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Evolving Systems, Inc. (NASDAQ:EVOL)

Q1 2014 Earnings Conference Call

May 6, 2014 4:30 pm ET

Executives

Thad Dupper - CEO

Dan Moorhead - VP, Finance

Analysts

Mike Crawford - B. Riley & Company

Donna Jaegers - D.A. Davidson

Operator

Good day, ladies and gentlemen, and welcome to the Evolving Systems 2014 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, today's meeting is being recorded.

I would now like to introduce your host Mr. Dan Moorhead, Vice President of Finance. Mr. Moorhead, please begin.

Dan Moorhead

Good afternoon, and welcome to Evolving Systems 2014 first quarter earnings call. I'm 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 to 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 turn the call over to Thad.

Thad Dupper

Thanks, Dan, and good afternoon, everyone. I'd like to begin with our bookings results which were the highlight of the quarter. Total orders in Q1 were up 30% from a year ago, continuing the momentum we began in the second half of last year. Drilling down our licensing services or LS bookings grew 42% to $5.1 million, which is an all time best and a new record for Q1.

Dynamic SIM Allocation or DSA LS bookings were up 95% compared with the same quarter last year and also set a new record as our best Q1 for DSA as well. We are pleased these bookings results which are all the more impressive considering we achieved them with add on business from existing customers. This underscores the growing size of our DSA installed base and the value our customers are deriving from DSA.

During the first quarter, we received upgrade orders for our new DSA module that provide support for LTE, a change request to support multiple language options during the activation experience. This is becoming a popular upgrade as our customers often need to support a very diverse subscriber base in order to integrate DSA into a carrier's customer care center and one to add an automated SIM ordering feature to DSA.

As you can surmise, these enhancements cover a broad range of functionality but fall into two main categories. First, to improve the overall subscriber activation experience and, second, to better integrate DSA with the carriers of the systems, the customer care or SIM ordering. Every time we implement these change request orders we enhance the value of DSA for our customers and as a byproduct make DSA a more robust solution and, thereby, extend our lead over our competitors.

While closing orders for DSA enhancements, we were also busy working on running new accounts. We currently have three DSA trials underway which we expect to conclude this summer, as well as a solid pipeline of DSA prospects.

Turning to backlog, as you'd expect given our booking results, backlog increased during the quarter. LS backlog was up 40% and DSA LS backlog was up 72%. As many of you know who follow EVOL, bookings and backlog are leading growth indicators for the business.

Now a few comments on our income statement. LS revenue was up 5% sequentially, led by DSA LS revenue which increased 26% over Q4. During Q1, we generated solid net income and EBITDA results with adjusted EBITDA up 15% sequentially, and for the quarter gross margins remained strong at 71%.

Towards the end of the quarter, we took a $200,000 restructuring charge in connection with our Telespree unit, which you will recall we acquired in October last year. This follows the $600,000 charge we took in Q4. As a result of these actions, our cost are now in line. And we are pleased that five months into our acquisition we have integrated Telespree or what we now call Evolving Systems Labs into EVOL, including transitioning some of their development activates to our India facility.

At the same time, we have leveraged Evolving Systems Lab noted expertise in cloud development and operations for the launch of our SaaS DSA Solution which we announced in March.

As a result of our continued order momentum, profitability and confidence in the business, we are pleased to report that our board of directors has declared a second quarter dividend which Dan will cover in a minute.

And as I do every quarter, I'd like to provide some color on our DSA deployments. In Brazil, to-date we have activated over 40 million DSA SIMs. And as a result, we are working on our second tranche of FUA replenishments with our customer there. We expect to close the second tranche later this year. To remind you, FUAs are first use activations occur when a carrier's initial license of activation has been exhausted.

FUA revenue is very high margin business. And as more customers consume their initial allocation, we look forward to what amounts to a new revenue stream for EVOL and one that is highly profitable. As mentioned earlier, DSA LS bookings consisted of a series of change requests one of which came from this customer to support a new (inaudible) SIM that will offer this carrier competitive edge as Brazil prepares to host the world cup this summer.

