Evolving Systems Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug.13.13 | About: Evolving Systems, (EVOL)

Evolving Systems (NASDAQ:EVOL)

Q2 2013 Earnings Call

August 13, 2013 4:30 pm ET

Executives

Daniel J. Moorhead - Principal Accounting Officer, Principal Financial Officer, Vice President of Finance & Administration and Secretary

Thaddeus Dupper - Chairman of the Board, Chief Executive Officer and President

Analysts

Michael Crawford - B. Riley Caris, Research Division

Richard Jeans - Edison Investment Research Limited

Gary Singer

Operator

Good day, ladies and gentlemen, and welcome to the Evolving Systems Second 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Dan Moorhead, Vice President, Finance. Please begin.

Daniel J. Moorhead

Good afternoon, and welcome to Evolving Systems’ 2013 Second Quarter Earnings Call. I am Dan Moorhead, Vice President of Finance; and joining me today is Thad Dupper, Chief Executive Officer.

During the course of this call, we will be making forward-looking statements based on current expectations, estimates and projections that are subject to risks. Specifically, our statements about future revenue, expenses, cash, taxes and the company’s growth strategy are forward-looking statements. Listeners should not place undue reliance on these statements. There are many factors that could cause actual results that differ materially from our forward-looking statements. We encourage you to review our publicly filed documents, including our SEC filings, news releases and website for more information about the company.

With that, I’ll now turn the call over to Thad.

Thaddeus Dupper

Thanks, Dan, and good afternoon, everyone. We were pleased with our profit metrics and the ability to generate strong cash flows in Q2. However, our results for the quarter were impacted by a new DSA account we expected to be closed in the second quarter that subsequently closed early in the third quarter. That said, total bookings for the quarter increased by 6% with dynamics in allocation, or DSA bookings, up 48% year-over-year. In addition, as I just mentioned, our third quarter bookings are off to a strong start. That, combined with the contour of our DSA pipeline and deal flow, we remain confident that we will post strong, if not, record DSA orders and revenue for 2013, which follows a record 2012, where DSA revenue doubled from $5 million to $10 million.

Based on this outlook, as well as our strong cash flows, today, we announced that we are increasing our quarterly dividend to $0.10 from $0.08, representing the company's second dividend increase this year.

I would like to spend some time on the 2 new DSA accounts we recently announced. In June, we announced the new DSA win in Argentina. It was our first win in that country and second within Telefónica Group. It also represented another successful order via our SIM partner channel. The other point worth mentioning is this was a competitive displacement win. You have heard us express confidence in our ability to outdistance the competition based on DSA's functionality, as well as our proven production experience, but this marks our first competitive displacement win. The second new DSA win was with an African carrier, who is a member of one of the top 5 global carrier groups. I'd like to provide some color on this deal, and explain why ultimately, this became a Q3 order. We had completed our negotiations with the carrier. The contracts were finalized, and we were progressing through the final stages of the signature process when the carrier's global procurement organization inserted themselves into the mix. And let me add, in addition to this African carrier, we were and are in advanced discussions at another carrier in this group for DSA. In any case, when global procurement learned that 2 of their properties were in the final stages of ordering DSA, they decided to put the individual deals on hold and negotiate an enterprise licensing agreement for DSA. The benefit to EVOL is clear, that this group, with over 250 million total subscribers and 20 properties located in the growth markets of Africa and Asia, will have the benefit of group level DSA pricing. This represents our first enterprise-wide licensing agreement with DSA, and it's one of -- it's with one of the world's top 5 carriers. It's this activity, plus the other opportunities in the DSA funnel, why we remain confident that we are on track to make 2013 a record year for DSA.

Putting aside of the new deals, I would like to provide an update on how DSA is performing in the field. Today, I will highlight one of our largest DSA accounts, an account that has dramatically ramped its DSA SIM activations from under 1 million per month at the start of the year to now almost 2.5 million per month, and this underscores one of the key benefits of DSA, the ability for a carrier to greatly increase the number of SIM cards it can put in the retail channel without incurring the costs typically associated with traditional SIMs. As another point of reference, this carrier had a peak activation rate of over 150,000 cards in a single day during July in support of a marketing campaign. And while we are thrilled with the performance of DSA, we are even more gratified with the contribution DSA made to the business. Before DSA, this carrier's market share was a leading 42% in the end market. Once DSA went into production, their market share increased by 2.5% to 44.5%. That's a noteworthy market share increase in only 6 months.

