Symbolic Logic, Inc. - Quarter Report: 2014 June (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2014

 

OR

 

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

 

For the transition period from               to               

 

Commission File Number: 001-34261

 

EVOLVING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

 

(303) 802-1000

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

 

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

 

As of July 31, 2014 there were 11,639,597 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).

 

 

 

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EVOLVING SYSTEMS, INC.

Quarterly Report on Form 10-Q

June 30, 2014

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PART I — FINANCIAL INFORMATION
Item 1	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013 (Unaudited)
	Condensed Consolidated Statements of Operations for the Three and Six months Ended June 30, 2014 and 2013 (Unaudited)
	Condensed Consolidated Statements of Comprehensive Income for the Three and Six months Ended June 30, 2014 and 2013 (Unaudited)
	Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Six months Ended June 30, 2014 (Unaudited)
	Condensed Consolidated Statements of Cash Flows for the Six months Ended June 30, 2014 and 2013 (Unaudited)
	Notes to Unaudited Condensed Consolidated Financial Statements
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3	Quantitative and Qualitative Disclosures About Market Risk
Item 4	Controls and Procedures
PART II — OTHER INFORMATION
Item 1	Legal Proceedings
Item 1A	Risk Factors
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3	Defaults upon Senior Securities
Item 4	Mine Safety Disclosures
Item 5	Other Information
Item 6	Exhibits
Signature

 

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PART I — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

(unaudited)

 

		June 30,			December 31,
		2014			2013
ASSETS
Current assets:
Cash and cash equivalents		$	12,376		$	13,785
Short-term restricted cash		24			—
Contract receivables, net of allowance for doubtful accounts of $69 and $73 at June 30, 2014 and December 31, 2013, respectively		6,190			6,420
Unbilled work-in-progress, net of allowance of $328 and $317 at June 30, 2014 and December 31, 2013, respectively		4,461			2,423
Deferred income taxes		98			131
Prepaid and other current assets		1,290			1,173
Total current assets		24,439			23,932
Property and equipment, net		462			342
Amortizable intangible assets, net		655			702
Goodwill		18,504			17,936
Long-term restricted cash		—			24
Long-term deferred income taxes		262			248
Total assets		$	44,322		$	43,184
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of capital lease obligations		$	5		$	8
Accounts payable and accrued liabilities		3,954			4,479
Income taxes payable		807			459
Unearned revenue		4,295			4,287
Total current liabilities		9,061			9,233
Long-term liabilities:
Capital lease obligations, net of current portion		9			11
Contingent earn-out obligation		178			178
Long-term unearned revenue		721			1,027
Total liabilities		9,969			10,449
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued and outstanding as of June 30, 2014 and December 31, 2013		—			—
Common stock, $0.001 par value; 40,000,000 shares authorized; 11,816,253 shares issued and 11,637,364 outstanding as of June 30, 2014 and 11,779,507 shares issued and 11,600,618 outstanding as of December 31, 2013		12			12
Additional paid-in capital		94,619			93,895
Treasury stock 178,889 shares as of June 30, 2014 and December 31, 2013, at cost		(1,253		)	(1,253		)
Accumulated other comprehensive loss		(2,122		)	(3,016		)
Accumulated deficit		(56,903		)	(56,903		)
Total stockholders’ equity		34,353			32,735
Total liabilities and stockholders’ equity		$	44,322		$	43,184

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2014			2013			2014			2013
REVENUE
License fees and services		$	5,182		$	3,518		$	9,549		$	8,025
Customer support		2,757			2,267			4,972			4,429
Total revenue		7,939			5,785			14,521			12,454
COSTS OF REVENUE AND OPERATING EXPENSES
Costs of license fees and services, excluding depreciation and amortization		1,513			1,301			2,991			2,837
Costs of customer support, excluding depreciation and amortization		488			401			908			709
Sales and marketing		1,321			1,245			2,981			2,546
General and administrative		943			768			1,777			1,663
Product development		955			684			1,838			1,397
Depreciation		52			37			98			74
Amortization		24			97			47			195
Restructuring		26			—			237			—
Total costs of revenue and operating expenses		5,322			4,533			10,877			9,421
Income from operations		2,617			1,252			3,644			3,033
Other income (expense)
Interest income		4			3			7			6
Interest expense		(4		)	(5		)	(9		)	(11		)
Other loss		(27		)	—			(27		)	—
Foreign currency exchange (loss) gain		(76		)	188			(172		)	145
Other (expense) income, net		(103		)	186			(201		)	140
Income from operations before income taxes		2,514			1,438			3,443			3,173
Income tax expense		838			529			1,116			1,091
Net income		$	1,676		$	909		$	2,327		$	2,082
Basic income per common share		$	0.14		$	0.08		$	0.20		$	0.18
Diluted income per common share		$	0.14		$	0.08		$	0.20		$	0.18
Cash dividend declared per common share		$	0.10		$	0.08		$	0.20		$	0.16
Weighted average basic shares outstanding		11,635			11,423			11,628			11,416
Weighted average diluted shares outstanding		11,907			11,691			11,912			11,691