In Saudi Arabia, we are activating 17,000 data SIMs today. Often when we mention the prepaid market and its fit with DSA what comes to mind is mostly voice and SMS traffic. But as highlighted with our Saudi customer, this isn't the case. And beyond that, it demonstrates that DSA is just as well suited to activate data-only SIMs as it is to activate traditional SIMs. This, of course, is very relevant as carriers around the world look to upgrade their networks to LTE in order to provide a growing list of data services.

And speaking of LTE, in Mexico, we are in the final stages of testing our LTE version of DSA and plan to shortly migrate into production.

In Africa, at one of our newest DSA accounts, and this is the account where we earn that accelerated deployment bonus I just spoke of last quarter, we are now in production and are completing 98% of the SIM activations in less than two minutes.

Turning to Tertio Service Activation, or TSA. Following a strong fourth quarter TSA LS bookings moderated $1.6 million. Of note, most of UK, where our TSA customers ordered upwards of $1 million new change request during the quarter. And with an installed base of 30 carriers, we continue to rely on the Tertio customer base to generate a steady run rate or change requests for this business.

I'll close by summarizing our Q1 achievements. We posted record LS bookings in Q1 with LS orders up 42% year-over-year. DSA LS bookings grew 95% year-over-year, another record and our best start since we introduced DSA in 2007.

In Q1, we introduced the SaaS-based version of our DSA product and are now offering DSA in the cloud. This makes DSA a viable option for a whole new group of carriers, we estimate as many as 100, who don't necessarily have to budget or staff for a premise-based DSA solution but who could, nonetheless, benefit from DSA. And our SIM activation rates are growing with indications that we will achieve record level of FUA license renewals in 2014.

We are consistently generating solid profitability which enables us to pay dividends to our investors. This is best illustrated that since Q3 2010, when we first began paying a dividend, we have returned over $53 million to our shareholders in special and quarterly dividends.

In summary, based on our bookings performance, increasing backlog and our FUA license renewal expectations, we are confident that we are well-positioned to deliver a strong performance in the second quarter as well for the entire year.

With that, I'll turn the call over to Dan.

Dan Moorhead

Thanks, Thad. First quarter revenue was $6.6 million versus $6.7 million in Q1 last year. License and services revenue was $4.4 million, compared to $4.5 million last year, while customer support revenue was flat year-over-year as $2.2 million. Total cost of revenue and operating expenses increased by 14% in Q1 to $5.6 million from $4.9 million.

Of this $700,000 increase, approximately $600,000 was related to Telespree operations, including the $200,000 restructuring charge, $200,000 of sales and marketing expense and $200,000 in product development. These expenses will be reduced going forward due to the restructuring completed at the end of the quarter.

All of these increases contributed the lower operating income in Q1 of $1 million versus $1.8 million in the year ago first quarter.

GAAP net income in the first quarter was $700,000 with diluted earnings per share of $0.05. That compares to GAAP net income of $1.2 million or $0.10 per share a year ago. Adjusted EBITDA in Q1 was $1.4 million compared with $2 million in the same quarter last year. The company used $300,000 in operations in the first quarter as compared to $2.8 million of cash generated from operations in the same period last year.

Bookings and backlog. We define bookings as new, non-cancelable orders expected to be recognized as revenue during the following 12 months. Total first quarter bookings were $7.4 million, which represented a 30% increase from $5.7 million in the same quarter last year. LS bookings increased to $5.1 million, which was a 42% increase over $3.6 million in the first quarter last year. DSA LS bookings in Q1 increased 95% to $3.5 million from $1.8 million in Q1 last year. TSA LS bookings were $1.6 million compared to $1.8 million in Q1 last year. Customer Support or CS bookings in Q1 were $2.4 million, up 10% from $2.2 million year-over-year.

Total backlog at March 31 was $13.1 million which is up 34% from $9.8 million at the same time last year. LS backlog was at 40% year-over-year to $7.8 million from $5.6 million. DSA LS backlog grew 72% year-over-year to $5.3 million from $3.1 million and TSA LS backlog was flat at $2.5 million. CS backlog increased 26% to $5.3 million from $4.2 million year-over-year.

