Dan Moorhead - Vice President, Finance & Administration

Mike Crawford - B Riley & Company Brian Kinstlinger - Maxim Group

Good afternoon, and welcome to Evolving Systems 2015 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.

Thanks, Dan. Welcome and good afternoon.

For Q1, we had the following highlights: Dynamic SIM Allocation or DSA revenue was up 13% year-over-year; Tertio Service Activation or TSA license and service bookings were strong, up 58% year-over-year to $2.5 million. This was the first greater than $2 million TSA quarter since 2013.

And profitability continue to be good with gross margins at 76%, up from 71% year-over-year, op income up 39%, net income up 32% and adjusted EBITDA up 17% year-over-year. Cash was up 13% with cash balances of $11 million, up from $9.8 million.

As you know, we close every earnings call with the reminder that our results can be affected by the movement in or out of an order or two, while for Q1 this was particularly true. Our Q1 license and service bookings were impacted by a new DSA account order that we closed on April 2missing the quarter.

We also had another DSA new account opportunity that we were confident we would close in the quarter and that decision has been put on hold. The confluence of these two events made for lower bookings than expected.

The knock-on effect will impact Q2 revenue. Had both orders closed as forecast, our license and service bookings would have been in the mid-$5 million range and in line with what we were expecting.

So our primary focus is to make Q2 a strong bookings quarter and with the new DSA contract already in, we're off to a good start. In addition, for Q2 we are pursuing several other new DSA deals, as well as a good funnel of enhancements and upgrades.

Starting with Q2 license and service bookings, we are confident that our second-half financial performance will improve over first half and that is predicated on the following points. First Use Activations or FUAs for the second half are forecast to be 1.3 million, up 800,000 from the first half.

The continued momentum of closing new DSA accounts, plus several of our DSA accounts are planning major upgrades to their systems. And to give some insight into what features drive DSA upgrades, the ability to do a SIM swap is a prime example, which is a good lead-in to our latest production launch of DSA.

I'm pleased to announce that we are now live with DSA in India. And one of the interesting use cases is for subscribers who are upgrading to a 4G phone sold through the Indian equivalent of Amazon.

For every 4G phone sold online, the package includes a DSA SIM. The subscriber then sends an SMS text to the carrier with SIM swap in the text line from the old handset, then inserts the DSA SIM into the new 4G phone, DSA then does the rest; activating the subscriber's phone and transferring all the pertinent SIM information.

Its features like SIM swap that drive upgrades and also demonstrates how are - by our - investment in R&D, we continue to extend our DSA leadership. Another area where we are seeing a significant increase in investment and focus is around partnerships.

We are working to integrate DSA’s activation experience with firms that market mobile apps and ads. Different from the Indian case just mentioned, where the user buys a phone and a SIM at the same time is a use case we are currently testing in Asia, where the subscriber purchases a phone, then later buys the SIM.

This is what is referred to as the BYOD or Bring Your Own Device scenario. When a subscriber inserts a DSA SIM into a BYOD smartphone, the carrier via DSA can download apps.

For example, one area where the carriers appear to have a focus is the downloading of their self-care app. Today, only a small percentage of users have their carrier self-care app loaded on their smartphones.

How many of you listening today have your carrier’s self-care app on your phones? The benefit to the carrier of having the self-care app on the phone is well proven.

It significantly reduces calls to the call center, as well as non-revenue generating visits to the stores, plus it has an up-sell capability too. DSA can push the self-care app onto the phone during the SIM activation experience and depending on the size of the app, usually in 10 to 15 seconds.

Another use case for app download is around mobile customer acquisition. The promotion and downloading of apps such as retail apps, games, as well as social media apps all represent good use cases.

And this is the area where our partners are specifically helping us, in the area of marketing content, an UX or user experience optimization. Another partnership we are working on is on personal cloud backup.

This is an area of particular interest to carriers. First, by providing personal cloud backup, it makes subscribers stickier and less likely to churn.

Second, it's a service carriers can initially offer for free and then later look to charge by offering an upgraded service via the premium price model. Rather than yield the backup business to the likes of Dropbox and Apple, carriers want to offer their own backup capability.

The other point worth keeping in mind, in the BYOD world where phones are purchased unlocked and not linked to any particular carrier, the SIM activation process becomes the carrier's first touch point with the new subscriber, being the first and perhaps the best opportunity for a carrier to form a relationship with the subscriber. Being able to personalize the experience based on location, date and device type are at the very core of DSA’s value proposition and extending that to include the relevant marketing of mobile apps, device backup and self-care are just a few such value-added services that we are discussing with our customers.

In addition, we are working on the licensing models for these partnerships. We like the impact FUAs or First Use Activations have had on our business.

So we want to continue in that direction with usage-based pricing for these offers. And to remind you, today we have 12 patents that address the technical specs of providing these capabilities.

As you can tell, we think mobile app download represents a tremendous opportunity for EVOL, one made more relevant by the emergence of the BYOD market direction and more quickly realized through partnerships. We will keep you informed as these partnerships progress.

To close, considering the increased momentum we are seeing in signing new DSA accounts, our new product features, as well as our partnering activities, we are confident that we have a plan in place that will position us to accelerate our performance as the year progresses and that we continue to be well positioned for long-term growth. As you can tell, we are eager to get on with it.

With that, I thank you for joining us today and will turn the call over to Dan.

Thanks, Thad. First quarter financial results.

Revenue in the first quarter grew by 1% to $6.7 million from $6.6 million in the same quarter last year. License and services revenue decreased slightly to $4.3 million from $4.4 million a year ago.

Customer support revenue increased 5% to $2.3 million from $2.2 million. Total cost of revenue and operating expenses decreased 6% in the quarter to $5.2 million from $5.6 million a year ago.

The decrease reflected in part $211,000 in restructuring charges in the first quarter of 2014 related primarily to our Q4 2013 acquisition of Telespree Communications. Higher gross margins and lower operating expenses led to a 39% increase in operating income to $1.4 million in the first quarter from $1 million in Q1 a year ago.

GAAP net income increased 32% in the first quarter to $900,000 from $700,000 last year, resulting in diluted earnings per share of $0.07 versus $0.05 a year ago. Adjusted EBITDA grew by 17% in Q1 to $1.6 million from $1.4 million in the same quarter a year ago.

On the balance sheet, we reported cash and cash equivalents of $11 million at March 31, up 13% over $9.8 million at December 31. Working capital stood at $15 million versus $15.8 million at year-end.

Bookings and backlogs. We define bookings as sales orders that are expected to be recognized as revenue during the following 12 months.

First quarter bookings totaled $6.5 million compared to $7.4 million in the first quarter last year. On a year-over-year basis, LS bookings were $4.3 million versus $5.1 million; DSA LS bookings were $1.7 million versus $3.5 million; TSA LS bookings were $2.5 million versus $1.6 million; total customer support or CS bookings were down slightly at $2.2 million from $2.4 million.

Total backlog at the end of the first quarter declined to $10.4 million from $13.1 million last year. LS backlog totaled $5.5 million compared to $7.8 million a year ago and included $3.6 million in DSA and $1.9 million in TSA.

CS backlog was $4.9 million, down from $5.3 million last year. Dividend update.

Our Board of Directors declared a second quarter dividend of $0.11 per share payable May 29, 2015 to stockholders of record on May 22, 2015.I’ll close with our usual reminder that a single order can have a significant impact on our quarterly results. Accordingly, 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?

Thank you. Regarding the DSA pipeline, it was nice to see you closed the one deal on April 2.

And can you talk a little bit more about the other one that is on hold and you mentioned some other opportunities as well, please?

Yeah. Hi, Mike, how are you?

Good.

Yeah. We do business in a lot of faraway places and sometimes I feel the maturity of the business process sometimes is less mature than perhaps we’d like and the decisioning sometimes reflects that.

So we had an opportunity, we worked on it. It was via one of our SIM partners and the approval process, budgeting process just doesn't seem to be as mature and as refined as we would like, as a result the order didn't come in.

That said, we still think we can get it, although we're not forecasting it for this quarter. What we are forecasting for the quarter though are a number of other new DSAs.

And as we said in our comments, we're confident that we'll be closing additional DSAs and as everybody listening knows, adding new accounts in DSA is always important to us. So we like the funnel.

We are far along in quite a few decision processes and now we just have to get the paper and we're confident that we'll be getting that in Q2. The other comment I would make for the audience is, we have a relatively favorable comp in Q2 with bookings from last year, 3.7 to license and service bookings a year ago Q2.

So we think that's a favorable number that we can compare positively against, and we think that is another reason we can grow backlog. So adding new DSA accounts, closing orders, whether they're new accounts or upgrades, posting that number, driving backlog, we think is a top priority for us and that's where we're focused on.

And then of the number of DSA deals that you're working on, are these again a broad mix of your own, plus your two primary SIM partners or is there one channel that seems to be rising to the forefront?

Yeah, now for Q2, I would say there is some SIM partner in that, but the bulk of it is direct sales. And sometimes we like that because we have a lot of control over it, as you'd imagine.

So I'd say the majority of Q2 is direct sales with one or two names from the SIM partners. For the year at large, our SIM partners have a nice funnel, but we think for Q2 what will carry the day will be the work of our direct sales force.

And then you talked about your AppLoader, so how many carriers are doing this now?

So in our last call, we announced the first order for AppLoader. So we have one carrier that's testing it currently.

But with these partners we're talking about, we’re integrating DSA with either our AppLoader, in some case they have a version of the AppLoader. But what we're seeing is a lot of interest through this trial and through these partnerships with downloading apps.

And we really think it's the higher end of the food chain and as smartphone adoption accelerates in the international markets, particularly in the emerging markets, we think it's a sweet spot and we're seeing a lot of activity. We just had a call this week with one of our carriers, current DSA customer, to cover what we can do with app loading with one of our partners.

And the backup capability is also via AppLoader, where when we're activating the SIM, we would download the cloud backup app. So between self-care, cloud backup, mobile apps, social media apps, gaming apps, we really are spending a lot of cycles on this because we think it represents an enormous opportunity for us.

Okay. Thank you.

And then last question, I know you don't provide guidance, but given the status of your bookings and backlog, it would appear that maybe the second quarter is going to look a lot more like Q1, but then with your recent wins, we should expect the jump in revenue and earnings on the income statement in the second half of the year. Is that fair?

I think that's fair. I think that's very much aligned with what we were saying.

Okay. Great.

Thank you very much.

Thanks, Mike.

Hi guys, how are you?

Hey, Brian.

So the first question I have, you mentioned some FUA numbers. In the first quarter, how much of the 500,000 that you expect in the first half was recognized in the first quarter, then how much is versus the projection in the second quarter?

I think that was all of it, wasn’t it Dan?

Yeah. Q2 is - sorry, so the 500K was all in Q1.

Q2, we have - we don't have anything forecasted in Q2 at this moment, and then the rest would be in Q3 and Q4.

Got it. Okay.

And then essentially there is less FUA, while revenue may look the same in 2Q than 1Q that generally drives earnings down with FUA, is that accurate?

I think that's accurate, but we have this new DSA we closed in April 2, that's in our backlog now, but it's not in our reported backlog. And then what we have to do is drive bookings to drive hours, which drives revenue.

So I think you're right on that. The other thing is, forecasting some of these renewals is more art than science.

So there is a potential that one or two of them could come into the quarter. So we have to be a little careful.

We're not doing microsurgery. But right now we're not forecasting any FUA revenue in Q2.

But we are planning to work a lot of hours from backlog and also from new sales, so that's our focus.

Just to be clear the one you signed April 2, it takes some time to get them ready to launch and go live. So they're not really going to be a big contributor rather than some services revenue in 2Q.

Is that right or is that wrong?

Well, it's not the biggest DSA project we've ever done. So typically we’d model and we close the DSA.

In the quarter after we close it, we usually get something like 25% of the hours in the first quarter and then almost 25% per quarter after. It's almost even like that.

So the fact that this closed so early in the quarter, we're going to generate quite a few hours [ph] from that. Yeah.

Okay. And then can you take us through the expected timing for customers that haven’t gone live yet, but have made an order and when you expect them to go live?

And what's your rough timing quarter and maybe not month?

Well, most of the orders we've gotten have gone live now. So the ones that we're in the process of putting into production would be that Q4 order that we got, obviously the one we just closed in April.

Everybody else I think is pretty much dialed in. Our Russia customer, I think, is working with low volume right now, but they've got some big upgrade plans.

So most of our orders are in production with the arrival of India and I think the Philippines also went into production, also the second Philippine carrier. So I'd say other than the last two orders, most of our customers are nearer in production right now.

And then you mentioned in 2Q, it sounds like there's a lot of activity. You mentioned there's two SIM partner deals that are closed, but you mentioned that direct sales are playing a bigger role.

So are you saying that it’s potentially four to six new DSA orders that could occur either in the second quarter or early in the third quarter, is that what we're talking about?

Well, that's a big number. So just to kind of give some color, in the past years we've done four new accounts a year.

Last year we only did one new account. Year-to-date, we've already closed one, this April order.

We think we'll have a strong quarter for new accounts for Q2. I don't want to pin it down to a number, because as we saw in Q1, predicting closes sometimes can lead to disappointment.

But what I would say is, the funnel is of a size and shape that we should be able to have very good new account closes for Q2. Whether it's a record or not, I may stop just short of saying that, but that certainly would be a goal for the quarter.

Yeah. And then for the one where you had mentioned they got delayed for budgetary issues, is it that they communicated that the budget was there and then the money was no longer there when it came down to make the order?

And is that an annual budget, is that a quarterly budget that you think that ultimately that could be still signed this year?

Yeah. I don't think it was as much a budgeting issue as it was an approval issue and a decisioning issue.

We felt the budget existed. We think the budget still exists.

It's just a question of who's making the decision and who's calling the shots with this carrier and we're learning. This was through a SIM partner.

We think they still want DSA. We're just going to be a little more conservative with this account seeing as it was hard to predict their behavior.

Now that said aside, we think we have enough opportunity in the key two funnel, without that opportunity, without that deal, just go very high on DSA bookings and DSA new accounts. So leaving now an aside, we’re pretty confident that we can set a good number for Q2.

Great. And the last question I have, do you see any of the players that are trying to build similar technology having any positive traction and gaining traction on you, just curious, competitive landscape?

You've heard me say before, Brian, occasionally we run across some competition, but we don't think that's a significant issue for us. We're the leader in this space, we invest heavily in this space.

We have the largest number of production customers. We do the highest volume of SIM activations, as you heard this discussion about SIM swap feature that's in production in India.

This app loading work that we're doing with partnerships. We believe we're the leaders and we’ll continue to remain the leaders in this space.

Occasionally, we do run across partners, personally I believe when carriers bring up partners, they do that to try to inflict some price pressure on us rather than a viable alternative, a technical alternative for us.

Got it. Thanks so much.

Thanks, Brian.

Hi, Thad. Sorry, I haven't seen the press release, because it's not on your website yet.

But can you talk about - obviously AT&T just closed on their merger of Nextel Mexico, were they use to sell [ph] Nextel customers of Evolving?

No. I mean, I'm just thinking back years ago when we were doing numbering before I answer that.

They are not current customers of EVOL with service activation in DSA. We do have customers in Mexico, but they are not our used to sell in Nextel.

Okay. And can you update us on - I don't know if you said some earlier, I joined a little late.

Last year you had a number of trials with potential customers, can you give us an update on how those trials have gone or if anything is active on them still?

Right. So one of the trials closed in December.

So that was our win in December. And another one of the trials is one of the new accounts we're counting on to this quarter.

So we feel good about it. We are reluctant to go into trials as you recall from when we used to speak, Dana.

Having said that, I would say we’re two for two, but again we don't want to wave the flag and do a lot of trials because they take so much resource. Now two for two assuming we close this deal this quarter, right.

Okay. All right, great.

Thanks, Thad.

Right. Nice talking to you, Dana.

Thank you.

Well, thank you for joining us today and we look forward to giving you an update during the course of the quarter, and if not, on our earnings release, which will probably be in early August. Thank you for joining us.

Cheers.