Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Brian Ervine – EVP, Chief Financial and Administrative Officer

Thad Dupper – President and CEO

Analysts

Michael Coady – B. Riley & Co.

Jon Hickman – MDB Capital

Jeffrey Meyers – Cobia Capital

Evolving Systems, Inc. (EVOL) Q2 2008 Earnings Call Transcript August 6, 2008 5:00 PM ET

Operator

Good day, everyone, and welcome to the Evolving Systems second quarter earnings results conference call. This call is being recorded. At this time, I'd like to turn the conference over to the company’s Chief Financial Officer, Brian Ervine. Please go ahead, sir.

Brian Ervine

Good afternoon, and welcome to Evolving System's 2008 second quarter conference call. I am Brian Ervine, Chief Financial Officer, and with me again 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, 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, as well as our news releases and websites for more information about the company.

Now our second quarter financial highlights. We achieved solid results across the board in the second quarter with year-over-year growth in revenue, profitability, and new license and services orders. Starting with the top line, revenue grew by 6% to $9.6 million in Q2 versus $9.1 million in the year-ago second quarter. It was our sixth consecutive quarter of year-over-year revenue growth, an accomplishment we attribute to several factors, including new customer engagements, new product introduction, growth in existing customer accounts, and sales momentum from our successful entry into emerging markets.

Once again, our revenue included a strong contribution from license fees and services, which grew to $5.3 million from $4.7 million year over year. This growth more than offset a nominal decline in customer support revenue, which was $4.3 million versus $4.4 million last year. Total revenue by market unit was $5.3 million in Service Activation, $3.5 million in Numbering Solutions, and $800,000 in Mediation.

On the expense side, Q2 total costs of revenue and operating expenses came in at $8.5 million, the same as our year-ago second quarter total. Certain categories increased while others decreased year over year. Costs of license fees and services remained flat at $1.9 million year over-year. Lower travel expenses, increased utilization of Indian resources, and higher L&S revenue contributed to a reduction in cost of license fees and services as a percentage of revenue in Q2 2008 compared to Q2 2007. Cost of customer support declined year-over-year to $1.6 million from $1.7 million, reflecting lower overall labor costs required to support the small decline in customer support revenue.

As expected, general and administrative expense declined to $1.2 million from $1.6 million as a result of reductions in professional fees, headcount, and facility costs, and product development expense increased to $950,000 from $358,000 due to the enhancements we continue to make to key portfolio solutions. With higher revenue and flat expenses, our operating income grew 75% in the second quarter to $1.1 million from $629,000, the eighth consecutive quarter of operating income, a positive trend for us.

Net income in the second quarter increased to $775,000 or $0.04 per basic and diluted share. This represented a ten-fold improvement in earnings over the same quarter last year when we reported net income of $72,000, or less than $0.01 per basic and diluted share. Adjusted EBITDA rounded to $2 million in the quarter, up from $1.4 million in Q2 a year ago.

On to our six month results. Revenue was up 7% in the first half to $18.8 million, from $17.6 million last year. The key growth driver was license fees and services, which grew by 17% in the first half to $10.2 million from $8.7 million, more than compensating for a 3% decline in customer support revenue. Our year-to-date solutions mix included $10 million in Activation, $6.4 million in Numbering Solutions, and $2.4 million in Mediation; with all three contributing to the first half year-over-year revenue growth. Our total costs of revenue and operating expenses through mid year increased to $17.6 million from $16.7 million, representing a 5% growth compared with the 7% increase in revenue. The higher cost base was primarily attributable to product development expense, which grew to $2 million from $907,000, reflecting investments in new and existing solutions that we believe are key to building our top line into the future.

Sales and marketing expense was also up through six months to $4.4 million from $4.2 million, in support of our successful efforts to win business in emerging markets.

