Symbolic Logic, Inc. - Quarter Report: 2020 September (Form 10-Q)





UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended  September  30, 2020



OR



☐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)



Securities registered pursuant to Section 12(b) of the Act.





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 ☒ No ☐



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  Yes ☒ No ☐



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





If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒



As of November 9, 2020, there were  12,195,440 shares outstanding of Registrant’s Common Stock (par value $0.001 per share).





 

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EVOLVING SYSTEMS, INC.







 

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NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Organization — Evolving Systems, Inc. (“we,” “us,” “our,” the “Company,” “Evolving” and “Evolving Systems”) is a provider of real-time digital engagement solutions and services to the wireless carrier and consumer financial services markets. We maintain long-standing relationships with many of the largest wireless companies worldwide. The Company’s portfolio includes market-leading solutions and services for real-time analytics, customer acquisition and activation, customer value management and loyalty for the telecom industry and their partners.



Our software solution platforms enable carriers’ marketing departments to innovate, execute and manage highly personalized and contextually relevant, interactive campaigns that engage consumers in real time and enhance customer retention through deploying loyalty programs. In 2019, we introduced Evolution, this platform supersedes our existing platforms and provides an upgrade path to our existing loyalty and customer value management “CVM” platforms. Evolution was built by combining, integrating, and improving upon the best components and features of our current platforms as well as adding new enhancements.



Our service activation solution, Tertio® (“TSA”) is used to activate bundles of voice, video and data services for wireless, wireline and cable network operators; our SIM card activation solution, Dynamic SIM Allocation TM (“DSA”) is used to dynamically allocate and assign resources to Mobile Network Operators (“MNOs”) devices that rely on SIM cards; our Mobile Data Enablement TM (“MDE”) solution provides a data consumption and policy management solution for wireless carriers and Mobile Virtual Network Operators (“MVNOs”) that monitor the usage and consumption of data services; our Total Number Management™ (“TNM”) product is a scalable and fully automated database solution that enables operators to reliably and efficiently manage their telephone numbers as well as other communication identifiers (i.e. SIMs, MSISDNs IMSIs, ICCIDs, IPs). Our solutions can be deployed on premise or as a Software-as-a-Service (“SaaS”). 



Evolving Systems provides software solutions and services throughout the world. The COVID-19 global outbreak has caused instability and volatility in multiple markets where our clients conduct business. We have leveraged our ability to provide support remotely resulting in limited effect on our day to day operations. The inability to travel has delayed interactions with our clients on projects and in the traditional modes of sales development. The financial covenants under our debt facilities (see Note 7) are related to cash balances and quarterly operational results which have been adversely affected by project delays related to customer interactions being postponed or our customers’ ability to make timely payments. We believe our current liquidity and funds from our ongoing operations will be sufficient to fund operations and meet the Company’s cash needs for term loan payments through the full repayment of the loan on December 31, 2020,  along with our working capital and capital expenditure requirements for at least the next twelve months from the date of filing of these condensed consolidated financial statements. In making this assessment, we considered our $3.5 million in cash and cash equivalents and our $4.8 million in working capital at September 30, 2020, along with our ability to historically generate positive cash flows from operations.



Interim Condensed 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 (“US GAAP”) and in conformity with the instructions to Form 10-Q and Article 8 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 US GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures included in these condensed consolidated financial statements are adequate to make the information presented not misleading. The 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 US GAAP and SEC regulations for interim financial statements. The results for the three and nine months ended September 30, 2020 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, 2019 included in our Annual Report on Form 10-K as filed with the SEC on March 30, 2020.



Use of Estimates — The preparation of condensed consolidated financial statements in conformity with US 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 condensed consolidated 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 progress toward completion and direct profit or loss on contracts, allowance for doubtful accounts, deferred taxes and income tax valuation allowance, fair values of long-lived assets, valuation of intangible assets, useful lives for property, equipment and intangible assets, capitalization of internal software development costs and fair value of stock-based compensation amounts. Actual results could differ from these estimates.



