INVESTORS ARE NOW FEELING SECURE WITH THIS US SAFETY STOCK

Mass shootings in the USA continue to happen almost daily—which is the main reason I started covering EVOLVE TECHNOLOGIES (EVLV-NASD) in 2022.

Their technology is used to detect guns and knives in large public places—and still keep people moving quickly and easily. Several pro-sports stadiums now use it.

I’ve been cautious on the stock as they transition from selling their product to basically giving it away and getting customers to pay them on a SaaS model— Security-as-a-Service. They don’t have enough cash in the kitty to get them to positive cash flow. That acts as a cap on the stock, quite often.

BUT — the stock has broken out to new 52 week highs—$5/share—as they announced a blockbuster quarter, with huge increases in recurring revenue:

Evolv Technology Reports Record First Quarter Financial Results

They have a lot of money in the bank—and they’ll need it as they give their product away, and SaaS revenue takes time to grow.

But by bidding up the stock here, the Street is transitioning to a much higher multiple. You can always raise money on success. In this updated, subscriber report, I talk about what I see as the good and the bad. I always do my best to use simple English; no words over 9 letters is my mantra.

This is the type of report I do for my paid subscribers—you have it here free. I cover small cap stocks across several sectors—energy, biotech, commodities, and more.

I’m giving away one more free report, on one of my favourite US-listed stocks– a biotech has me very interested right now. In Europe, they have been selling their product/service for years, extending the life of patients with terminal illnesses for…well…years.

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QUICK FACTS

Share Price: $4.00
Shares Outstanding: 145 million
Market Cap: $580 million
Net Cash: $200 million
Enterprise Value: $385 million

POSITIVES

• Excellent balance sheet with $200 million of cash
• Proven solution for a big societal challenge
• Reduces cost and improves effectiveness for customers

NEGATIVES

• Still burning cash: ~$90 million last year, $70 million this year
• Future growth looks strong, but has to happen for this to work out
• Have had supply chain issues
• Nobody watching the stock so it could take a while for the market to figure this out

READ THIS BEFORE YOU BUY EVLV

Companies that came public by way of the 2020/2021 SPAC boom are HATED by the market. The main ETF for the sector is down 80% from last summer.

Ouch!

Evolv Technologies is no exception. The company has seen its stock drop 80%+. Today the stock remains down a healthy 70% from the $10 SPAC price.

The performance is largely their own doing. Like so many SPACs, Evolv came to market with a great story and BIG projections.

FWIW, the story is a good one. Evolv supplies a solution that’s quickly gaining traction for a big challenge facing society—mass shootings and violence.

Already adopted by major sporting stadiums, household name corporations, casinos, cultural facilities as wells as schools/churches Evolv’s technology can make us safer, and do it with a more convenient and less expensive security solution.

Evolv sells a next generation weapons detection systems, a screener, that prevents mass-casualty events at venues like schools, arenas/stadiums, workplaces, places of worship, nightclubs, movie-theatres, grocery stores, malls — sadly anywhere and everywhere these tragedies occur. Which is EVERYWHERE.

Source: Evolv November 2021 Investor Presentation

I don’t have to tell you that the market for preventing mass shootings is growing rapidly.

In the United States, there are as many as 444 million privately-owned guns in circulation. According to the Gun Violence Archive, in 2021 there were 693 mass shootings in the United States an all-time record in a year when most people were not free to gather.

This terrible mental illness problem is—sadly—only getting worse!

Source: Evolv Investor Presentation

Evolv’s technology is Next-Level. The company’s devices allow for 10x higher volume of people to go through than metal detectors AND they say they are better at finding hidden weapons.

If this is all true—and there are some big recent sales that suggest it is—that means no massive waiting lines for patrons; and more importantly better safety for everyone.

EVLV’s tech can differentiate between everyday objects and potential threats. It is done in a touch-less manner, which allows visitors to pass through the screener without stopping or removing objects from their person.

The systems allow visitors to walk through the security entrances at customers’ venues at a normal pace with their bags in hand and without emptying their pockets.

This speeds up the security screening process BIG TIME–while reducing the number of nuisance alarms, allowing security guards to focus their attention on real threats. 

Imagine how getting through an airport to your plane could go from 45 minutes to five minutes!!

SPEED BUMPS

The story is SOLID. Unfortunately, driving adoption has been a rough road. Evolv has hit more than a few bumps.

In their SPAC presentation material (from 2021), Evolv followed the same playbook as other SPACs. They made crazy growth projections to drive interest in the stock.

Their March 2021 de-SPAC presentation forcast over $1 billion of revenue by 2025!

Source: Evolv March 2021 Investor Presentation

Of course, you make those kinds of projections and you set yourself up for failure.

Last year Evolv disappointed the market with 2022 FY guidance that called for revenue in the range of $29-$31 million, down significantly from their own estimate of $50+ million a year before.

On the day the new guidance was announced, the stock tumbled by nearly 40% on the day – to a low of $1.70 per share.

What is interesting is that Evolv turned out to be too conservative. A few quarters later they raised guidance back to $48 million. By year-end they ended up hitting $55 million of revenue for the year after all!