Again, the higher revenue number coupled with the slower growing cost structure resulted in a nice improvement in operating income year-to-date, $1.2 million versus $859,000 a year ago. Net income through the first six months of 2008 was $531,000 or $0.03 per basic and diluted share versus a net loss of $254,000 or $0.01 per basic and diluted share in 2007. Keep in mind we reported net income of $598,000 for all of 2007m so we're pleased with the direction of our bottom line.

Now let us take a look at bookings and backlog. We booked $8.3 million in new orders in the second quarter, matching our first quarter total. That number included $5.3 million in license fees and services orders, which represents our strongest second quarter performance in that quarter, since we acquired Tertio Telecoms in 2004 and a 20% year-over-year increase. By market unit, bookings included $4.9 million Activation, $3.1 million Numbering Solutions, and $300,000 Mediation. Bookings through six months totaled $16.6 million, which was actually down from $18.8 million in the first half last year due to timing differences in booking certain annual customer support renewals. Of the $16.6 million in new orders, $10.8 million was license and services business, a 15% increase over the year-ago figure of $9.4 million and the best first half in L&S bookings since the Tertio acquisition. Our June 30 backlog grew by 16% to $17.6 million from $15.1 million a year ago. License and services backlog equaled our largest to date at $7.1 million, up 29% from Q2 last year and customer support backlog was $10.5 million, up 9% from Q2 last year.

Turning to the balance sheet. We made significant progress during the first half of the year in strengthening our balance sheet. You'll recall that in the first quarter, the remaining balance of our convertible preferred stock was converted into common stock, resulting in the final elimination of the preferred stock balance that had been as high as $11.3 million at the start of 2007. Additionally, our first quarter debt refinancing lowered our average cash interest rate and contributed to year-over-year interest expense savings of 37% in the second quarter and 32% in the six month period. The preferred stock retirement and debt refinancing, coupled with accelerated payments on our non-current obligations in the first half, lowered our total preferred stock and long-term debt obligations by $9.3 million during the first half. We generated $3.9 million in cash from operations through the first six months, down from $6.1 million a year ago, due primarily to longer collection cycles, prevalent in certain international markets, combined with an early $790,000 Q1 payment of non-current accrued interest on our sub debt. We closed the second quarter with cash and cash equivalents of $7.2 million.

Now a final comment on the remainder of 2008. While we don't give specific numbers guidance, we do provide indications on where our business is heading and objectives we have set for ourselves. Earlier this year, we announced our revenue objective for 2008 is to grow revenue each quarter on a year-over-year basis. We have accomplished this for six straight quarters and we plan to continue the trend in Q3 and Q4 of 2008. Our total expense base declined sequentially about $0.5 million in Q2 from Q1. For the second half, we expect our quarterly expense base to approximate our Q1 '08 run rate rather than the Q2 '08 run rate, primarily representing increased investments in labor and higher costs of international travel. If we accomplish our revenue objectives, we would expect to see modest improvement in year-over-year adjusted EBITDA.

With that, I'll turn the call over to Thad Dupper. Thad?

Thad Dupper

Thanks, Brian. As you've just heard, we continue to make improvements on virtually every one of our operational metrics. Among the many positive results that Brian just covered, there is one that I'd like to highlight, and it's the one that we posted six consecutive quarter year-over-year revenue growth. This is significant because it clearly illustrates that Evolving Systems has become a company that can consistently and profitably grow. Moreover, we continue to make progress in growing an impressive backlog in our license and service business, and in particular, with our Dynamic SIM Allocation, or DSA business.

In the first quarter, DSA accounted for 10% of our L&S orders. In the second quarter, DSA contributed 27% to the L&S orders. We believe our DSA solution is a key ingredient to our future growth and has the potential to drive higher margin revenue than our traditional Activation and Number Management solutions. As you know, since the beginning of 2007, we have focused on three strategic initiatives improving our balance sheet, investing in the emerging markets, and expanding our product portfolio. Brian covered the improvements we have made to our balance sheet. I will now comment on our initiatives regarding the emerging markets and product development.