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Foreign Currency — Our reporting currency is the U.S. dollar. The functional currency of our foreign operations, generally, 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 condensed 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 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 (expense) in the period in which they occur.



Principles of Consolidation — The unaudited condensed 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.



Revenue Recognition —  The majority of our license fees and services revenue is generated from fixed-price contracts, this provides for licenses to our software products and services that customize such software to meet our customers’ needs. In most instances, customization services are determined to be essential to the functionality of the delivered software. Under Financial Accounting Standards Board (“FASB”) Topic 606, Revenue from Contacts with Customers (“ASC 606”), revenue is recognized when our customer obtains control of promised goods or services in an amount that reflects the consideration we expect to receive in exchange for those goods or services. We measure revenue based on consideration specified in a contract with a customer and exclude any sales incentives. Furthermore, we recognize revenue when we satisfy a performance obligation by transferring control over the service to our customer.



A performance obligation is a promise in a contract to transfer a distinct service to the customer. The transaction price of a contract is allocated to each distinct performance obligation and recognized as revenue when or as the customer receives the benefit of the performance obligation. Losses on fixed-price projects are recorded when identified. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer, are excluded from revenue.



Nature of goods and services



The following is a description of our products and services from which we generate revenue, as well as the nature, timing of satisfaction of performance obligations, and significant payment terms for each:



i. License Revenue



License revenue represent the fees we receive from the licensing of our software products. In most instances, customization services are determined to be essential to the functionality of the delivered software. The license along with the customization services are transferred to our customers over time. In arrangements where the services are not essential to the functionality of the delivered software, we recognize license revenue when the license agreement has been approved and the software has been delivered. We can identify each party’s rights, payment terms, and commercial substance of the content. Where applicable, we identify multiple performance obligations and record as revenue as the performance obligations are fulfilled based on their estimated allocated standalone selling price. The selection of the method to measure progress towards completion requires judgment and is based on the extent of progress towards completion of the performance obligation. We recognize revenue using the input method of accounting based on labor hours.



ii. Customer Support Revenue



Customer support services includes annual support fees, recurring maintenance fees, and minor product upgrades generally as a single performance obligation. The Company also offers a warranty support fee which represents a separate performance obligation that is provided for up to a year with initial license purchase. The Company allocates the contract transaction price related to warranty support fees based on pricing consistent with what we would offer to other market participants. Upon the conclusion of the warranty period, the customer can choose to continue to receive support and maintenance services via our customer support offerings. We recognize revenue from our support ratably over the service contract period.



iii. Services Revenue



We recognize revenue from fixed-price service contracts using the input method of accounting based on labor hours. These contracts generally include a single performance obligation. Under the input method, revenue is recognized on the basis of an entity’s efforts or inputs toward satisfying a performance obligation. We recognize revenue from professional services provided pursuant to

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time-and-materials based contracts and training services as the services are performed, as that is when our performance obligation to our customers under such arrangements is fulfilled.



iv. Managed Services



We recognize revenue from our managed services contracts primarily over the service contract period generally as a single performance obligation. On occasion, our managed services contracts will contain a specified number of hours to work over the term of the contract. Revenue for this type of managed service contract is recognized using the input method of accounting, as previously described.



Disaggregation of revenue



In the following table, revenue is disaggregated by primary geographical market, major products/service lines, and timing of revenue recognition (in thousands):







Contract balances



The following table provides information about receivables, assets, and liabilities from contracts with customers (in thousands):







Contract receivables are recorded at the invoiced amount and do not bear interest. Credit is extended based on the evaluation of a customer’s financial condition and collateral is not required. Unbilled work-in-progress is revenue which has been earned but not invoiced. The contract assets (unbilled work-in-progress) are transferred to the receivables when invoiced.



Management expects that incremental commission fees paid to employees and intermediaries as a result of obtaining contracts are recoverable and therefore the Company capitalized them as contract costs in the amount of  $0.2 million at each of September  30, 2020 and December 31, 2019.