It still wasn’t good enough, largely because much of the incremental revenue was lower quality hardware sales. Evolv’s gross margins were a paltry 3% in 2022. Q4 gross margins were barely positive.

Source: Evolv Q4 2022 Presentation

Subscription revenue came in at only $17.5 million (only about 1/3 of overall revenue). At the time of the SPAC subscriptions were expected to be most of the revenue in 2022.

2023 IS… COMPLICATED

This year the revenue picture is muddied by a pivot.

Evolv is foregoing hardware revenue in favor of a subscription only model.

Because of the pivot, Evolv is forecasting flat revenue for 2023. Guidance calls for $55 – $60 million of revenue.

But as Evolv calls it, this is “an odd comp” as they transition away from product revenue.  Subscription revenue is always recognized over the life of the contract and thus is lighter up front, thus causing the growth dip.

Evolv expects to reach 80% weighted subscription revenue in the next 18-24 months. 

Does this mean the growth story is intact?

That is the million-dollar question (literally).

Evolv says that without the change in focus to subscription, 2023 revenue would be “in the range of about $115 million to $120 million” or over 100% growth.

That would be great. But making revenue projections based on a “what could have been” comp is always going to draw skepticism.  At this point, investors want to see the money. 

If I seem to be painting an ugly picture here, I am. But it is not without hope. Among this litany of over-promises and under-delivers, there remains a very interesting business here.

IT IS NOT ALL BAD

Consider the following:

Evolv grew their customer base by well over 200% last year.

Source: Evolv Analyst Day 2023

Evolv’s technology also provides big time cost savings for the facility because it allows for a huge reduction in manpower required with current best practices.

Source: Evolv November 2022 Investor Presentation

So far, payback for facilities that switch to Evolv is just months. Labor costs can be reduced by up to 70%.

They can paint a good story, can’t they? Safer for society, more convenient for patrons and a big-time cost saving for the venues. It seems like a no-brainer solution that could go everywhere.

A BIG UNTAPPED MARKET

These touchless security screening systems are already well proven — having screened over 200 million visitors worldwide. 

The company believes that they have screened more visitors through advanced AI-based detection systems in the United States than any organization, other than the United States Transportation Security Administration (“TSA”). 

Source: Evolv 2023 Investor Day Presentation

Existing customers include many iconic venues across a wide variety of industries:

• major sports stadiums
• notable performing arts and entertainment venues
• major tourist destinations and cultural attractions
• large industrial workplaces
• federal and commercial office buildings
• school districts
• healthcare facilities
• houses of worship

I can see a future where this kind of safety measure is mandatory for any sort of large gathering. Either that or we find a magic pill for all mental illness. Weapon control seems impossible.

The total addressable is believed to be $20 billion globally. If a venue operator has already adopted any type of security screening device to date, it is most likely a legacy metal detector that relies on inventions that are almost 100 years old.

Source: Evolv November 2022 Investor Presentation

Unlike Evolv’s stock price—which has been a rough ride—unit sales growth has actually been very strong. Q4 included.

In Q4 Evolv:

• Added 25 hospital buildings for a total of 100
• Added 6 new professional sports teams – they have over 30 NFL, MLB, MLS and NHL teams as customers
• Doubled the number of schools they are in QoQ to 400

Unit deployment has ticked up 7 of the last 8 quarters.

Source: Evolv Analyst Day 2023

THE REVENUE MODEL IS A PROBLEM

Unfortunately, unit growth comes at the price of margins.

The accounting treatment of Evolv’s sales has been a source of investor frustration. The company is trying to fix this and to be perfectly honest, they need to if they want to generate interest in the stock.

I’ve been watching Evolv for almost a year now and am still struggling with how to think about the margins of this business.

The issue is the recognition of hardware and software sales, what the margins of each are, and just more generally, what is really going on.

Evolv is really selling two products. There is the Express unit – the physical walk-through detector, and the software that powers it.

The detector unit is, of course, is the majority of the upfront cost. Evolv sells the unit at negative margin. Northland Securities estimates that margin on hardware sales can be as much as -40% (that’s “negative” 40!). The reason is that the sale lets Evolv get their foot in the door – gain a customer and generate the long tail of subscription revenue.

But on their income statement, because Evolv must recognize all the hardware revenue up front (while the software revenue accrues over the life of the contract – usually 4 years) the more units they sell the worse margins look.

In quarters where Evolv sells a lot of units, gross margins tend to zero (like we saw in Q4).

To combat this, since Q2 Evolv has been trying to change their go-to market strategy – and with it the accounting around it. Instead of selling units, they began packaging the unit as a lease that goes with the subscription. With the lease model, the upfront revenue recognition goes away and with it, the dismal looking margins.

But this only worked up to a point. Many customers still wanted to purchase units. It all has to do with capex budgets vs opex budgets and how for big institutions like school boards and hospitals it matters which bucket the money comes from.

For example a large school district purchased >160 units in H2. They wanted to own them. A nice customer add but a big drag on margins.

Exacerbating the problem has been Evolv’s move from a direct-sales model to one that includes a network of third-party channel partners.