To date, the results have been telling. In the first half of 2008, our revenue growth has been driven primarily by new customer engagements in three of the emerging market regions

Central and Latin America, the Middle East and Africa, and Asia Pacific. For 2008, these three regions have contributed year-over-year revenue growth of 22%, 152%, and 136%, respectively. Furthermore, this year, all of our new customer engagements have come from these markets. Our new DSA solution and our channel strategy are beginning to show traction as well. As you know, on July 14, we announced the sale of our DSA solution to MTN South Africa, a major milestone for our company. We closed this Q2 order in cooperation with our SIM card partner, Oberthur Technologies. As one of the leading SIM card manufacturers in the world, Oberthur is a billion-dollar company with well over 200 GSM customers. Currently, we are working with Oberthur to expand our relationship. If we can leverage the Oberthur relationship to its full potential, the results could be very exciting for us.

As you know, our initial focus and success with DSA has been in the emerging markets. However, we have recently seen a notable uptick in the interest for our DSA solutions from carriers who operate in the traditional markets of North America and Western Europe. We believe one of the reasons for the increased interest in DSA from established carriers is related to the economic realities that many of these carriers are facing. Today, these carriers are looking to make their networks more efficient and DSA, among other things, allows a carrier to extend the capacity of their existing networks. In the current economy, solutions that can enable carriers to put off expensive network upgrades are generating a lot of interest. As a result, we are having more meetings with carriers regarding how DSA can improve the utilization of their networks and specifically extend the life of their HLRs. As you've heard me say before, for a company the size of Evolving Systems, it takes just one or two more DSA orders per year to dramatically impact our results, both on the top and bottom line.

In addition to the progress we have made with DSA, it is gratifying to see the advances we are posting across our entire product portfolio. As you saw in the details of the financials we released today, we continue to increase our R&D investment for our core product offerings of service activation, number inventory, and number porting.

In closing, we will continue to focus on delivering the year-over-year improvements that you have come to expect from us. Thank you, again, for joining us today.

Operator, you may now open the call for questions.

Question-and-Answer Session

Operator

Yes. Certainly, sir. (Operator instructions) And we'll take our first question from Michael Coady with B. Riley.

Michael Coady – B. Riley & Co.

Thanks. Hey, Thad and Brian. Congrats on the solid profitability.

Brian Ervine

Thanks, Michael.

Michael Coady – B. Riley & Co.

In regard to the DSA bookings in the first quarter and the second quarter going from 10% to 27% of L&S orders, could you, I guess, describe how – what your expectations are in the third quarter from your two DSA customers alone? Will they continue to expand – I mean, do you expect them to continue to expand orders, upgrades, follow-ons, et cetera, such that that number will probably go up even without another DSA order?

Thad Dupper

Hey, Mike. It's Thad. I'll take this. You know, we'll get some upgrades from our existing DSA customers, but that's not really the growth engine for DSA. In order for us to really propel DSA and post the numbers you've seen, we have to continue to close new DSA customers. Now, I'm very confident that for 2H '08 we'll generate new DSA customers. I have a little caution about Q3 for a new DSA customer, and the only caution associated with that is –while here in the U.S. we take a vacation in August, in many of the countries we do business with, they virtually shut down in August. So, you know, I'm a little bit concerned that we can get our paperwork completed for new accounts by 9/30, September 30, but I'm very confident that we can post new customer wins for DSA in the second half of the year. So I hope that answers your question.

Michael Coady – B. Riley & Co.

Sure, it does. Thanks, and could you talk about your work with Oberthur and any progress there and just the overall pipeline?