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Capitalized commission fees are amortized based on the transfer of services to which the assets relate which may range from two to three years and are included in sales and marketing. In each of the three month periods ended September  30, 2020 and 2019, the amount of amortization was less than  $0.1 million and there was no impairment loss in relation to the costs capitalized. For the nine month periods ended September 30, 2020 and 2019, the amount of amortization was $0.2 million and less than $0.1 million, respectively, and there was no impairment loss in relation to the costs capitalized. Applying the practical expedient in ASC 606 paragraph 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs are included in sales and marketing.



The contract liabilities primarily relate to unearned revenue. Amounts billed in advance of performance obligations being satisfied are recognized as unearned revenue.



For the three months ended September  30, 2020 and 2019, we recognized revenue of $2.0 million and $2.1 million, respectively, which was included in the corresponding contract liability balance at the beginning of the period. For the nine months ended September 30, 2020 and 2019, we recognized revenue of $3.1 million and $2.5 million, respectively, which was included in the corresponding contract liability balance at the beginning of the period.



Transaction price allocated to the remaining performance obligations



Remaining performance obligations represent the transaction price of firm orders for which work has not been completed as of the period end date and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity). As of September  30, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations with lives greater than one-year totaled $10.1 million. The Company expects approximately 63% of remaining performance obligations to be recognized into revenue within the next twelve months, with 30% in 1-2 years and 7% in 3-4 years.



We apply the practical expedient in paragraph ASC 606-10-50-14 and do not disclose information about remaining performance obligations that have original expected durations of one-year or less. We apply the transition practical expedient in paragraph ASC 606-10-65-1(f)(3) and do not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when we expect to recognize that amount as revenue.



Stock-based Compensation — We account for stock-based compensation by applying a fair-value-based measurement method to account for stock-based payment transactions with employees, non-employees and directors. We record compensation costs associated with the vesting of unvested awards 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. We recognize forfeitures as they occur rather than estimating them at the time of the grant.



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 losses and tax credit carryforwards. 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 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.



Segment Information —  We define operating segments as components of our enterprise for which separate financial information is reviewed regularly by the chief operating decision-makers to evaluate performance and to make operating decisions. We have identified our Chief Executive Officer and Senior Vice President of Finance as our chief operating decision-makers. These chief operating decision makers review revenues by segment and review overall results of operations.



We currently operate our business as one operating segment which includes two revenue types: license fees revenue and services revenue (as shown on the condensed consolidated statements of operations). License fees revenue represents the fees received from the license of software products. Services revenue includes services directly related to the delivery of the licensed products, such as fees for custom development, integration services, SaaS services, managed services, annual support fees, recurring maintenance

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fees, fees for maintenance upgrades and warranty services. Warranty services that are similar to software maintenance services are typically bundled with a license sale.



Recently Adopted Accounting Pronouncements —  In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326) — Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires entities to establish an allowance for credit losses for most financial assets. Prior US GAAP was based on an incurred loss methodology for recognizing credit losses on financial assets measured at amortized cost and available-for sale debt securities. The update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 31, 2018. The amendments in this ASU did not have a material impact on our condensed consolidated financial statements.



In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (ASC 820) — Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 removes certain disclosures, modifies certain disclosures and adds additional disclosures. ASU 2018-13 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The amendments in this ASU did not have a material impact on our condensed consolidated financial statements. 



Recent Accounting Pronouncements — In December 2019, the FASB issued ASU 2019-12, Income Taxes (ASC 740) — Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 which modifies ASC 740 to simplify the accounting for income taxes. The ASU removes certain exceptions for recognizing deferred taxes for investments, performing intra-period allocation and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. ASU 2019-12 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2020. We have not yet completed the full assessment of the impact on our condensed consolidated financial statements or related disclosures.