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands except per share data)

(unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2014			2013			2014			2013
Net income		$	1,676		$	909		$	2,327		$	2,082
Other comprehensive income (loss):
Foreign currency translation gain (loss)		583			(288		)	894			(1,436		)
Other comprehensive income (loss)		583			(288		)	894			(1,436		)
Comprehensive income		$	2,259		$	621		$	3,221		$	646

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands, except share data)

(unaudited)

 

													Accumulated
							Additional						Other						Total
		Common Stock					Paid-in			Treasury			Comprehensive			Accumulated			Stockholders’
		Shares		Amount			Capital			Stock			Loss			(Deficit)			Equity
Balance at December 31, 2013		11,600,618		$	12		$	93,895		$	(1,253	)	$	(3,016	)	$	(56,903	)	$	32,735
Stock option exercises		32,651		—			125			—			—			—			125
Common Stock issued pursuant to the Employee Stock Purchase Plan		3,576		—			27			—			—			—			27
Stock-based compensation expense		—		—			201			—			—			—			201
Issuance of common stock related to acquisition		1,832		—			19			—			—			—			19
Excess tax benefits from stock-based compensation		—		—			352			—			—			—			352
Restricted stock issuance, net of cancellations		(1,313	)	—			—			—			—			—			—
Common stock cash dividends		—		—			—			—			—			(2,327		)	(2,327		)
Net income		—		—			—			—			—			2,327			2,327
Foreign currency translation adjustment		—		—			—			—			894			—			894
Balance at June 30, 2014		11,637,364		$	12		$	94,619		$	(1,253	)	$	(2,122	)	$	(56,903	)	$	34,353

 

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

 

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EVOLVING SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		For the Six Months Ended June 30,
		2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	2,327		$	2,082
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		98			74
Amortization of intangible assets		47			195
Amortization of debt issuance costs		8			10
Stock based compensation		201			154
Unrealized foreign currency transaction (gains) and losses, net		172			(145		)
Provision for deferred income taxes		19			173
Change in operating assets and liabilities:
Contract receivables		240			(902		)
Unbilled work-in-progress		(2,232		)	2,569
Prepaid and other assets		(74		)	68
Accounts payable and accrued liabilities		(383		)	(729		)
Unearned revenue		(421		)	1,883
Net cash provided by operating activities		2			5,432
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(140		)	(133		)
Restricted cash		—			53
Net cash used in investing activities		(140		)	(80		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital lease payments		(5		)	(2		)
Common stock cash dividends		(2,327		)	(913		)
Excess tax benefits from stock-based compensation		352			240
Proceeds from the issuance of stock		153			116
Net cash used in financing activities		(1,827		)	(559		)
Effect of exchange rate changes on cash		556			(265		)
Net (decrease) increase in cash and cash equivalents		(1,409		)	4,528
Cash and cash equivalents at beginning of period		13,785			8,844
Cash and cash equivalents at end of period		$	12,376		$	13,372
Supplemental disclosure of cash and non-cash financing transactions:
Income taxes paid		$	47		$	106
Common stock dividend declared		—			913
Property and equipment purchased and included in accounts payable		88			—
Issuance of common stock related to acquisition		19			—

 

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

 

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EVOLVING SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — BASIS OF PRESENTATION

 

Organization — We are a provider of software solutions and services to the wireless, wireline and cable markets. We maintain long-standing relationships with many of the largest wireless, wireline and cable companies worldwide. Our customers rely on us to develop, deploy, enhance, maintain and integrate complex, highly reliable software solutions for a range of Operations Support Systems (“OSS”).  We offer software products and solutions focused on activation and provisioning: our service activation solution, Tertio® (“TSA”) used to activate complex bundles of voice, video and data services for traditional and next generation wireless and wireline networks;  our SIM card activation solution, Dynamic SIM Allocation TM (“DSA”) used to dynamically allocate and assign resources to wireless devices that rely on SIM cards; our cloud-based (SaaS) service activation, self—service mobile applications and data enablement solutions to wireless carriers and Mobile Virtual Network Operators (MVNOs); and our connected devices activation solution, Intelligent M2M Controller and DataSpreeSM  that support the activation of M2M devices.