Balance sheet. Cash and cash equivalents at March 31 were $12.4 million, compared to $11.5 million a year ago and $13.8 million at year end. Working capital was $14.5 million, compared to $14.3 million a year ago and $14.7 million at year end.

Dividend update. As announced today in our earnings release, our board declared a second quarter dividend of $0.10 per share payable May 30, 2014 to stockholders of record on May 20, 2014.

I'll close with the usual reminder that a single order can have a significant impact on our quarterly results. Accordingly, we continue to advice 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 are now happy to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions).

And our first questioner is Mike Crawford with B. Riley & Company. Please go ahead.

Mike Crawford - B. Riley & Company

Thank you very much. Can you provide some more color in which markets or in what capacity these three DSA trials are?

Thad Dupper

Hey, Mike. How are you doing? I'm going to give you high level because half the people who show up on our call I think are our competitors, so I don't want to give away too much. But North America, Asia and Europe are the locations that are high level.

Mike Crawford - B. Riley & Company

Okay. All were new customer spin?

Thad Dupper

Oh, yeah. No -- yeah. These are trials with somebody who doesn't have DSA.

Mike Crawford - B. Riley & Company

Okay. But as opposed to, I guess what I meant a carrier that might be affiliated with a larger group where some of the other subsidiaries have DSA?

Thad Dupper

No, they're all brand new. They are not parts of groups. Now, we have other properties within groups where we already have DSA in the funnel. But specifically what you are asking about these three trials, and these trials are new names with new groups.

Mike Crawford - B. Riley & Company

All right, thanks. And then, it's nice to see the bookings and backlog up substantially. And I realize that some of these projects have different size, scale and scope of others. But to what extent can you tell how it might flow into revenue going forward, given I think it's three or four quarter typical kind of a order to operation process, may be even five quarters?

Thad Dupper

You're right. And that's a good question, Mike. The benefit of getting all these change request rather than new accounts is we always convert a change request to revenue a lot faster than a new account. Sometimes when you get a new name kicking off the project has a little bit of a lag. But when we're doing an enhancement in an existing account, we know the people, they know us, the accounting and the passing of paper is easier. So I would say the shape and form of this backlog compared to prior quarters, a year is a backlog that can be converted to revenue much more efficiently than in the past. And that's one of the reasons we are so bullish on our Q2 outlook.

Mike Crawford - B. Riley & Company

Okay, great. And then, last question relates to just operational cost. So now that you've got may be Telespree integrated in where you wanted, is it fair to say that total operating expenses will be down directionally from Q1 and then may be start to creep up going forward if your business continues to grow or how would you characterize it?

Thad Dupper

Yes, I agree with that. I mean, we've taken two restructuring charges so we have taken -- what do we think like $2 million out of the business, out of the OpEx?

Dan Moorhead

Yes, like (inaudible).

Thad Dupper

So we have taken a lot out of the business. Now, those of you have received the proxy and who studied the Q know we haven't paid a bonus in a long, long time. So at some point we would like to pay a bonus again. So some cost may come back into the P&L but nothing near the $2 million we took out. So I would expect with backlog up, we should be able to drive revenue and with cost down that should translate into a good EBITDA performance, yes.

Mike Crawford - B. Riley & Company

Okay. Great. Thank you.

Dan Moorhead

Thanks Mike.

Operator

Our next questioner is Donna Jaegers of D.A. Davidson. Please proceed.

Donna Jaegers - D.A. Davidson

Maybe this is more of a question for Dan. On the Telespree the $600,000 in cost, can you give us which line -- can you clarify which line items those costs are falling in to mostly? And that's the existing cost? I'm sorry; I got three companies reporting at the same time to this so I'm a little confused this afternoon.

Dan Moorhead

You're talking, so the $600,000 from Q4 would be primarily from LS line and the product development line.

Donna Jaegers - D.A. Davidson

Okay.

Dan Moorhead

So -- and then, in Q1 it would be that -- it would probably be fairly evenly spread between product development and a little more sales and marketing in Q1 as it decreases.

Donna Jaegers - D.A. Davidson

And the number at Q1 was $200,000, right?

Dan Moorhead

$211,000, yes.

Donna Jaegers - D.A. Davidson

Okay. And then, Thad, given what you're -- how happy are you with the Telespree acquisition, given all the charges you had to take of -- you have appetite for others sort of these little bolt on acquisitions or is it more trouble than it's worth?

Thad Dupper

No, I wouldn't say that. I would say its work. So I don't think its business as usual. I think we have a very talented crew in San Francisco, so I think its great addition. We love their technology, their cloud experience, their development methodology, their patent. So it's in that gain, no question about it. Now, you know we run a tight ship. So it has taken the two quarters to kind of get the expenses in line. But overall, we are very pleased with that in terms of the technology and the development. And as we said, our team in San Francisco was very helpful in the launch of the SaaS DSA product about six weeks ago.

Donna Jaegers - D.A. Davidson

And obviously, since that's only six weeks ago its early days but any -- what's the customer reaction so far?

Dan Moorhead

Well, it's good. It's interesting. I was just out on the road. And I will say, U.S. based companies, U.S. listed companies that offers cloud-based solutions in the international marketplace have to contend with the new challenge and it's the Eric Snowden challenge. So privacy of data and confidence that carriers have that data you'll be storing in their cloud will not be shared with the NSA is an issue we never had a deal with in the past, but it's on the table now. So I'd say it's more than an annoyance, but we heard it in mobile world and we heard it a few times. That said, the power and the benefit of DSA is pretty straightforward. And we are pleased with the interest we're seeing six weeks in.

Donna Jaegers - D.A. Davidson

Okay. Wouldn't DS -- wouldn't cloud DSA -- don't you house the could in the U.S., so wouldn't that be a complication?

Thad Dupper

No, we have -- well, we do have a cloud in the U.S., in California. We have plans to add a cloud in Amsterdam and Singapore. But that's not Panama, and that's not Africa. And a lot of these three carriers have very strong opinions nowadays about data leaving their country and their sovereignty. Now, we have an idea to put a proxy server in the country to deal with that. But what you're hearing is it's an added complexity that's a reality in today's day and age, if you're offering SaaS-based services to companies outside the U.S., now we are dealing with it.

And again, I come back to the strength of the business case of DSA is growing and that will hold the day. We just have to deal with these issues and these questions about privacy and data location. But we are going to deal with that. And the products running and activating millions of SIM cards every day and the benefit that it provides to carriers is becoming more and more evident. And the tagline we use is the new standard in SIM card activation. And every week that goes by, that becomes more and more of a -- as an agreed upon standard in the industry, and we are proud of that.

Donna Jaegers - D.A. Davidson

Okay. And then, just one other last question. Given the three tests that are underway, is there any typical timeframe between wrapping up a test than securing an order?

Thad Dupper

Yes, there is. And it has to do with the complexity of getting the master contract sign. You have to get the master contract translated and whatever the individual carrier's governance is in approving a deal. But first things first. Getting the trail done, making the trial successful and then closing the deal that's where we're headed and we know how to do it. So we're pleased with that.

And then, in addition, we've got, just like we showed in this quarter, the ability to have a very good bookings quarter even without posting a new name. And that's a testament to the size of -- and the growth of our installed base. So we'll get these names but along the way we're going to be working hard on upgrades as well as you saw in Q1.

Donna Jaegers - D.A. Davidson

Okay. And the North American carrier that's testing DSA, that would be for prepaid? So it's obviously DSA.

Dan Moorhead

Not (inaudible) I think that was not prepaid. Actually, I think those are tablets, the data tablet.

Donna Jaegers - D.A. Davidson

Okay.

Dan Moorhead

Yes.

Donna Jaegers - D.A. Davidson

Great. Thanks.

Dan Moorhead

Thanks Donna.

Operator

(Operator Instructions).

I am showing no questions at this time and would like to turn the conference back for any further remarks.

Thad Dupper

Well, thank you all for joining us again today. We are pleased with our results and we're going to work hard to covert this backlog. And we look forward to sharing our Q2 results with you in early August. Have a nice, safe summer. Cheers.

Operator

Ladies and gentlemen, thank you for participating in today's program.

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