In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments – Issue 4: Cross-Reference to Line of-Credit or Revolving-Debt Arrangements Guidance in Subtopic 470-50. Stakeholders requested that paragraphs 470-50-40-17 through 40-18, which describe the accounting for fees between debtor and creditor and third-party costs directly related to exchanges or modifications of debt instruments, reference paragraph 470-50-40-21 for line-of-credit or revolving-debt arrangements. We have not yet completed the full assessment of the impact on our condensed consolidated financial statements or related disclosures.



Management has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a significant impact on our condensed consolidated financial statements and related disclosures.







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NOTE 2 — INTANGIBLE ASSETS



We amortize identifiable intangible assets on a straight-line basis over their estimated useful lives. As of September 30, 2020, and December 31, 2019, identifiable intangibles were as follows (in thousands):















Amortization expense of identifiable intangible assets was $0.2 million for each of the three months ended September  30, 2020 and 2019 and $0.7 million for each of the nine months ended September 30, 2020 and 2019.  Expected future amortization expense related to identifiable intangibles based on our carrying amount as of September  30, 2020 for the following five years is as follows (in thousands):







 



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NOTE 3 — BALANCE SHEET COMPONENTS



The components of accounts payable and accrued liabilities are as follows (in thousands):







 



NOTE 4 — EARNINGS (LOSS) PER SHARE



Basic earnings (loss) per share is computed by dividing loss or income available to common stockholders by the weighted average number of shares of common stock outstanding during the period, including common stock issuable under participating securities. Diluted earnings (loss) per share is computed using the weighted average number of shares of common stock outstanding, plus all potentially dilutive common stock equivalents using the treasury stock method. Common stock equivalents consist of stock options and restricted stock.



The following is the reconciliation of the numerators and denominators of the basic and diluted earnings (loss) per share computations (in thousands except per share data):







Weighted average options to purchase approximately 0.4 million shares for the three and nine months ended September 30, 2020, and 0.6 million shares of common stock equivalents for the three and nine months ended September 30, 2019,  were excluded from the computation of diluted weighted average shares outstanding because the effect would have been anti-dilutive since their exercise prices were greater than the average market value of our common stock for the periods.

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NOTE 5 — STOCK-BASED COMPENSATION



We recognized $0.1 million of compensation expense in the condensed consolidated statements of operations, with respect to our stock-based compensation plans for each of the three months ended September  30, 2020 and 2019, and $0.2 million and $0.3 million for the nine months ended September 30, 2020 and 2019, respectively.



The following table summarizes stock-based compensation expenses recorded in the condensed consolidated statements of operations (in thousands):









Stock Incentive Plans



At September  30, 2020 and December 31, 2019,  no shares were available for grant under the 2007 Stock Plan, as amended. At September  30, 2020 and December 31, 2019,  0.2 million and 0.3 million options and restricted shares were issued and outstanding under the 2007 Stock Plan as amended, respectively.



At September  30, 2020 and December 31, 2019, there were approximately 0.5 million shares and 0.4 million shares available for grant under the 2016 Stock Plan, respectively. At September  30, 2020 and December 31, 2019, 0.2 million and 0.3 million options and restricted shares were issued and outstanding under the 2016 Stock Plan, respectively.



The fair value of restricted shares for stock-based compensation expensing is equal to the closing price of our common stock on the date of grant. The restrictions for stock awards generally vest over four years for senior management and over one year for the board of directors.



The following is a summary of restricted stock activity under the plans for the nine months ended September  30, 2020:









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The following is a summary of stock option activity under the plans for the nine months ended September  30, 2020:









There were no stock options granted during the nine months ended September  30, 2020 or 2019. The total fair value of stock options and restricted stock vested during the nine months ended September  30, 2020 and 2019 was $0.2 million and $0.3 million, respectively.

 



NOTE 6 — CONCENTRATION OF CREDIT RISK



For the three months ended September  30, 2020, we did not have a significant customer (defined as contributing at least 10%). For the three months ended September 30, 2019, we had one significant customer that accounted for 10% of revenue from operations, this significant customer is a large telecommunications operator in Europe.