 

Reclassifications - Certain reclassifications have been made to the 2013 financial statements to conform to the consolidated 2014 financial statement presentation. These reclassifications had no effect on net earnings or cash flows as previously reported.

 

Interim Consolidated Financial Statements — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these financial statements are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included in this document have been prepared on the same basis as the annual consolidated financial statements, and in our opinion reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance with GAAP and SEC regulations for interim financial statements. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that we will have for any subsequent period.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2013 included in our Annual Report on Form 10-K.

 

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

 

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

 

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

 

Goodwill — Goodwill is the excess of acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired.  Goodwill is not amortized, but tested for impairment annually or whenever indicators of impairment exist. These indicators may include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit.

 

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Intangible Assets — Amortizable intangible assets consist primarily of purchased software and licenses, customer contracts and relationships, trademarks and tradenames, and business partnerships acquired in conjunction with our purchase of Telespree Communications (“Evolving Systems Labs”).  These assets are amortized using the straight-line method over their estimated lives.

 

We assess the impairment of identifiable intangibles if events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.  If we determine that the carrying value of intangibles and/or long-lived assets may not be recoverable, we compare the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition to the asset’s carrying amount. If an amortizable intangible or long-lived asset is not deemed to be recoverable, we recognize an impairment loss representing the excess of the asset’s carrying value over its estimated fair value.

 

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

 

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

 

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

 

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

 

Cash and Cash Equivalents — All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents.

 

Revenue Recognition — We recognize revenue when an agreement is signed, the fee is fixed or determinable and collectability is reasonably assured. We recognize revenue from two primary sources: license fees and services, and customer support.   The majority of our license fees and services revenue is generated from fixed-price contracts, which provide for licenses to our software products and services to customize such software to meet our customers’ use.  When the customization services are determined to be essential to the functionality of the delivered software, we recognize revenue using the percentage-of-completion method of accounting. In these types of arrangements, we do not typically have Vendor Specific Objective Evidence (“VSOE”) of fair value on the license fee/services portion (services are related to customizing the software) of the arrangement due to the large amount of customization required by our customers; however, we do have VSOE for the warranty/maintenance services based on the renewal rate of the first year of maintenance in the arrangement. The license/services portion is recognized using the percentage-of-completion method of accounting and the warranty/maintenance services are separated based on the renewal rate in the contract and recognized ratably over the warranty or maintenance period. We estimate the percentage-of-completion for each contract based on the ratio of direct labor hours incurred to total estimated direct labor hours and recognize revenue based on the percent complete multiplied by the contract amount allocated to the license fee/services.  Since estimated direct labor hours, and changes thereto, can have a significant impact on revenue recognition, these estimates are critical and we review them regularly. If the arrangement includes a customer acceptance provision, the hours to complete the acceptance testing are included in the total estimated direct labor hours; therefore, the related revenue is recognized as the acceptance testing is performed. Revenue is not recognized in full until the customer has provided proof of acceptance on the arrangement.  Generally, our contracts are accounted for individually. However, when certain criteria are met, it may be necessary to account for two or more contracts as one to reflect the substance of the group of contracts. We record amounts billed in advance of services being performed as unearned revenue. Unbilled work-in-progress represents revenue earned but not yet billable under the terms of the fixed-price contracts. All such amounts are expected to be billed and collected within 12 months.

 

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

 

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

 

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

 

We recognize revenue from our Mobile Data Enablement (“MDE”) contracts based on the number of transactions per month multiplied by a factor based on a unique table for transaction volumes relating to each account.

 

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

 

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

 

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

 

Restricted Cash — As of June 30, 2014 and December 31, 2013 we had $24,000 of restricted cash related to securing a letter of credit for our San Francisco, California lease.  The restricted cash will become unrestricted at the expiration of the lease in 2015.