This particular market is predominantly a prepaid market, and we have seen time and time again what enables a carrier to capture market share is -- and especially in the prepaid markets, is the ability to get more shelf space with retailers and to saturate their channels with their sends, DSA sends, and again, to do it without the logistics and the network inventory headaches and costs associated with traditional SIMs. The upshot, DSA's core capabilities translated into tangible operational improvements that set the stage for market share growth.

And before I turn the call over to Dan, I would like to close with some other highlights for the second quarter. DSA customer support revenue for the first half was up 48% over the first half last year, as more of our DSA customers move into production. The importance here is we drive a very high gross margin on our customer support business. DSA license and service bookings for Q2 increased by over 48% year-over-year and our profitability remains noteworthy. Adjusted EBITDA, as a percent of revenue, increased to 28% in the first half from 21% a year ago. First half operating income was up 42%, and gross margins remained strong at 71%. Cash, which Dan will cover, was a real highlight for the quarter, up 51% year-to-date from our year-end balance. In summary, we ran into a timing challenge in Q2, and that impacted our results. However, with that order now in and the level of activity we're experiencing, we expect a strong Q3 for LS bookings. With that, I'll now turn the call over to Dan.

Daniel J. Moorhead

Thanks, Thad. I'll begin with second quarter results. Revenue in the second quarter was $5.8 million versus $6.7 million in Q2 last year. License and Services revenue was $3.5 million versus $4.5 million last year. Customer Support revenue increased to $2.3 million from $2.1 million. Total cost of revenue and operating expenses decreased 11% to $4.5 million from $5.1 million in Q2 last year. As Thad mentioned, gross margins remained strong at 71%, and we also reduced our operating expenses, including a 23% decrease in general and administrative expense and a 12% decrease in product development expense. The company generated operating income of $1.3 million in the second quarter compared to $1.6 million in the same quarter last year. We reported $200,000 in other income in the second quarter, consisting mostly of foreign currency gains. That compared to $1.1 million in other income in Q2 a year ago. This was related to interest income and gains on the sales of marketable securities. To remind everyone, these securities were purchased with the proceeds from the sale of our numbering business in 2011 and sold during the second quarter of 2012.

GAAP net income in Q2 was $900,000, with diluted earnings per share of $0.08 compared with GAAP net income of $2.1 million and diluted earnings per share of $0.19 a year ago. Again, most of the difference in GAAP net income year-over-year is related to the gains from marketable securities. Adjusted EBITDA in Q2 was $1.5 million versus $1.8 million a year ago. We generated $2.7 million in cash from operations in the second quarter compared with $1.7 million of cash used in operations in Q2 last year, a positive swing of $4.4 million.

Six months results. We reported revenue of $12.5 million in the first half of 2013, just slightly below revenue of $12.6 million in the first 6 months last year. License and services revenue was $8 million versus $8.3 million, and customer support revenue was $4.4 million versus $4.3 million. Total cost of revenue and operating expenses declined to $9.4 million in the first half from $10.4 million a year ago. Gross margins increased to 72% from 67% last year, and we decreased general and administrative expense by 13% and product development by 7%. Operating income increased 42% in the first half to $3 million from $2.1 million in the same period last year as a result of higher gross margins and lower operating expenses. Other income in the first half totaled $140,000, primarily foreign currency gains compared with other income of $1.4 million in the first half last year related to marketable securities.

GAAP net income through 6 months was $2.1 million versus $2.9 million a year ago. That equates to $0.18 diluted earnings per share versus $0.25 last year. Let me point out approximately $0.12 of the $0.25 of diluted earnings per share last year was related to the other income on marketable securities.

Adjusted EBITDA through 6 months was $3.5 million, up 31% from $2.6 million year-over-year. The company generated $5.4 million in cash from operations in the first 6 months 2013 compared with $200,000 in cash used in operations during the same period last year, a $5.6 million improvement over last year, which highlighted our DSA deliveries during 2013 and collections on those projects.