Source: Evolv Q4 Investor Presentation

Evolv has resellers in over 30 countries. These include Johnson Controls, Securitas Technology, and Motorola.

Motorola sells a Motorola Solutions-branded premium product based on the Evolv Express platform, co-branded as Motorola Solutions Concealed Weapons Detection on a global basis.

Source: Evolv November 2022 Investor Presentation

While channel partners can push the product out further and faster, they have left Evolv with even less control on the type of sales they generate.

HOW DO YOU SOLVE A PROBLEM IN ACCOUNTING

What we saw in the second half of 2022 was that as Evolv tried push a subscription focused model, unit sales still overwhelmed margins.

In response, Evolv said Jan 1 they would transition to a full subscription only model. That means all units would have to be leased.

To facilitate this, while at the same time still giving customers the choice they are asking for, Evolv entered into an agreement with their contract manufacturer – Columbia Tech – whereby Columbia will sell the equipment to the customer and pay Evolv a licensing fee for doing so.

The customer is still buying the product. It is just not being sold by Evolv. Evolv has essentially recruited a middleman to take on the low-margin revenue.

To be honest, I am not a big fan of accounting tricks to make the financials look better. It is a slippery slope.

I get why they are doing it. They have customers that want to own the product. The unit itself is not unique enough to warrant a big mark-up.

They want to a be a SaaS company, they want investors to see them that way, and that simply isn’t going to happen with lumpy, single-digit margins driven by equipment sales.

FINANCES/VALUATION

There is one place to start here and that is cash.

Evolv is burning the cash.

They ended 2022 with $230 million of cash. At the end of 2021 they had $307 million. Over that same time debt increased $19 million (to about $30 million).

That means cash drain from the coffers amounted to roughly $90 million in 2022.

Will this improve in 2023? The company says yes but the guidance says marginally.

Evolv guided to $165 – $175 million of cash at YE 2023 while taking on $10-$20 million more of debt.

At the midpoint, that implies $75 million in 2023.  Better than 2022 but still a long way from break even.

Analysts see at least three more years of cash burn ahead.  Evolv themselves has stopped guiding to a cash flow breakeven date.

The only sell-side coverage on Evolv (that I am aware of) comes from Stifel, Cowen and Northland.  

Stifel expects modest improvement this year, with adjusted EBITDA getting to ($62) million, and next year to ($48) million.

Stifel has a $2 target on the stock.

Cowen, which was the sole advisor of the Evolv SPAC in 2021, has a somewhat more optimistic take.

Their price target on the stock is $7. They believe that Evolv has a superior solution due to the AI and machine learning capabilities of the software that level them adjust to new threats faster.

Even so, Cowen isn’t expecting profitability any time soon. Their latest model (from March 7^th) estimates a $85 million loss in 2023, a $62 million loss in 2024 and a $41 million loss in 2025.

Evolv’s problem is that a subscription business is a great business model (recurring, sticky and high margin), but it takes time to build it. Subscription revenue was only $17.6 million in 2022. Annual recurring revenue (ARR) ended 2022 at $34 million and is expected to end 2023 within the range of $65-$70 million.

Source: Evolv Analyst Day 2023

Compare that to the Evolv’s OPEX, which rose $40 million in 2022, and they have some ways to go to profitability.

Source: Evolv 10-K

Evolv has said their recurring revenue business has margins of 60%. At a $70 million run rate (generously assuming the top end of the year-end guide), that equals $42 million of gross margin.

Without a substantial reworking of the cost structure, it is hard to see Evolv turning the corner on profitability in the near-term.

WHAT THE ANALYSTS SAY

FIRM                                                       TARGET PRICE

Cowen & Co                                              $7.00

Stifel                                                          $2.00

Northland                                                 $7.00

STOCK CHART

CONCLUSION — A TUG-A-WAR BETWEEN GROWTH AND CASH BURN

After loving SPACs to an irrational degree in 2020/2021 everyone now thinks that these stocks are now totally un-investable.

That is certainly the easy conclusion. But if you don’t keep looking, you’ll miss a diamond in the rough.

Is Evolv that diamond?  

It is hard to say. On the one hand, it’s a desirable product. It makes sense to me. Gun violence, mass shooting, all that bad stuff is (unfortunately) not going away.

Revenue is growing at a triple digit rates. Recurring revenue, which is high quality revenue, is expected to grow at a 100%+ clip this year. 

They have Tier 1 high-profile clients—franchises in the NFL (New England Patriots and Atlanta Falcons) and the MLB (New York Mets and Pittsburgh Pirates).

On the other hand… they don’t make money. They lose a lot of it. Their revenue model is broken and to fix it they are being forced into accounting tricks that make me queasy.

At $3 the stock has a market cap of $450 million. With net cash of about $200 million.

If Evolv can prove to the market that they are on the path to both growth and profitability, that leaves a lot of room to the upside for the stock to go.

That’s it! I hope you enjoyed and learned from this report. 

Again, this is the type of report I do for my paid subscribers. 

I’m giving away one more free report, on one of my favourite US-listed stocks–a biotech company with a working product in Europe, and is now fast approaching its FDA date in the USA.

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