For the nine months ended September 30, 2020 and 2019 one significant customer (defined as contributing at least 10%) accounted for 10% and 11% of revenue from operations, respectively. The significant customer is a large telecommunications operator in Europe.



As of ended September  30, 2020, we did not have a significant customer that accounted for approximately 10% of contract receivables and unbilled work-in-progress. As of December 31, 2019,  one customer accounted for 12% of contract receivables and unbilled work-in-progress.

 

NOTE 7 — LONG-TERM DEBT



East West Bank Term Loan Facilities



On August 16, 2017, we entered into a Term Loan Facility Agreement with East West Bank as lender in the amount of $4.7 million (the “Lumata Facility”). The Lumata Facility requires the Company to make monthly principal payments of approximately $0.1 million that commenced on July 31, 2018 and interest at the greater of (a) 3.5% or (b) the variable rate of interest that appears in the Wall Street Journal on a monthly measurement date plus in either case 1.5%. As of September  30, 2020, the U.S.A. Prime Rate was 3.25%. At September  30, 2020 the interest rate was  5.00%. In the event of a default, the interest rate increases by 5% per annum. Evolving Systems Inc. entered into the Lumata Facility as the parent guarantor; Evolving Systems BLS LTD and Evolving Systems Limited entered into the Lumata Facility as Original Guarantors (the “Original Guarantors”). The Lumata Facility is secured by all of the assets of EVOL Holdings and the original guarantors in accordance with the terms of a Debenture entered into by Evolving Systems Holdings and the Original Guarantors in favor of East West Bank. EVOL Holdings, Evolving Systems Inc. and the Original Guarantors also entered into a Subordination Deed whereby each of the parties agreed to subordinate all loans by and among each other to East West Bank. Lumata France SAS and Lumata UK Ltd are also bound to adhere to the finance documents as additional obligors.



The Lumata Facility required the Company to pay an arrangement fee (“Origination Fee”) of $23,650, payable in four equal installments, with the first payment due on the date of the Lumata Facility and the remaining three payments on the first, second and third anniversary thereof. The Company also agreed to pay East West Bank’s legal fees in connection with the transaction. The Company may prepay the Lumata Facility at any time, in a minimum amount of $250,000 and increments of $50,000, subject to a prepayment fee of 2% of the amount prepaid, on any prepayment made before the second anniversary date of the Agreement.



On February 29, 2016, we entered into the Fifth Amendment to the Loan and Security Agreement with East West Bank which provided for a Term Loan (the “Term Loan”) for $6.0 million. The $6.0 million Term Loan bore interest at a floating rate equal

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to the U.S. Prime Rate plus 1.0%. In the event of a default, the interest rate was to increase 5% per annum. The Term Loan was secured by substantially all of the 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. Interest accrued from the date the Term Loan was made at the aforementioned rate and was payable monthly. The Term Loan was to be repaid in 36 equal monthly installments of principal, plus accrued but unpaid interest, commencing on January 1, 2017 and continuing on the first day of each month thereafter through and including January 1, 2020. The Term Loan required the Company to maintain a minimum current ratio, a specified ratio of Total Liabilities to EBITDA and a minimum fixed charge coverage ratio, as defined in the Term Loan. The Term Loan required us to pay two annual credit facility fees of $18,750 and legal fees equal to $1,000.



On September 24, 2019 the Company agreed in principle to the terms of a new amendment and on October 4, 2019, we entered into the First Amendment (“First Amendment”) to the Lumata Facility. The purpose of the First Amendment was to waive certain events of non-compliance with respect to covenants not achieved in prior periods and to amend future covenant requirements. The First Amendment also required Evolving Systems to make an advance payment of principal of $666,666.66. The remaining terms and conditions of the Lumata Facility and payment schedule remain unchanged. The Company also agreed to pay East West Bank’s legal fees in connection with the transaction. The last payment was scheduled to be made January 31, 2021.