Thad Dupper

Sure. Well, as you saw, we closed the deal at MTN South Africa through this partner. And they're very, very large. I think they're the number two SIM card manufacturer in the world. It's interesting, Oberthur acquired Xpon Cards, so I believe the number two and three SIM card manufacturers merged in Q2 and became a very big rival, as you saw, over $1 billion. So, we have a new relationship with them. As you saw, the Q2 order came through Oberthur and there's more in the pipeline. So, as I alluded to in my comments, if we can be successful with this partner and we have no reason to believe why we couldn't, it speaks very well for the future that we can sell more DSA in partnership with this partner. Now, having said that, we still sell DSA standalone direct through our sales force. So, we think we have a two-pronged strategy here; one through the channel, which we've proven with the latest order, and the other through the direct sales team. And our guys are out there actively filling the funnel with not just DSA, but its Service Activation and Numbering, as well.

Michael Coady – B. Riley & Co.

Okay. And then I wanted to ask a little bit about Numbering. There was a release in June about your L&P 7.1 products and just kind of wondering what growth you're seeing in Number Manager and Order Path from the 5s because I haven't really heard about it in a little while.

Thad Dupper

Okay. Well, they're very stable and they're a big part of our business, an important part of the business. So, it is fair for you to ask about it. Today, NuStar announced their earnings today, and as you know, NuStar is the number portability center for North America and their volumes are going up. And in order for their volumes to go up, our products, Number Manager and Order Path, have to be able to sustain that increased transaction rate. So, our 7.1 release, among several features we put in it, but among the major features in the 7.1 release was the ability to improve the performance of those core products to sustain this increased importing transactions that we see through the impact. So, it is a very important part of the business. It's not a huge growth engine for us, and that's because most of the North American carriers, if not all of them, already have number portability solutions, and much like the pipes in your house, once you've got an L&P solution in place, the likelihood of changing it and swapping it out is not very high. But it's something we continue to invest in. And so that's kind of the domestic message.

Now, the area of growth and excitement, Michael, is in the international markets. So, you see International NumeriTrack continues to be a big part of our strategy. We closed the deal earlier in the year with an international provider to purchase International NumeriTrack. International NumeriTrack is a core ingredient of Dynamic SIM Allocation, and we also have Number Portability Gateway. NPG is our product that allows international carriers to do the carrier side of number portability and we're seeing increasingly – countries around the world adopting number portability. So, I would say in summary, the North American L&P customers are very stable. We're continuing to add features to that product set to sustain the increase in transactions we're seeing through the impact. But the growth from this side of the business is going to come from the international markets, primarily around NumeriTrack and Number Portability Gateway.

Michael Coady – B. Riley & Co.

Okay. Thanks for the thorough answer. Good luck in the back half of '08.

Thad Dupper

Great. Thanks Mike.

Brian Ervine

Thanks, Mike.

Operator

(Operator instructions) Moving on to Jon Hickman from MDB Capital.

Jon Hickman – MDB Capital

Hi. I just have a question on the balance sheet issue. So, the bulk of what is remaining as far as debt goes is the subordinated note. Is that it?

Brian Ervine

No, we have senior debt with our bank and we have about $1.3 million or so left on – excuse me – let's see. We have a revolver with our senior bank of $6 million. None of that is borrowed. We have a $2 million term loan that we're paying off over 24 months, and yes, it is about $1.3 million that we have remaining. And then, the majority of the outstanding debt is the subordinated debt. Also included in that is the accrued interest that goes with that subordinated debt that we currently do not have to pay on a current basis.

Jon Hickman – MDB Capital

And you don't have to pay that on a current basis because of –? Hello?

Brian Ervine

Sorry. Say that again? Could you repeat the question, Jon?

Jon Hickman – MDB Capital

Yes. You don't have to pay the current interest because of – is it a –?

Brian Ervine

Yes, the way the subordination is, is that it's completely behind the senior. We do have – and it's not scheduled to be due until the senior is fully repaid in 24 months, and so none of that is due at this point in time. Now, we do have the ability to make payments on the subordinated debt, as long as we don't violate any financial covenants or violate any international tax laws or anything like that and we're in compliance with our senior bank relationship.

Jon Hickman – MDB Capital

So, how much is on that now, about $5 million, $5.5 million?