 

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

 

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

 

Recent Accounting Pronouncements — In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11 regarding ASC Topic 740 “Income Tax.” This ASU clarifies the guidance on the presentation of an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This ASU will be effective for our fiscal year beginning January 1, 2014. We adopted this pronouncement as of January 1, 2014.   The adoption of this standard did not have a significant impact on our consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, Topic 606.  This Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this Update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to illustrate the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. This ASU is effective retrospectively for fiscal years, and interim periods within those years beginning after December 15, 2016 for public companies and 2017 for non-public entities. We are evaluating the effect, if any, on the Company’s financial position and results of operations.

 

NOTE 2 — ACQUISITION

 

On October 24, 2013 we acquired privately held Telespree, now known as Evolving Systems Labs, Inc. for an initial payment of approximately $1.6 million comprised of approximately $0.8 million in cash and approximately $0.8 million in stock.  We also

 

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agreed to make a payment on the 1 year anniversary of the transaction of $0.5 million, with such payment being available to secure Telespree’s representations and warranties in the agreement.  We are obligated to make additional payments in cash on the achievement of certain financial targets for the period from October 25, 2013 through October 24, 2016.

 

We accounted for this business combination by applying the acquisition method, and accordingly, the purchase price was allocated to the assets and liabilities assumed based upon their fair values at the acquisition date. The excess of the purchase price over the net assets and liabilities, approximately $1.1 million, was recorded as goodwill. The Company is in the process of finalizing the purchase allocation, thus the provisional measures of deferred income taxes, intangibles and goodwill are subject to change. The Company expects the purchase price allocation will be finalized in 2014. The results of Telespree’s operations have been included in the consolidated financial statements since the acquisition date.

 

We believe this acquisition complements our activation and SIM management products, adding technology used in the delivery and management of mobile data services to end-users.   Our strategic focus is primarily on the wireless markets in the areas of subscriber activation, SIM card management and activation, self—service mobile applications, data enablement solutions, connected device activation and management of services.

 

Total purchase price is summarized as follows:

 

		October 24, 2013
Cash Consideration		$	794
Final Cash Payment		494
Stock Consideration (73,281 shares)		761
Estimated Contingent Consideration		178
Total purchase price		$	2,227

 

The fair value of the 73,281 common shares issued was determined based on the closing market price of our common shares on the acquisition date.

 

The estimated contingent consideration arrangement requires us to pay $0.2 million of additional consideration to Telespree’s former shareholders if we meet certain performance metrics over the three years following the acquisition date.  In each of the years, the former shareholders are entitled to a deferred payment equal to 34 percent of all qualifying revenue in excess of the qualifying revenue threshold for such deferred payment period.  The initial qualifying revenue threshold is $2.3 million, but shall be increased in subsequent years if the qualified revenue falls under the qualifying revenue threshold in the previous period.

 

The contingent consideration was valued using the Income Approach-Probability Weighted Expected Payment.  Multiple forecasted scenarios were evaluated which include (i) an upside case, (ii) a base case and (iii) a downside case.  We determined the potential Deferred Payment cash flows of Telespree based on each scenario.  The cash flow payments were converted to a present value using a discount rate of 5 percent based on the cost of debt.  Finally, we probability weighted each scenario.

 

The following table summarizes the preliminary estimated fair values of the assets and liabilities assumed at the acquisition date:

 

		October 24, 2013
Cash and cash equivalents		$	382
Contract receivables		210
Unbilled work-in-progress		150
Intangible assets		718
Prepaid and other current assets		37
Deferred tax asset		98
Other assets, non-current		43
Total identifiable assets acquired		$	1,638
Accounts payable and accrued liabilities		$	504
Assumed liabilities		4
Total identifiable liabilities acquired		$	508
Net identifiable assets acquired		1,130
Goodwill		1,097
Net assets acquired		$	2,227

 

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We recorded $0.7 million in intangible assets as of the acquisition date with a weighted-average amortization period of five to eight years and are amortizing the value of the trade name, technology, and customer relationships over an estimated useful life of 3.8, 4.6 and 4.6 years, respectively.  Amortization expense related to the acquired intangible assets resulting from the acquisition, which is included in amortization expense, was approximately $24,000 and $47,000 for the three and six months ended June 30, 2014, respectively.

 

The $1.1 million of goodwill was assigned to the license and service segment.  The goodwill recognized is attributed primarily to expected synergies and the assembled workforce of Telespree.  As of June 30, 2014 there were no changes in the recognized amounts of goodwill resulting from the acquisition of Telespree.