On September 24, 2019, the Company agreed in principle to the terms of a new amendment and on October 4, 2019, we entered into the Sixth Amendment to the Loan and Security Agreement (“Sixth Amendment”) with East West Bank to the Term Loan. The purpose of the Sixth Amendment was to waive certain events of non-compliance with respect to covenants not achieved in prior periods and to amend future covenant requirements. The Sixth Amendment also required Evolving Systems to make an advance payment of principal of $333,333.33. In addition, the Sixth Amendment added any default under the Lumata Facility discussed above as an Event of Default under the Term Loan. The remaining terms and conditions of the Term Loan and payment schedule remained unchanged. The Company also agreed to pay East West Bank’s legal fees in connection with the transaction. The last payment of principal and interest was made November 1, 2019.



Financial covenants previously included in the credit facilities had been replaced by a minimum consolidated cash balance of no less than the total bank debt outstanding and a minimum trailing three month consolidated EBITDA fixed dollar amount mutually agreed to by the Company and East West Bank in the amendments.  



On July 1, 2020, we entered into the Amendment and Waiver Letter (“Second Amendment”) to the Lumata Facility. The purpose of the Second Amendment was to waive certain events of non-compliance with respect to covenants not achieved in prior periods and to amend future covenant requirements. The Second Amendment adjusted the loan amortization to be paid in full no later than December 31, 2020 and fixed the interest rate at 5% on the remaining principal. Monthly payments will be $0.1 million with the last payment scheduled to be made December 31, 2020.The Company also made an advance payment of $44,000 on June 1, 2020.



Financial covenants previously included in the amended credit facilities have been replaced by a monthly minimum consolidated cash balance of no less than $1.5 million and a fiscal quarter consolidated EBITDA fixed dollar amount mutually agreed to by the Company and East West Bank in the amendments. Evolving Systems has transacted all loan payments as originally scheduled and was in compliance with the new covenants as of September 30, 2020.



Paycheck Protection Program Loan



On April 15, 2020, the Company received loan proceeds in the amount of $318,900 under the Paycheck Protection Program (“PPP”). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after a period of eight to twenty-four weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the eight-week period.



The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until the Small Business Association remits the loan forgiveness amount to the lender. However if the borrower does not apply for forgiveness the deferral shall be 10 months after the end of the loan forgiveness covered period. The Company intends to use the proceeds for purposes consistent with the PPP. While the Company currently believes that its use of the loan proceeds will meet the conditions for forgiveness of the loan, we cannot assure you that we will not take actions that could cause the Company to be ineligible for forgiveness of the loan, in whole or in part. Any such portion not forgiven can be prepaid in whole or part without penalty. We have recorded the PPP loan as a long term loan payable on our Condensed Consolidated Balance Sheet and will reduce the balance at the time loan is forgiven or we begin to make payments.



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NOTE 8 — INCOME TAXES



We recorded income tax expense of $0.1 million for each of the three months ended September  30, 2020 and 2019, respectively. The net expense during the three months ended September  30, 2020 consisted of current income tax expense of $0.1 million. The current tax expense consists of income tax primarily from our U.K. and Indian based operations and foreign taxes withheld. The net expense during the three months ended September  30, 2019 consisted of current income tax expense of $0.1 million. The current tax expense consists of income tax primarily from our Indian based operations.



We recorded income tax expense of $0.7 million and $0.3 million for the nine months ended September 30, 2020 and 2019, respectively. The net expense during the nine months ended September 30, 2020 consisted of current income tax expense of $0.7 million. The current tax expense consists of income tax primarily from our U.K., Nigerian and Indian based operations and foreign taxes withheld. The net expense during the nine months ended September 30, 2019 consisted of current income tax expense of $0.3 million. The current tax expense consists of income tax primarily from our Indian and Nigerian based operations.



Our effective tax rate was 52%  and (101%) for the three months ended September  30, 2020 and 2019, respectively. The 2020 effective tax rate relates to our net income coming from our U.K. and Indian based operations as well as foreign withholding tax and net losses from our other operations for which we did not recognize a net deferred tax benefit.



