated by reference to the section of the Evolving Systems, Inc. 2004 Proxy Statement, anticipated to be filed within 120 days of December 31, 2003, entitled "Executive Compensation."

Item 12. Security Ownership of Certain Beneficial Owners and Management

        Incorporated by reference to the section of the Evolving Systems, Inc. 2004 Proxy Statement, anticipated to be filed within 120 days of December 31, 2003, entitled "Security Ownership of Certain Beneficial Owners and Management."

Item 13. Certain Relationships and Related Transactions

        Incorporated by reference to the section of the Evolving Systems, Inc. 2004 Proxy Statement, anticipated to be filed within 120 days of December 31, 2003, entitled "Certain Relationships and Related Transactions."

Item 14. Principal Accounting Fees and Services

        Incorporated by reference to the section of the Evolving Systems, Inc. 2004 Proxy Statement, anticipated to be filed within 120 days of December 31, 2003, entitled "Report of the Audit Committee-Review of Fiscal Year 2003 Financial Statements."

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PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)

The following documents are filed as part of this Annual Report on Form 10-K.

(1)

Consolidated Financial Statements: The following consolidated financial statements of Evolving Systems, Inc. are filed as part of this report.

(2)

Financial Statement Schedule. The following financial statement schedule for each of the years ended December 31, 2003, 2002 and 2001 is filed as part of this Annual Report on Form 10-K and should be read in conjunction with the Consolidated Financial Statements and the related notes thereto.

Schedules other than the one listed above have been omitted since they are neither required, nor applicable or the information is otherwise included.

(3)

Exhibits.

35

†

Incorporated by reference to the Registrant's Registration Statement on Form S-1 No. 333-43973.

The exhibits listed on the accompanying index to exhibits, immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Form 10-K.

(b)

Reports on Form 8-K.

        On November 4, 2003, we filed a Current Report on Form 8-K announcing that we had acquired privately-held CMS Communications, Inc. of Columbus, Ohio for 732,773 shares of Evolving Systems common stock. Also on November 4, 2003, we furnished a Current Report on Form 8-K reporting our 2003 third quarter results.

        On November 18, 2003, we filed a Current Report on Form 8-K announcing the terms related to the acquisition of CMS Communications, Inc.

        On December 8, 2003, we filed a Current Report on Form 8-K/A amending our Current Report on Form 8-K that was originally filed on November 18, 2003. The amendment included the audited financial statements of CMS Communications, Inc. and unaudited pro forma combined financial information.

        On December 17, 2003, we filed a Current Report on Form 8-K that pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934, on December 10, 2003, the following executive officers of Evolving Systems, Inc. (the "Company") entered into selling plans as described below:

Stephen K. Gartside, Jr., Executive Vice President of Sales and Operations, entered into an agreement to exercise 60,000 incentive stock options and to exercise and sell up to 84,000 non-statutory stock options of the Company (the "Plan"). Under the Plan, Mr. Gartside will exercise 5,000 incentive stock options each month and will exercise and sell up to 7,000 non-statutory stock options each month over a period commencing January 1, 2004 and ending December 31, 2004.

Brian R. Ervine, Sr. Vice President and Chief Financial Officer entered into an agreement to exercise and sell up to 40,000 incentive stock options of the Company. Under the Plan, Mr. Ervine will sell up to 4,000 shares per month over a period commencing January 1, 2004 and ending December 10, 2004.

Anita T. Moseley, Sr. Vice President and General Counsel entered into an agreement to exercise and sell up to 62,400 non-statutory stock options of the Company. Under the Plan, Ms. Moseley will sell up to 1,200 shares per week over a period commencing January 1, 2004 and ending December 28, 2004.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned; thereunto duly authorized, on the 22nd day of March, 2004.

POWER OF ATTORNEY

        KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Stephen K. Gartside, Jr. and Anita T. Moseley, or any of them, his or her attorney-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connections therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant and in the capacities and on the dates indicated have signed this report below.

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REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors of
Evolving Systems, Inc.

        In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Evolving Systems, Inc. and its subsidiary at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the consolidated financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/S/PRICEWATERHOUSECOOPERS LLP

Denver, Colorado
March 22, 2004

F-1

EVOLVING SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands except share data)