Symbolic Logic, Inc.
Q3 2016 Earnings Call Transcript

Published: 9 Nov 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Evolving Systems' 2016 Third Quarter Earnings Call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference call, Dan Moorhead, Chief Financial Officer. Sir, you may begin.

[Dan Moorhead:]

Good afternoon, and welcome to Evolving Systems' 2016 Third Quarter Earnings Call. I am Dan Moorhead, Chief Financial Officer, and joining me today is Thomas Thekkethala, 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 risk. 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 Web site for more information about the company. With that, I'll turn the call over to Thomas.

[Thomas Thekkethala:]

Thanks Dan. Good afternoon everyone. Let me outline a few of the highlights from the third quarter. In Q3 we announced three new orders from our customer acquisition and activation software and services in Africa and the Middle East. This validates our pivot away from selling technology to selling business outcomes, in this case, to accelerate subscriber growth for carriers. Let me clarify this pivot with one of the carriers as an example. In the past, we would submit proposals for our DSA technology for SIM activation, and find ourselves in competition with smaller companies offering similar, relatively untested technology components at lower prices. It resulted in a waste to the bottom in terms of price. In our new approach, we are bundling in other components, such as Smart Dealer, software welcome portal and basic RLM capabilities to activate SIMs from the point of sale, perform fingerprint recognition and ID scanning to complete know-your-customer registration processes, to upsell smartphone offers and plans to customers by detecting the type of device. This repositioning of a combination of customer acquisition and activation separates us from the competition, selling just technology components and is far more appealing to our carrier customers. So our initial proposals were to drive customer acquisition and activation at these carriers. However, there will be several follow-on opportunities at these carriers for our broader customer lifecycle management or CLM solutions. That increased consumer engagement and upsell beyond the activation increase consumer information monetization through advertising and third-party offers, and increase consumer retention and loyalty. All three of these orders were placed by major carrier group companies who have very large footprints in the Middle East, Africa, and Asia, where we believe there are significant opportunities to expand our CLM solutions and managed services across to the other group companies. We have had success doing this with some of our existing carrier groups where we won an initial deal at one group company in Asia, and then subsequently expanded to seven of their group companies in Africa. There's another important dimension to these three customer wins. Two of the three orders were from new customers, and were won in collaboration with high profile, global network OEM. Let me clarify the importance of this. The traditional European and U.S. network OEMs have come under immense pressure by the new Chinese OEMs. In response, the traditional OEMs are selling large business transformation deals where they are required to bundle in business outcome-oriented solutions over and above their traditional network equipment. Over the year of working with this global OEM, we have successfully demonstrated that our solutions, which are driving new revenue streams from our existing customers, can also be delivered within the scope of the OEM transformation deals, thereby creating a mutually beneficial relationship. We expect to grow our relationship with this OEM, as well as our other OEM partners over time. Let me also briefly recap the new business model we adopted following our acquisition of Sixth Sense Media a year ago. There are two major components to this model. The first is our transition from a software licensed model to a recurring revenue model based on our managed services that integrate our software experience and expertise to drive business outcomes for our customers. This transition is designed to generate more predictable recurring revenues over multiple years instead of a one-and-done traditional software license model. The second component of our new model is our focus on the broader CLM functions of consumer acquisition, engagement, monetization, and retention, not just for mobile services, but to move beyond the next generation services, like mobile banking, entertainment, and retail. Mobile operators are being awarded payment banking licenses, and we are working with them, as well as companies like Nova Gaming, where we're driving new customer acquisition upsell retention for the gaming and entertainment industry. These new opportunities have been made possible by the transformative power of the mobile channel as a new interactive channel for businesses to engage consumers in real-time. The volumes of data from consumer history and their real-time transactions is massive. The challenge is to convert this data into knowledge. Evolving Systems is currently investing in building new next-generation platforms to harness these new opportunities. These platforms incorporate big data, stream processing, and machine learning technologies in partnership with teams that architected core solutions at Yahoo Labs, Amazon, and LinkedIn. The resulting solutions will depend less on marketing intuition and much more on sophisticated machine learning algorithms to make the right offer to the right consumer at the right time and place. From a financial performance standpoint, we continue to generate very solid profit metric with substantial increases in third quarter net income and EBITDA, up 65% and 76% respectively. Let me expand upon this a little bit. Historically, the company's software development, delivery, and support functions were designed as separate departments to support classic software license sales. Migrating to managed services has helped us achieve much higher cost efficiencies, where multiple customers can be supported by an integrated global team operating 7/24. The company also used traditional methodologies that started with well-defined software requirements, and went through long phases of design, development, QA, and implementation. This presented many challenges as customers' requirements changed while we were focused on hours worked. In migrating to the new lean methodologies, the focus across engineering was shifted from hours worked to throughput achieved in small incremental deliverables being delivered more frequently to customers. The combination of our migration to managed services and lean methodologies has resulted in streamlined operations, improvements in throughputs, and annualized savings of over $6.5 million. In closing, we are pleased with our third quarter performance, particularly our profitability, and the pace of our transition. We have undergone many important changes over the past 12 months, and are a leaner more-focused organization to achieve the kind of growth we believe is possible for Evolving Systems. With that, I'll turn the call over to Dan for a recap of the financial results. Dan?

