Evolving Systems: Underlying Profits Higher

Evolving Systems’ (EVOL) Q2 results reveal the group’s high-margin cash generation at work. While revenues were below target due to a DSA contract slipping into Q3, underlying profits were significantly higher on a sharp rise in margins and cash flow was strong. The company has recently won two additional dynamic SIM allocation (DSA) deals with telecom operators in Argentina and Africa. The valuation looks attractive at c 12x our cash-adjusted FY14 earnings, given the growth prospects, while the chunky 4.3% FY13 dividend yield is underpinned by the strong cash flow.

Q2 results: Contract slips into Q3, margins strong
Q2 revenues dipped 13% to $5.8m, as one of the DSA wins slipped into Q3. This was because the customer’s parent company wanted to negotiate an enterprise-wide licensing framework to facilitate future deals across its 20 operating companies. H1 revenues were just 1% lower, given the stronger Q1, at $12.4m. Adjusted EBITDA for the six months jumped 31% to $3.5m as the margin expanded by more than 700bp. H1 cash flow from operations was $5.4m compared with a $0.2m outflow in the corresponding period. The group ended the period with $13.4m in net cash, up from $11.5m as at 13 March 2013 and $8.8m at 31 December. The quarterly dividend has been raised by 2c to 10c.

Forecasts: Ease FY13 revenues, up FY14 profits
We have eased our FY13 revenue forecast by $1m to $27.5m given the weaker-than-expected Q2 revenue. However, noting the strong margins and good cost control, we have maintained our FY13 adjusted EBITDA. Management says that several DSA customers are close to capacity and will need to purchase additional batches of first use activation (FUA) licences next year, and we have therefore maintained our FY14 revenues. These FUA licences are near 100% gross margin revenues for Evolving. Hence, we have also increased our FY14 EBITDA by $0.7m to $9.2m. We forecast the group to end-2013 with net cash of $9.7m, rising to $12.1m a year later, after taking the increased quarterly dividends into account.

Valuation: Growth with a large cash pile
Adjusted for the $13.4m cash pile, the shares trade on c 14.7x our FY13 earnings, falling to c 12.5x in FY14. While this is slightly above its peers, the rating looks attractive, given the group’s growth prospects driven by its leading position in the large and fast-growing dynamic activation markets and its strong operating margins and low capex requirements.

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