 

NOTE 3 — GOODWILL AND INTANGIBLE ASSETS

 

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

 

		License and Services						Customer Support			Total
		U.S.			UK			UK			Goodwill
Balance as of December 31, 2013		$	1,097		$	7,532		$	9,307		$	17,936
Effects of changes in foreign currency exchange rates (1)		—			254			314			568
Balance at June 30, 2014		$	1,097		$	7,786		$	9,621		$	18,504

 

(1)         Represent primarily the impact of foreign currency translation for instances when goodwill is recorded in foreign entities whose functional currency is also their local currency. Goodwill balances are translated into U.S. dollars using exchange rates in effect at period end. Adjustments related to foreign currency translation are included in other comprehensive income.

 

We conducted our annual goodwill impairment test as of July 31, 2013, and we determined that goodwill was not impaired as of the test date. From July 31, 2013 through the date of this report, no events have occurred that we believe may have impaired goodwill.

 

We amortized identifiable intangible assets on a straight-line basis over their estimated lives ranging from one to seven years and include the cumulative effects of foreign currency exchange rates.  As of June 30, 2014 and December 31, 2013, identifiable intangibles were as follows (in thousands):

 

		June 30, 2014									December 31, 2013									Weighted-
		Gross Amount			Accumulated Amortization			Net Carrying Amount			Gross Amount			Accumulated Amortization			Net Carrying Amount			Average Amortization Period
Purchased software		$	439		$	37		$	402		$	439		$	9		$	430		4.6 yrs
Trademarks and tradenames		63			8			55			63			2			61			3.8 yrs
Customer relationships		216			18			198			216			5			211			4.6 yrs
		$	718		$	63		$	655		$	718		$	16		$	702		4.54 yrs

 

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Amortization expense of identifiable intangible assets was $24,000 and $0.1 million for the three months and $47,000 and $0.2 million for the six months ended June 30, 2014 and 2013, respectively.  Expected future amortization expense related to identifiable intangibles based on our carrying amount as of June 30, 2014 was as follows (in thousands):

 

Twelve months ending June 30,
2015		$	95
2016		94
2017		94
2018		94
2019		86
Thereafter		192
		$	655

 

NOTE 4 — EARNINGS PER COMMON SHARE

 

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

 

Our policy is to treat unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, as participating securities, included in the computation of both basic and diluted earnings per share.  The following is the reconciliation of the denominator of the basic and diluted EPS computations (in thousands, except per share data):

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
Basic income per share:		2014			2013			2014			2013
Net income available to common stockholders		$	1,676		$	909		$	2,327		$	2,082
Basic weighted average shares outstanding		11,635			11,423			11,628			11,416
Basic income per share:		$	0.14		$	0.08		$	0.20		$	0.18
Diluted income per share:
Net income available to common stockholders		$	1,676		$	909		$	2,327		$	2,082
Weighted average shares outstanding		11,635			11,423			11,628			11,416
Effect of dilutive securities - options		272			268			284			275
Diluted weighted average shares outstanding		11,907			11,691			11,912			11,691
Diluted income per share:		$	0.14		$	0.08		$	0.20		$	0.18

 

For the three months ended June 30, 2014 and 2013, 0.2 million and 0.1 million shares, respectively, of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

For the six months ended June 30, 2014 and 2013, 0.2 million and 0.1 million shares, respectively of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

 

NOTE 5 — SHARE-BASED COMPENSATION

 

We account for stock-based compensation by applying a fair-value-based measurement method to account for share-based payment transactions with employees and directors, and record compensation cost for all stock awards granted after January 1, 2006 and awards modified, repurchased, or cancelled after that date, using the modified prospective method. We record compensation costs associated with the vesting of unvested options on a straight-line basis over the vesting period. We recognized $0.1 million of compensation expense in the consolidated statements of operations, with respect to our stock-based compensation plans for the three

 

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months ended June 30, 2014 and 2013 and $0.2 million for the six months ended June 30, 2014 and 2013.  The following table summarizes stock-based compensation expenses recorded in the consolidated statement of operations (in thousands):

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2014			2013			2014			2013
Cost of license fees and services, excluding depreciation and amortization		$	20		$	7		$	36		$	14
Cost of customer support, excluding depreciation and amortization		2			1			4			2
Sales and marketing		10			6			21			11
General and administrative		48			59			90			116
Product development		33			6			50			11
Total share based compensation		$	113		$	79		$	201		$	154

 

Stock Incentive Plans

 

In January 1996, our stockholders approved an Amended and Restated Stock Option Plan (the “Option Plan”).  Under the Option Plan, as amended, 4,175,000 shares were reserved for issuance.  Options issued under the Option Plan were at the discretion of the Board of Directors, including the vesting provisions of each stock option granted. Options were granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years and expire no more than ten years from the date of grant. The Option Plan terminated on January 18, 2006; options granted before that date were not affected by the plan termination.  At June 30, 2014 and December 31, 2013, 0.1 million and 0.2 million options remained outstanding under the Option Plan, respectively.