Our effective tax rate was 92% and (4%) for the nine months ended September 30, 2020 and 2019, respectively. The 2020 effective tax rate relates to our net income coming from our U.K.,  Indian and Nigerian based operations as well as foreign withholding tax and net losses from our other operations for which we did not recognize a net deferred tax benefit.



As of September  30, 2020 and December 31, 2019 we continued to maintain a valuation allowance on our domestic net deferred tax asset for foreign tax credit (“FTC”) carryforwards, certain state net operating loss (“NOLs”) carryforwards and research and development tax credits other than $0.5 million in FTC. We also have $0.3 million of foreign deferred tax assets, offset by foreign deferred tax liabilities of $0.2 million. Our deferred tax assets and liabilities as of September  30, 2020, and December 31, 2019, were comprised of the following (in thousands):











As of September  30, 2020 and December 31, 2019 we had no liability for unrecognized tax benefits.



We conduct business globally and, as a result, Evolving Systems or one or more of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, namely the U.S., U.K., France, and India. Although carryovers can always be subject to review by taxing authorities, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2014.



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On March 27, 2020, President Trump signed into U.S. federal law the CARES Act, which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. In particular, under the CARES Act, (i) for taxable years beginning before 2021, net operating loss carryforwards and carrybacks may offset 100% of taxable income, (ii) NOLs arising in 2018, 2019, and 2020 taxable years may be carried back to each of the preceding five years to generate a refund and (iii) for taxable years beginning in 2019 and 2020, the base for interest deductibility is increased from 30% to 50% of EBITDA. We are planning on accelerating our alternative minimum tax credit refund.



Transfer Pricing Adjustments, net



The Company’s tax positions include the Company’s intercompany transfer pricing policies and the associated taxable income and deductions arising from intercompany charges between subsidiaries within the consolidated group. During fiscal year 2018, the Company finalized an Advance Pricing Arrangement (“APA”) with Evolving Systems and its subsidiaries. This APA determined the amount of income which is taxable in each respective jurisdiction. The Company applied this methodology in accordance with the APA and the adjustments necessary to reflect the reduction in U.S. pre-tax income resulted in an increase in domestic income before income tax expense of $1.2 million and $3.4 million and a corresponding decrease in foreign income before income tax expense in the three and nine months ended September  30, 2020, respectively.



NOTE 9 —GEOGRAPHICAL INFORMATION



We are headquartered in Englewood, a suburb of Denver, Colorado. We use customer locations as the basis for attributing revenue to individual countries. We provide products and services on a global basis through our offices in North Carolina and our U.K.-based subsidiaries. Additionally, personnel in Cluj, Romania, Grenoble, France, and Bangalore and Kolkata, India, provide software development services and support to our global operations. Financial information relating to U.S.-based companies and by international geographical regions exceeding the threshold (defined as contributing at least 10%) of revenue from operations is as follows (in thousands):













NOTE 10 — COMMITMENTS AND CONTINGENCIES



(a)Lease Commitments



Under ASU 2016-02, Leases (“Topic 842”), operating lease expense is generally recognized evenly over the term of the lease. The Company has operating leases primarily consisting of facilities with remaining lease terms of one year to seven years. We lease office and operating facilities under non-cancelable operating leases. Current facility leases include our offices in Englewood, Colorado, New York, New York, London, England, Bangalore, Kolkata,  India, Johannesburg, South Africa, Kuala Lumpur, Malaysia, Grenoble, France, Cluj-Napoca, Romania and Madrid, Spain. The Company entered into one new lease in Kuala Lumpur, Malaysia in the nine months ended September  30, 2020, this contributed less than $0.1 million to our right-of-use asset/operating lease liability. Our lease for the Kolkata facility provided us with the option to terminate the lease in August 2020. We did not exercise our termination option and have included costs through the July 2026 lease end date, since this was the plan from the onset there has been no change to the right of use assets.  Total rent expense consisted of operating lease expense of $0.1 million and short-term lease expense of less than $0.1 million for the three months ended September  30, 2020 versus operating lease expense of  $0.1 million and short-term lease expense of less than $0.1 million for the three months ended September 30, 2019. Total rent expense consisted of operating lease expense of $0.3 million and short-term lease expense of $0.2 million for the nine months ended September 30, 2020 versus operating lease expense of $0.4 million and short-term lease expense of $0.1 million for the nine months ended September 30, 2019.  There was no sublease rental income for the nine months ended September  30, 2020 and 2019. We paid $0.2 million and $0.5 million against Lease obligations – operating leases in the three and nine months ended September  30, 2020, respectively, compared to $0.1 million and $0.4 million in the three and nine months ended September  30, 2019 respectively.



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Leases with an initial term of twelve months or less are not recorded on the condensed consolidated balance sheet. For lease agreements entered into or reassessed after the adoption of Topic 842, we combine the lease and non-lease components in determining the lease liabilities and right-of-use (“ROU”) assets.



Our lease agreements generally do not provide an implicit borrowing rate; therefore, an internal incremental borrowing rate is determined based on information available at lease commencement date for purposes of determining the present value of lease payments.



ROU lease assets and lease liabilities for our operating leases were recorded in the condensed consolidated balance sheet as follows (in thousands):









Future lease payments included in the measurement of lease liabilities on the condensed consolidated balance sheet as of September  30, 2020, for the following five fiscal years and thereafter were as follows (in thousands):











(b)Other Commitments



As permitted under Delaware law, we have agreements with officers and directors under which we agree to indemnify them for certain events or occurrences while the officer or director is, or was, serving at our request in this capacity. The term of the indemnification period is indefinite. There is no limit on the amount of future payments we could be required to make under these indemnification agreements; however, we maintain Director and Officer insurance policies, as well as an Employment Practices Liability Insurance Policy, that may enable us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September  30, 2020 or December 31, 2019.



We enter into standard indemnification terms with customers and suppliers, in the ordinary course of business, for third party claims arising under our contracts. In addition, as we may subcontract the development of deliverables under customer contracts, we could be required to indemnify customers for work performed by subcontractors. Depending upon the nature of the indemnification, the potential amount of future payments we could be required to make under these indemnification agreements may be unlimited. We may be able to recover damages from a subcontractor or other supplier if the indemnification results from the subcontractor’s or supplier’s failure to perform. To the extent we are unable to recover damages from a subcontractor or other supplier, we could be required to reimburse the indemnified party for the full amount. We have never incurred costs to defend lawsuits or settle claims relating to an indemnification. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, there were no liabilities recorded for these agreements as of September  30, 2020 or December 31, 2019.



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Our standard license agreements contain product warranties that the software will be free of material defects and will operate in accordance with the stated requirements for a limited period of time. The product warranty provisions require us to cure any defects through any reasonable means. We believe the estimated fair value of the product warranty provisions in the license agreements in place with our customers is minimal. Accordingly, there were no liabilities recorded for these product warranty provisions as of September  30, 2020 or December 31, 2019.



Our software arrangements generally include a product indemnification provision whereby we will indemnify and defend a customer in actions brought against the customer for claims that our products infringe upon a copyright, trade secret, or valid patent of a third party. We have not historically incurred any significant costs related to product indemnification claims. Accordingly, there were no liabilities recorded for these indemnification provisions as of September  30, 2020 or December 31, 2019.



(c)Litigation



From time to time, we are involved in various legal matters arising in the normal course of business. The Company has been served a complaint from the Company’s former Chief Executive Officer claiming he was not properly compensated upon termination along with additional allegations. The Company has engaged legal counsel through our insurance carrier and has begun discovery and has scheduled mediation with the other party. The Company intends to defend this matter rigorously and the ultimate outcome is not estimable or determinable at this time.