Turning to bookings and backlog. We define bookings as new, noncancelable orders expected to be recognized as revenue during the following 12 months. In the second quarter, total bookings were $6.1 million, up 6% from $5.8 million in the same quarter last year, and up sequentially from $5.7 million in the first quarter of this year. Total bookings included $3 million in License and Services and $3.1 million in Customer Support. DSA license and services bookings increased 48% to $1.6 million from $1.1 million over the comparative second quarter. Tertio Service Activation or TSA license and services bookings were $1.4 million, down from $3 million last year.

Moving to 6 months bookings. Total bookings were $11.8 million, up from $11.4 million in the first half last year. License and Services bookings were $6.5 million and Customer Support came in at $5.3 million. DSA license and services orders came in at $3.4 million versus $3.7 million last year. TSA license and services orders totaled $3.1 million compared with $4.3 million last year. Total backlog at June 30 was $10.3 million, which was up from $9.8 million in the first quarter, but down from $11.4 million at the same time last year. DSA Licensing Services backlog was $2.9 million compared to $4.7 million last year. TSA Licensing Services backlog was $2.2 million versus $2.7 million a year ago. Customer Support backlog increased to $5.2 million compared to $4 million last year.

Balance sheet highlights. Cash and cash equivalents at June 30 were $13.4 million, up 51% from $8.8 million at 2012 year end. Our working capital balance at the end of Q2 increased to $14.5 million from $13.9 million at year end.

Dividend update. As noted in our press release today, the company's Board of Directors declared a third quarter dividend of $0.10 per share, payable September 13, 2013, to stockholders of record on August 30, 2013.

In conclusion, as we do every quarter and as we saw in Q2, we remind you that we remain a company where the delay of a single key order can affect our quarterly results. With that, we continue to advise that it's more accurate to judge our performance on an annual rather than quarterly basis. With that, we thank you again for joining us today, and we are now happy to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We have a question from Mike Crawford of B. Riley & Co.

Michael Crawford - B. Riley Caris, Research Division

Thad, I think it was way back in Q4 2010 when Evolving lost a deal in Argentina to local, like 3 guys in a garage and it was on price. Is that the competitive displacement that you've now won in 2013?

Thaddeus Dupper

No, that deal in Q4 2010 was in Brazil.

Michael Crawford - B. Riley Caris, Research Division

Oh, in Brazil? Okay.

Thaddeus Dupper

And this is Argentina so it's close, but it was a little more than 3 guys in a garage. But the carrier in Argentina was apparently dissatisfied with the service they were getting. And we came in, and with our credentials and our production experience, we were able to also with the reference within the Telefónica Group in Mexico, where we have DSA in production, we were able to win the business. So it was a nice win for us.

Michael Crawford - B. Riley Caris, Research Division

Okay, great. And then, with the other large group, I'm sorry, you said 250 million total subscribers, and did you say 20 carriers in the group?

Thaddeus Dupper

Yes, in excess of 250 million subscribers, so more than that. And today, they currently have 20 -- what we call OpCos, operating companies, different footprints, where they operate wireless networks.

Michael Crawford - B. Riley Caris, Research Division

And the African carriers the first one in that group and now you expect to close on a second now that the group has an enterprise agreement?

Thaddeus Dupper

Well, shortly, we expect to close on a second, but long term, we'd like to close on more because we've already had the pricing at the OpCo level. We already have our targets lined up, and our sales team are beginning to contact some of these other properties. So you're right.

Michael Crawford - B. Riley Caris, Research Division

And then, lastly, what about your M2M product under development?

Thaddeus Dupper

Right. So I had said I wanted to close it this quarter, and I have good news for you. The person involved with that M2M deal was also the salesperson who closed Argentina. So I gave them a buy this quarter and -- because they got the Argentina deal done, and I needed them to focus on that. Now he's going to turn his attention to that deal, as well as some North American interest that we're seeing. So we're pretty interested in the fact that we're gathering and generating interest in North America. And one of the comments I said in the script, I think, is very important. The ability to flood the market with SIM cards is something all carriers want to do. And we think that that's becoming a very, very strong characteristic of the product DSA, and that's becoming one of the top features of the product. So when we talk to carriers, we say, "Wouldn't you like to put a couple more million SIMs out in the channel and do it very, very cost effectively?" And that's what DSA allows you to do.