 

In June 2007, our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”) with a maximum of 1,000,000 shares reserved for issuance. In June 2010, our stockholders approved an amendment to the 2007 Stock Plan which increased the maximum shares that may be awarded under the plan to 1,250,000. In June 2013, our stockholders approved an amendment to the 2007 Stock Plan which increased the maximum shares that may be awarded under the plan to 1,502,209.  Awards permitted under the 2007 Stock Plan include:  Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant, generally vest over four years for employees and one year for directors and expire no more than ten years from the date of grant.  At June 30, 2014, there were approximately 0.1 million shares available for grant under the 2007 Stock Plan, as amended.  At June 30, 2014 and December 31, 2013, 0.6 million and 0.5 million options were issued and outstanding under the 2007 Stock Plan as amended, respectively.

 

During the three months ended June 30, 2014 and 2013, there were no grants of restricted stock to members of our senior management.  During the six months ended June 30, 2013 there were 16,000 grants of restricted stock to members of our senior management.  No grants of restricted stock were offered during the six months ended June 30, 2014.  During the three months ended June 30, 2014 and 2013, 2,000 and 6,000 shares of restricted stock vested, respectively. During the six months ended June 30, 2014 and 2013, 4,000 and 13,000 shares of restricted stock vested, respectively.    No shares of restricted stock were forfeited during the three months ended June 30, 2014 and 2013.  Approximately 938 and 1,250 shares of restricted stock were forfeited during the six months ended June 30, 2014 and 2013, respectively. The fair market value of restricted shares for share-based compensation expensing is equal to the closing price of our common stock on the date of grant. Stock-based compensation expense includes $15,000 and $40,000 for the three months ended June 30, 2014 and 2013, respectively, and  $30,000  and  $0.1 million for the six months ended June 30, 2014 and 2013, respectively, of expense related to restricted stock grants. The restrictions on the stock awards are released quarterly, generally over two and four years for senior management and over one year for board members.

 

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

 

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		For the Three Months Ended June 30,				For the Six Months Ended June 30,
		2014		2013		2014		2013
Expected term (years)		6.3		6.3		6.0		6.1
Risk-free interest rate		1.71	%	1.42	%	1.69	%	0.96	%
Expected volatility		54.75	%	59.14	%	55.88	%	60.78	%
Expected dividend yield		5.03	%	4.83	%	3.99	%	3.62	%

 

The following is a summary of stock option activity under the plans for the nine months ended June 30, 2014:

 

							Weighted-
							Average
				Weighted-			Remaining		Aggregate
		Number of		Average			Contractual		Intrinsic
		Shares		Exercise			Term		Value
		(in thousands)		Price			(Years)		(in thousands)
Options outstanding at December 31, 2013		676		$	5.11		4.76		$	3,491
Options granted		169		10.15
Less options forfeited		(118	)	12.56
Less options exercised		(59	)	5.41
Options outstanding at June 30, 2014		668		$	5.03		6.13		$	2,660
Options exercisable at June 30, 2014		437		$	2.79		4.42		$	2,545

 

There were 14,000 stock options granted during the three months ended June 30, 2014 and 2013. The weighted-average grant-date fair value of stock options granted during the three months ended June 30, 2014 and 2013 was $2.65 and $2.41, respectively.  As of June 30, 2014, there was approximately $0.8 million of total unrecognized compensation costs related to unvested stock options.  These costs are expected to be recognized over a weighted average period of 2.68 years.  The total fair value of stock options vested during the three months ended June 30, 2014 and 2013 was approximately $0.1 million and $39,000, respectively.  The total fair value of stock options vested during the six months ended June 30, 2014 and 2013 was approximately $0.1 million, respectively.

 

The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $4,000 for the three months ended June 30, 2014 and 2013.  The deferred income tax benefits from stock option expense related to Evolving Systems U.K. totaled approximately $8,000 for the six months ended June 30, 2014 and 2013.

 

Cash received from stock option exercises for the three months ended June 30, 2014 and 2013 was $17,000 and $0.1 million, respectively.  Cash received from stock option exercises for the six months ended June 30, 2014 and 2013 was $0.1 million, respectively.

 

During the three months ended March 31, 2014, we had net settlement exercises of stock options, whereby the optionee did not pay cash for the options but instead received the number of shares equal to the difference between the exercise price and the market price on the date of exercise. Net settlement exercises during the three months ended March 31, 2014, resulted in approximately 7,094 shares issued and 26,376 options cancelled in settlement of shares issued.  There were no net settlement exercises during the three months ended June 30, 2014.

 

Employee Stock Purchase Plan

 

Under the Employee Stock Purchase Plan (“ESPP”), we are authorized to issue up to 550,000 shares.  Employees may elect to have up to 15% of their gross compensation withheld through payroll deduction to purchase our common stock, capped at $25,000 annually and no more than 10,000 shares per offering period. The purchase price of the stock is 85% of the lower of the market price at the beginning or end of each three-month participation period. As of June 30, 2014, there were approximately 65,000 shares

 

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available for purchase.  For the three months ended June 30, 2014 and 2013, we recorded compensation expense of $4,000 and $500, respectively, and $11,000 and $1,000, for the six months ended June 30, 2014 and 2013, respectively, associated with grants under the ESPP which includes the fair value of the look-back feature of each grant as well as the 15% discount on the purchase price.  This expense fluctuates each period primarily based on the level of employee participation.

 

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

 

		For the Three Months Ended June 30,				For the Six Months Ended June 30,
		2014		2013		2014		2013
Expected term (years)		0.25		0.25		0.25		0.25
Risk-free interest rate		0.03	%	0.06	%	0.04	%	0.07	%
Expected volatility		43.37	%	44.00	%	43.29	%	45.31	%
Expected dividend yield		4.67	%	4.83	%	4.53	%	4.16	%

 

Cash received from employee stock plan purchases for the three months ended June 30, 2014 and 2013 was $16,000 and $2,000, respectively.  Cash received from employee stock plan purchases for the six months ended June 30, 2014 and 2013 was $43,000 and $4,000, respectively.

 

We issued shares related to the ESPP of approximately 2,000 and 400 for the three months ended June 30, 2014 and 2013, respectively.  We issued shares related to the ESPP of approximately 6,000 and 800 for the three months ended June 30, 2014 and 2013, respectively.

 

NOTE 6 — CONCENTRATION OF CREDIT RISK

 

For the three months ended June 30, 2014, three significant customers (defined as contributing at least 10%) accounted for 40% (19%, 11% and 10%) of revenue from operations.  The significant customers for the three months ended June 30, 2014 are large telecommunications operators in Nigeria, United Kingdom and Mexico.  For the three months ended June 30, 2013, one significant customer accounted for 13% of revenue from operations. The significant customer for the three months ended June 30, 2013 is a large telecommunications operator in Saudi Arabia.  For the six months ended June 30, 2014, three significant customers accounted for 37% (14%, 13% and 10%) of revenue from operations. These customers are large telecommunications operators in the United Kingdom, Nigeria and Mexico.  For the six months ended June 30, 2013, one significant customer accounted for 11% of revenue from operations. This customer is a large telecommunications operator in the Philippines.

 

As of June 30, 2014, two significant customers accounted for approximately 47% (35% and 12%) of contract receivables and unbilled work-in-progress.  These customers are large telecommunication operators in Nigeria and Mexico.  As of December 31, 2013, four significant customers accounted for approximately 56% (18%, 15%, 12% and 11%) of contract receivables and unbilled work-in-progress.  These customers are large telecommunications operators in Nigeria, United Kingdom, Brazil and Luxembourg.