[Dan Moorhead:]

Thanks Thomas. Third quarter financial results; third quarter revenue increased 6% year-over-year to $6.1 million from $5.8 million. License and Services or LS revenue increased 10% to $3.6 million, and Customer Revenue or CS revenue was flat at $2.5 million. Continued weakness in the British pound hurt our top line, but the overall impact was positive to earnings as our expenses were also lower due to the weak pound. Total cost of revenue and operating expenses in Q3 declined by 9% year-over-year to $4.4 million from $4.8 million last year. This improvement included lower spending in all expense categories as a result of our restructuring efforts. Profitability continued to improve in the third quarter. Gross margin increased to 79% from 75% year-over-year. GAAP net income was up 65% year-over-year, and resulted in $0.08 per diluted share versus $0.05 in the same quarter last year. It was the most profitable quarter of 2016 and our 34th consecutive profitable quarter overall. Adjusted EBITDA increased 76% year-over-year to $2 million from $1.1 million, with 33% adjusted EBITDA margins, up from 20% a year ago. On the balance sheet we reported cash and cash equivalents of $6.9 million at September 30, up from $5.9 million at the end of Q2. Cash flow from operations was $5.5 million for the first nine months of 2016, up 91% compared to last year. Working capital was $7.7 million, up from $7.1 million in Q2, and $3.5 million at 2015 year-end. Nine month results, revenue through nine months was $18.7 million, up from $18.5 million in the same period a year ago. LS revenue was $10.6 million, and CS revenue was $8 million. Total cost of revenue and operating expenses through nine months declined 2% year-over-year to $14.8 million from $15.2 million, even though the $14.8 million figure included $1 million in restructuring charges. Adjusted EBITDA expenses were 12% lower year-over-year, and that decrease is inclusive of the expenses added with the acquisition of Sixth Sense Media. In all, we've taken approximately $1.5 million in total restructuring charges since the acquisition of SSM in September 2015. Our headcount and other expense reductions over that period have taken out more than $6.5 million in annual costs. Gross margins through nine months were 79%, up from 75% in the same period last year. Adjusted EBITDA increased 50% year-over-year to $5.8 million from $3.9 million. Adjusted EBITDA margins grew to 31% from 21% year-over-year, and GAAP net income was $2.1 million or $0.18 per diluted share compared to $2.2 million or $0.19 per share last year. Booking and backlog highlights, we define bookings as sales orders that are expected to be recognized as revenue during the following 12 months. Let's start with our Q3 booking results. Total Q3 bookings were $5.7 million versus $5.8 million last year. Q3 LS bookings increased to $3.9 million from $3.8 million, and CS bookings were $1.8 million versus $2 million. For the nine month period, total bookings increased to $18.9 million from $18.2 million. LS bookings increased 11%, to $12.1 million from $10.9 million, and total CS bookings were $6.8 million compared to $7.3 million. Our total backlog at September 30 increased by 17% year-over-year to $12 million from $10.3 million, and the LS backlog grew 41% to $7.4 million from $5.2 million, last year. I'll close with the 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're now happy to take your questions. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Brian Kinstlinger from Maxim Group. Your line is open.

[Brian Kinstlinger:]

Hi, good evening. How are you?

[Thomas Thekkethala:]

Good, Brian.

[Brian Kinstlinger:]

So my first question is a little bit around bookings first of all. I realize they're lumpy, but when I look year-over-year they're up a little bit, but you also have acquired Sixth Sense [indiscernible] business little billion bigger, taking [ph] through how I as an investor will look at the bookings and what that means that look to the next year in terms of revenue growth, are they one-to-one correlated or they not as much correlated just trying to get a sense for what that means for the future?

[Thomas Thekkethala:]

Brian, Thomas here. I think one of the things -- themes that we've been talking about is the last year's numbers also included SSM in the third quarter because the deal actually closed, I think on the 30th of September but one of the things that I've been highlighting as a theme is that as we're moving away from the classic lumpy license models to the managed service models, we are going to experience some changes as you eventually take a large license upfront, you end up taking it as a managed service period over time, over 36 months. So those are some of the adjustments that we're beginning to start understanding and starting to model and we expect this recurring license base and the revenue base to grow as we grow into 2017.

[Brian Kinstlinger:]

Okay. And then showing the reasonable assumption to maybe look at bookings to buy three or five years and expect that is kind of the annual lift year-over- year from bookings, I mean if it's recurring managed services revenue, is that how we should think about it?

[Thomas Thekkethala:]

Well, some customers basically sign up for managed services on an annual basis and so these obviously have the opportunity of ending, I don't know whether that was your question but most of the times since you're not licensing somebody to software and they're very dependent on your people and your expertise and your experience, our experience has been that they just continue with renewing that on an annualized basis.

[Brian Kinstlinger:]

And then can you go through the two new customer wins that were new customers to you, you mentioned that there are two new orders, there were two new customers for you and go through how long sales cycles took and those start relatively small and there is opportunity for growth maybe take us through some of the details.

[Thomas Thekkethala:]

Yes, as I mentioned in the call what has been happening is the because of the lot of the pricing pressures that Europe and American OEM guys are experiencing from the traditional from the Chinese OEM vendors, what has been happening is they have been bidding what is referred to an industry as transformation deals, so they come into the carrier and they basically talk about a 4G network upgrade and they tend to 4G because if you're just simply selling network equipment 4G, they run into competition from the Chinese manufacturers, so what the American and European vendors are doing is to come in and stock about $500 million transformation deals that includes much more than the network equipment, it includes increases in activation, increases in many other business parameters that they actually sign up for, so as part of that, they end up partnering with software companies like us to bring that forward to their customers. So in this case, we've been building up relationship with one of the largest OEMs in the world and they have now understood that we can actually be integrated into their networks and drive new revenue for their carrier customers. So once that has become validated, you start getting orders from them on these big transformation deals. So in terms of the sales cycle here it's really that when the large OEMs close the transformation deals, they turn around and we get the back to back orders.

[Brian Kinstlinger:]

So only the sales cycle for you to come to the agreement with them for example and how long will it take them to get to this point where they will agree to partner with you?

[Thomas Thekkethala:]

Yes I think they've obviously been aware of this last year but this year as they started focusing more on transformation deals in 2016, I think it has taken us about six months or so to really establish our credentials and everything else with this new OEM and then in this quarter, we've seen two deals in that.

[Brian Kinstlinger:]

Okay, great.

[Thomas Thekkethala:]

And these are with the other point I made is that with big carrier groups. So when this gets rolled out at group company number one and it's rolled out successfully then the OEM is motivated, then take it to the next group company and so on and so forth.

[Brian Kinstlinger:]

Thanks so much.

[Operator:]

Thank you. And our next question comes from Josh Seide with Maxim Group. Your line is open.

[Josh Seide:]

Hi, thanks for taking the questions. Can you just talk a bit more about this three major carrier wins during the quarter in terms of when those might meaningfully hit the top line and then what the overall opportunity is there. Thanks.

[Thomas Thekkethala:]

Yes, so traditionally Josh, when we had these sort of wins because of, sort of waterfall methodology that we adopted the revenue recognition, we typically take nine to 12 months. We believe with these lean methodologies that have been reduced and should be recognized over the next six to eight months and hopefully sooner with the throughput focus that we have in engineering. So, as I mentioned there were two new carrier wins with a new OEMs both of them, both these carriers are part of very large carrier groups and third win was something that is also very big carrier group, that is one that we end up winning directly.

[Josh Seide:]

Okay. And then regarding this three carrier wins is it fair to say that each carrier made a DSA license purchase that was ultimately that was bundled with RLN managed services in an effort to make that the offering more competitive with compatible across providers.

[Thomas Thekkethala:]

So what we've done now is rather than talking about DSA and things like that. We're basically broken these things down into components so we've had components like smart dealer and software welcome portal, hat launcher and lots of different components so, what we find to do now is essentially understand the carriers goals, some of pressures that they're under and then present a solution that include multiple components that together deliver these business outcomes.

[Josh Seide:]

Okay, that's helpful and then could you just quickly elaborate a bit on the OEM that you mentioned earlier and this way in terms of what particular infrastructure that OEM is providing to the two carriers that you mentioned.

[Thomas Thekkethala:]

Providing that the classic, 4G entire network infrastructure, the entire 4G network is what's been provided by the big OEMs now.

[Josh Seide:]

Okay. Thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from Jeff [indiscernible]. Your line is open.

[Unidentified Analyst:]

Hi, Tom. Hi, Dan. I have four questions for you more of the macro level but a follow-on to the very first question that was asked you, you look like you're running at about 80% gross margin which is extraordinary leverage for even relatively low revenue growth in terms of bringing money down to the bottom line. Looking out obviously that interested in guidance for next year and I know that something that you don't want to provide but looking out over the longer term let's look at five years what kind of revenue growth you think you can generate in aggregate out of your current model. You're operating at a extremely efficient level, you have cut expenses and you have this high gross margin so, do think you can operate at 5% revenue growth over the next five years 10%, 15% some kind of area metric that you may be pointing towards or think you can accomplish given the growth in your marketplace etcetera.

[Dan Moorhead:]

No, again I'm somewhat that relatively new at Evolving but I think, we'll be targeting at least basic hitting in the neighborhood of 10% type of growth over the next five years. Given that are you as I explained earlier there are going to be some differences in the early quarters that is what Q3, Q4 this year Q1, Q2 of next year as we gradually migrate out of this lumpy license or orientation to a more predictable, recovering revenue model.

[Unidentified Analyst:]

Okay, and that's really -- this speaks of potential for much greater net income growth.

[Dan Moorhead:]

Yes.

[Unidentified Analyst:]

I have three more questions that really move even further up the chain in terms of the macro view of evolving. One is probably for then what is your capital allocation outlook going out over the next two, three, four years? I know your first priority is probably to get that loan off your books in 2018 and obviously investing in the business, but how do you view it from your crow's nest up there?

[Dan Moorhead:]

No I think that was a pretty good path that obviously I'd like to get rid of the debt. It's cheap money, but we'd still like to get rid of that. We are going to make some investments in the business, in product and in sales, and other things. And then third will look probably the non-organic growth. So if there are acquisitive activities that are favorable and fit our box then we'll look at those as well.

[Unidentified Analyst:]

Okay. The next one is a long question for both Tom and you. In terms of your long-term outlook, it would appear that evolving could make a very attractive partner for a much larger company. It would provide a tactical tuck-in acquisition. You have a rock solid balance sheet. You have a high gross and net profit margins and a larger company could acquire you and pick up new products or services and/or relationships with new customers and yet still have a potentially a creative acquisition from a financial point of view. Has the Board or would the Board take on an active program to seek out the potential for this kinds of strategic move?

[Thomas Thekkethala:]

Dan, I'll let you take that one. Are you there?

[Dan Moorhead:]

Yes, I'm sorry was on mute. I was just going to say having been involved in building, young companies from five, 10 and 20 guys to eventually growth profitability and their exit. One of the things that I think is very important for us is that we continue to execute on our core competencies continue to drive revenues and profitability numbers up. And in that kind of an environment, if larger OEM or somewhat comes forward and make such an offer, I mean then one can evaluate it. But I don't -- I'm not a big supporter off trying to distract the business at this point in time to go out and see somebody interested in acquiring on. I'm much more of the mindset from my past experience of putting our heads down, executing, driving up these numbers and becoming very attractive, which would of course result in a very attractive offer in at that point.

[Unidentified Analyst:]

Okay, because timing obviously is critical in that process, so also the environment and what's going on in the valuation of companies and we happen to be possibly nearing the end of a very long cycle of very attractive valuation for many companies. In conjunction with that, I have a last question is that is that I've noticed Tom that your compensation is probably still more heavily weighted towards current performance than it is for the longer-term strategic view in the sense that if one takes your aggregate annual cash compensation and bonus opportunity relative to the equity compensation that you have it since to be more weighted in many companies, the equity central of the COO is usually many multiples of their annual gas compensation? The potential of yours is not in that league yet, has the Board considered potentially restructuring that arrangement to give you a longer term incentives in terms of the equity involved, so that you could have greater participation in that kind of outcome?

[Thomas Thekkethala:]

I can't really comment on that I'm not ready to the committee discussions around this topic. I would [indiscernible] then that situation because I really believe very strongly that what we have some core assets, 70 odd customers and there are some great opportunities because mobile is such a transformative technology and we have a lot of experience and expertise within the company to help drive that, not just for the telecom carriers. But as I mentioned for mobile banking, gaming entertainment and retail, what is really changed in the mobile channels. So I remain very, very bullish and I expect I hope that the board sees things the same way and makes the right kind of decisions for the entire management team.

[Unidentified Analyst:]

Excellent, thank you very much.

[Operator:]

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back over to Dan Moorhead, Chief Financial Officer for closing remarks.

[Dan Moorhead:]

Yes, I'd just like to say thanks again for joining us today. We have appreciate your support and look forward to speaking with your for you when we announce our year-end earnings in the February, March timeframe. Thanks a lot.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you all may disconnect. Everyone have a great day.