Operator

The next question is from Richard Jeans of Edison Investment Research.

Richard Jeans - Edison Investment Research Limited

Firstly, how is the overall pipeline? Is the overall DSA pipeline growing, continuing to grow? And also, the costs, I mean, you noticed your costs have been coming down, but are your costs bottoming out now? That would be the second.

Thaddeus Dupper

So the first question is we feel very good about the DSA pipeline. So that's why we've been so aggressive in our comments today. So we feel good about that pipeline both near-term and long-term. In terms of costs, costs were down, and my immediate reaction to that is most of the costs are down because of the bonus.

Daniel J. Moorhead

And because of revenue's down. So the -- when cost of sales are down, we have some -- I would say cost of sales is made up of some fixed costs with the people that are -- that work for the company and then the variable stuff that comes along with the product. So obviously, as we -- with revenue lower than our third-party comps, they're going to be a little bit lower.

Richard Jeans - Edison Investment Research Limited

R&D, is this sort of a level now going forward? Is this...

Thaddeus Dupper

No. R&D is down because we didn't pay a bonus because we didn't hit our numbers in Q2. That's all.

Richard Jeans - Edison Investment Research Limited

All right, okay, but -- so going forward, you could be -- it's all -- it's quite lumpy, isn't it? I mean, this deal that you got in Africa, it sounds like it was very large compared with your existing -- your previous DSA deals, isn't it? How does it compare in size with the previous ones?

Thaddeus Dupper

Yes, all new DSA deals tend to be large. So when one sweats, it leaves a mark. When it comes in, it's good. So this deal that closed in Africa was a good-sized, new DSA account.

Richard Jeans - Edison Investment Research Limited

And in terms of DSA, well, people buying new blocks of SIMs. Is that sort of -- I mean, you were -- bookings of 1.6 million in Q2, is that just -- this is mainly the Argentine deal or is it you're also getting in -- any taking on any of the existing DSA guys taking on new SIM batches?

Thaddeus Dupper

Right. So it's a good question, Richard. Certainly, Argentina made up a big part of that, but a lot of it was change request. Now what you're referring to is when we need to reload the license, what we call first-use activations, what I mentioned on our last call and we're standing by today, is we'll have 4 carriers in reload mode in 2014. Some of that may move into Q4 2013. But what we're very happy about is we like that DSA customer support revenue's growing because it's recurring. And we like that we're going to have 4 customers in production in reload status, if you will, in 2014, where they'll have to re-up their license, which comes in at virtually 100% gross margin. So we like the contour of that, and we like where we're going in terms of driving revenue, having more of our revenue recurring, and then the byproducts of that will be higher profitability for the company.

Operator

[Operator Instructions] The next question is from Gary Singer of Ramis (sic) [Romulus] Holdings.

Gary Singer

More of a statement than a question, Thad. I just want to say that we've been a shareholder for what, 6, 7 years, probably the largest shareholder for 4, 5 years. And I just want to thank you and your team for consistently delivering good numbers and finding ways to, whether it be special dividends, increased dividends, buybacks, creating value for your shareholders, and notwithstanding the delay this quarter, which ultimately sounds like it may benefit us in the future, I just wanted to express that.

Thaddeus Dupper

Thank you, Gary. We appreciate it.

Operator

[Operator Instructions] And I do show we have a question from Alan Lee [ph], private investor.

Unknown Attendee

I talked to you a few years ago. I was -- I had a question about first use activation you were just talking about. I'm just wondering if you could shed light on how that works. I know each carrier gets a certain number of SIM cards activated built into the contract, and then after that, each new SIM card activated generates a fee to Evolving Systems. Is that how it works?

Thaddeus Dupper

That's exactly right. So what happens, Alan, is when we do the initial contract with DSA, it comes with, if you will, a tranche of activations. Once that tranche is exhausted, and that's why you hear us always citing numbers like 2.5 million SIMs activated a month, we monitor and track each account and how many activations they do every month. Once they exhaust the initial tranche that came with the original license, they have to extend or renew the license. And that renewal and extension are already pre-negotiated rates. So when that happens, what's good about it is it's 100% gross margin. We send a key to them. There's no project management. There's no coding. We don't have to send people on-site. All we do is send an invoice. We send a key to enable the software to activate another 15 million SIM cards or whatever we've negotiated, and they send us the cash.

Unknown Attendee

Is it per SIM -- I guess, it is per SIM card activated. So you're talking per customer. So if you're in Africa and you've got 1 million new customers in a week or month, you're getting a fee for each one. Can you give us an idea what's the fee about, like is it a $0.10, is it a $1?

Thaddeus Dupper

Right, it's not a dollar, it's less than that. It's somewhere between a couple pennies and maybe $0.20 in general when we're dealing with the markets we're in. But the activation rates, as you already mentioned in your question, are very, very high. So when we'll start activating 2.5 million SIMs a month per carrier, those pennies start to add up of to millions of dollars, and it goes right to the EBITDA line.

Unknown Attendee

So pretty much starting next year, your earnings per share is going to take off?

Thaddeus Dupper

No, Alan, I'm glad you mentioned that because one of the by-products of increased dividend is a little bit higher, a lower EPS because of tax. And maybe Dan, you just want to add a comment about how increasing the dividend from 5 to 8 and 8 to 10 is good for our investors, but at the same time, it squeezes EPS a little bit.

Daniel J. Moorhead

Yes, so there's a couple of component of tax that caused tax expense to weigh a little bit on EPS, and we talked about one of them last quarter on the call. We talked about how the NOLs that we have are pre-FAS 123R NOLs so before stock comps was expensed in the P&L, and so NOL is related to those. And the benefit that we get on offsetting income doesn't actually offset tax expenses, it rolls through our balance sheet, and it's an entry, additional paid in capital, and so what that does is that causes our tax rate to -- our effective tax rate to show kind of that 34% to 37% when our cash rate is usually 20% to 22%. So the other piece of that is with the dividend, most of our income is in the U.K. at this point, with our U.K. subsidiary. And so what has happened at this point is we need to get that cash back to the U.S. to pay the dividend. And so we have to make an election, a tax election. And to make a long story short, what does that is, basically, we show tax expense on the U.S. books for all of the U.K. earnings. Current tax for the amount of dividend we bring back deferred tax for stuff we don't. So, in essence, basically, we're showing that 34% to 37%, and that's the drag and there's a piece of NOL in there, and there's a piece of dividend in there. But the combination of those 2 items, it's really -- we expect the drag on EPS for 2013 to be probably $0.04 to $0.06. And in the future, obviously, we'll have to take the FUA revenue and earnings into that as well. So it's just -- it's part of bringing the money back in the U.K.

Thaddeus Dupper

Yes, what I would say for like me, the non-CPAs on the call, in order to pay the dividend, we have to bring cash back to the U.S. When we bring it back, we pay a hefty tax fee on it. It's noncash because of our NOLs, but it does impact the EPS a little bit. So as Dan was saying, the impact of the higher dividend, which is a good thing, maybe $0.04 to $0.06 in EPS because of higher tax to repatriate the dollars, but I expect everybody on the call is supportive of the high dividend even at the cost of a little bit of noncash tax dollars.

Unknown Attendee

Right, okay, so -- but maybe now EPS is going to go way up, but revenue and then it...

Thaddeus Dupper

Revenue, op income and EBITDA should all increase, and EPS is going to increase too. It's just -- it's going to increase a little bit slower because our tax spikes a little higher with the $0.10 dividend as supposed to the $0.05 or $0.08 dividend. I don't want to make more of it than it is.

Operator

The next question is from Carlos Kasano [ph], a private investor.

Unknown Attendee

I just want to congratulate you guys in a good quarter, and keep up the good work. That's all I have to say from this end.

Thaddeus Dupper

Well, thank you, Carlos.

Operator

[Operator Instructions]

Thaddeus Dupper

I think you should wrap it up because we don't have a call -- question.

Operator

Yes, sir. There are no further questions at this time. I'll turn the call back over for closing remarks.

Thaddeus Dupper

Thank you very much. Thank you for joining us today, and we look forward to a busy summer in giving you a good update in the November time frame with our Q3 results. Have a safe and happy summer. Cheers.

Operator

Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.

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