Brian Ervine

Let me just tell you here, specifically on the debt where we are as of June 30. So, we have – and I got the numbers a little bit wrong on the senior term, so I'm getting ahead of myself. The senior term loan as of June 30 is at $3.3 million. And the subordinated debt with accrued interest is at $5.6 million. So, the total debt outstanding on our books including the subordinated interest – remember, we made an early payment on that subordinated debt in the first quarter of $1 million.

Jon Hickman – MDB Capital

Yes.

Brian Ervine

But the total is $8.9 million. If you compare that to where we were at the beginning of this year, we had $18.3 million outstanding if you include the preferred stock and all the debt balances. And so the progress we've made and the comment I made earlier is that our total debt position from December 31, 2007 to June 30, 2008 has been reduced $9.3 million. And another point, Jon, I know you're new to our business, but it's important for you to understand, is the seasonality a little bit of our business and our cash flows. A larger portion of our cash flows from operations come in during the first half of every year, because some of our larger customer support renewals pay upfront in advance during the first half of the year. And so, when you look at our balance sheet, a lot of the cash that we have on the balance sheet is there to serve the unearned revenue balance that we have on our balance sheet and to basically – so that we can deliver on our customer support obligations for the remainder of the year. So, we typically burn cash in the second half of the year.

Jon Hickman – MDB Capital

Okay. So, when did you make that pre – that early payment of $1 million?

Brian Ervine

We made the early $1 million payment during the first quarter of 2008.

Jon Hickman – MDB Capital

Okay, so – and you're paying 14% on the subordinated note, right?

Brian Ervine

For accounting – yes, for cash basis it's 14. For accounting on our books it comes in a little bit lower effective rate because we've been in accruing it all along at around 12 to 12.5%. That's the blended rate.

Jon Hickman – MDB Capital

So, can you talk about the strategy here? Are you going to wait the 24 months and then start – when the term's paid and –

Brian Ervine

I think the strategy's going to be the same as what we've continued to do so far. And so this year, like I said, we also paid down $2 million additional on our senior debt. So total prepayments on debt for 2008 over and above what was scheduled – this year we've already made is $3 million. And so, our strategy will be to continue to knock down our debt at an accelerated fashion as long as the business there is to support that.

Jon Hickman – MDB Capital

If the stock price goes higher, would you use an equity offering to get rid of that?

Brian Ervine

Right now we're not interested in doing an equity offering; obviously, where we're trading today, and that's always another possibility should we need to look at that option.

Jon Hickman – MDB Capital

Just so you know, I've had a couple investors tell me that that is a hindrance to purchasing your stock.

Brian Ervine

Well, and I appreciate that comment, and I also note that you're new to our company and so that's why I want you to really understand the progress that we've made. So, if you look at it from the history of where we've come from and the $9.3 million improvement in debt, you can see that really the debt is not an issue for us and we're generating plenty of EBITDA. Look at our working capital balance at June 30. Our total working capital is basically zero. So, it would not be prudent for us to get too far ahead of ourselves on the debt. But, anyway, we've made significant improvements, and I think it's important that you understand where we've come from so you can tell that story better when you talk to people in the future.

Thad Dupper

And, Jon, it is Thad. Let me just add a comment to what Brian said. This senior debt, the balance of $3.3 million, is going to be paid off on schedule between now and the end of next year. It's a 24-month term. We're already eight months into it. So, that senior debt is going to go away normal course of business. Now you turn your attention to the subordinated debt of $5.6 million. You just heard from Brian's comments that this year we made $3 million additional payment to debt. If the business continues to perform or accelerates its performance, which is certainly our goal, we should be able to take care of a large part of that subordinated debt. So, we would be very reluctant to print up shares at this discounted price of $2 a share to retire that debt when we're already on a course and speed to retire the senior debt by the end of 2009 and probably knock down the subordinated debt in an accelerated fashion, given the performance of the business.