 

NOTE 7 — LONG-TERM DEBT

 

On October 22, 2012, we entered into a $5.0 million Loan and Security Agreement (the “Revolving Facility”).  The $5.0 million Revolving Facility bears interest at the greater of 2.75% or the U.S.A Prime Rate minus one half of one percent (0.5%).  Prime Rate was 3.25% as of June 30, 2014.  The Revolving Facility is secured by all assets of Evolving Systems, including a pledge, subject to certain limitations with respect to stock of foreign subsidiaries, of the stock of the existing and future direct subsidiaries of Evolving Systems.  There is no mandated borrowing required against the Revolving Facility.  To take an advance under the Revolving Facility, we must have a balance of $3.0 million in cash on deposit and have quarterly net income and a specified ratio of current assets to current liabilities, as defined in the Revolving Facility.  The Revolving Facility requires us to pay an annual credit facility fee of $10,000.  All accrued interest on outstanding borrowings under the Revolving Facility is payable monthly, with any outstanding balance due with a final maturity of October 22, 2014.  As of June 30, 2014, we are in compliance with the covenants and have $5.0 million available to borrow under this Revolving Facility.

 

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NOTE 8 — INCOME TAXES

 

We recorded net income tax expense of $0.8 million and $0.5 million for the three months ended June 30, 2014 and 2013, respectively.  The net expense during the three months ended June 30, 2014 consisted of current income tax expense of $0.8 million and a deferred tax benefit of $10,000. The current tax expense consists primarily of income tax from our U.S., U.K. and India based operations. The deferred tax benefit was primarily related to distributed foreign earnings, a decrease in deferred tax assets related to accrued liabilities and capitalized expenses for tax purpose related to the acquisition of Telespree.  The net expense during the three months ended June 30, 2013 consisted of current income tax expense of $0.4 million and a deferred tax expense of $0.1 million. The current tax expense consists primarily of unrecoverable foreign withholding tax in the U.S. and U.K. and income tax from our U.S., U.K. and India based operations. The deferred tax expense was primarily related to undistributed foreign earnings offset by intangible assets from our U.K. based operations.

 

We recorded net income tax expense of $1.1 million for the six months ended June 30, 2014 and 2013.  The net expense during the six months ended June 30, 2014 consisted of current income tax expense of $1.1 and a deferred tax expense of $47,000.  The current tax expense consists primarily of income tax from our U.S., U.K. and India based operations, and unrecoverable foreign withholding taxes in the U.S.  The deferred tax expense was primarily related to undistributed foreign earnings, a decrease in deferred tax assets related to accrued liabilities and capitalized expenses for tax purpose related to the acquisition of Telespree.  The net expense during the six months ended June 30, 2013 consisted of current income tax expense of $0.9 and a deferred tax expense of $0.2 million.  The current tax expense consists primarily of income tax from our U.S., U.K. and India based operations, and unrecoverable foreign withholding taxes in the U.S. and U.K.  The deferred tax expense was primarily related to undistributed foreign earnings offset by a tax benefit related to intangible assets from our U.K.-based operations.

 

Our effective tax rate of 33% for the three months ended June 30, 2014 decreased from an effective tax rate of 37% for the three months ended June 30, 2013.  The decrease in our effective tax rate relates to a higher proportion of our income being generated in the U.K., for which the statutory corporate tax rate was decreased in 2014.

 

Our effective tax rate of 32% for the six months ended June 30, 2014 was decreased from our effective tax rate of 34% for the six months ended June 30, 2013.  The decrease in our effective tax rate relates to a higher proportion of our income being generated in the U.K.

 

In conjunction with the acquisition of Evolving Systems Labs, we recorded certain identifiable intangible assets of $0.7 million.  These assets are amortizable for both book and tax purposes.

 

As of June 30, 2014 and December 31, 2013 we continued to maintain a valuation allowance on portions of our domestic net deferred tax asset.  Such assets primarily consist of certain NOL carryforwards and other tax credits.  These NOL’s are comprised of windfall tax benefits related to stock-based compensation.  When utilized, windfall tax benefits related to stock-based compensation are recorded as a reduction to our taxes payable when realized, with a corresponding credit to additional paid in capital, not income tax expense. The $0.4 million of net deferred tax assets as of June 30, 2014, were comprised of the following:

 

		June 30, 2014
Deferred tax assets:
Net operating loss carryforwards		$	2,303
Research & Development Credits		303
AMT/MAT credit		990
Stock Compensation		609
Depreciable assets		144
Intangibles		84
Accrued liabilities and reserves		131
Total deferred tax assets		4,564
Deferred tax liabilities
Undistributed Foreign Earnings		$	(842	)
Total deferred tax liability		(842		)
Net deferred tax assets, before valuation allowance		$	3,722
Valuation allowance		(3,362		)
Net deferred tax asset		$	360

 

As of June 30, 2014 and December 31, 2013 we had no liability for unrecognized tax benefits.

 

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