Jon Hickman – MDB Capital

So, do you think that by the end of 2009 you could knock another – just on a normal course, that you could knock another $2 million off the subordinated debt?

Thad Dupper

We'd like to, but let me go back to one or two more DSAs. They're coming in as $1 million to $2 million a pop. If the business can perform a little above plan, obviously we're going to take a look at using the cash to pay off 14% interest debt. So, that would be our hope, but the business has to perform.

Jon Hickman – MDB Capital

Okay. That is it for me. Thanks.

Thad Dupper

Great, and welcome, by the way.

Operator

Ladies and gentlemen, we do have one question left in the queue. (Operator instructions) And moving on to Jeffrey Meyers with Cobia Capital.

Jeffrey Meyers – Cobia Capital

Great. Thanks, guys. Can you just talk a little bit about the Activation and Mediation businesses, what you're seeing there in terms of numbers of RFPs out in the field and also just in terms of the competitive environments there?

Thad Dupper

Yes, Jeffrey, we'd like to. This is Thad. We had a very good year in 2007, where we closed ten new accounts, and I believe, and I'll ask the team to correct me if I'm wrong, but I believe eight of those ten new accounts were Activation for 2007. The large majority were. Where we've been very successful, and it's part of our strategy, so we don't think we're stumbling into it, is securing additional activation business in the emerging markets. So, last year we were able to win a deal in Indonesia for activation, Malaysia for activation. We added eight new countries across Africa and Latin America for activation last year. So, it still remains and will continue to remain a very important ingredient to our business.

The second part of the Activation business, which we find very attractive is once we get installed as the activation layer, it has a very nice follow-on effect of change requests and additional orders because obviously if a carrier wants to introduce a new feature, they have to be able to active it. So, that usually requires a change in the activation layer, which represents some sort of additional business to us. And then final, the final component of the Activation business which is attractive – as carriers increase their subscription, the number of subscribers, they have to get an extended license from us to cover that increase in subscribers. And again, when you look at the subscriber growth in Asia, in Africa, in Latin America where we're putting our big investment; that is where the high subscriber growth is. There isn't that much subscriber growth in Western Europe and North America right now in comparison. So, we think the indicators, the metrics, are very positive for the Activation business. I tend to get caught up in Dynamic SIM, but Activation is a very important and successful part of our business.

A comment on Mediation. Mediation is a nice profitable part of our business. We don't have many customers in Mediation, but the customers we have are A, very satisfied and very steady and predictable in terms of their follow-on business. So, that's a nice part of the business, but as we've said before, in terms of our strategy, we're putting most of our R&D investments in Activation, in Numbering, and as a byproduct of that, Dynamic SIM. Most of the innovation we're bringing into Mediation is being customer funded.

Jeffrey Meyers – Cobia Capital

Who are you seeing most often in the Activation side of the business?

Thad Dupper

You mean as competitors?

Jeffrey Meyers – Cobia Capital

Yes.

Thad Dupper

It's very steady. It's very stable, and you're right. Most of the business outside the U.S. is all RFP driven, so we will repeatedly see Comptel from Helsinki as an activation competitor. To a lesser extent, we'll see Medisolve. I think they seem to have gotten distracted by their absorption into Oracle, but we see them. And those are really the two big ones. Every once and a while you'll see another name or two; maybe Intek from the U.K. occasionally, but those are the three names that would come to mind.

Jeffrey Meyers – Cobia Capital

Right. Okay. Great. Thanks, guys.

Thad Dupper

Thank you.

Operator

(Operator instructions) And there are no further questions at this time.

Thad Dupper

All right. Well, this is Thad Dupper again. Thank you for joining us. We are pleased to share our Q2 results and we look forward to speaking with you all with our Q3 results, which will be announced probably in the early November time frame. Have a safe summer, and thank you, again, for joining us.

Operator

And this does conclude today's conference. Thank you for your participation and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Evolving Systems, Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts