EVOL is an investment that has been in the portfolios since July. Here is the original research report issued at the time.
The company is extremely well managed. The executive team there seems to very deliberate in the actions they are taking, whether acquisitions or other use of the cash they are so good at generating. The DSA technology that is the bread and butter of the company seems to gaining efficiency and acceptance in the marketplace. Despite the run it has seen since July, I don't see much risk in the share price here at all. Let me demonstrate why by highlighting a few points from the conference call.
To understand what follows you must first understand the way EVOL's revenue model works. When EVOL signs a new DSA customer it includes a license for a set number of SIM activations. Once the activations are spent, the customer must then renew their license with a new set of activiations that EVOL refers to as FUAs (first use activations).
FUAs are a 100% margin product. They are all profit.
Here is what seems to have been missed in the conference call:
EVOL management: As we look to 2014, we expect to see more FUA renewals. And with the -- and with that, we expect to see the corresponding impact on our top and bottom lines. And while this FUA renewal did help our margins in Q3, during the quarter we did incur fees for our acquisition of Telespree Communications, a transaction I'll talk about in just a minute.
Yes, 4 are in FUA. So we've had one in FUA for a long time. Now we just got the second one. And numbers 3 and 4 are coming right along, I mean, momentarily.
Cameron M. Wright - Jay A. Fishman, Ltd.
Okay. So you just got the second one with 2 close to the pike?
Thaddeus Dupper - Chairman of the Board, Chief Executive Officer and President
Yes. We -- number 2 came online in Q3 for FUAs. And customer 3, I don't know if it's Q4 or not, but it's close. And customer 4, I think we're forecast for Q1. Isn't it, Dan?
Daniel J. Moorhead - Principal Accounting Officer, Principal Financial Officer, Vice President of Finance & Administration and Secretary
That might be Q2. But it's coming in, yes, the first half 2014.
So we feel good about our DSA funnel. We're making progress in the M2M space, and we think both will contribute, of course, DSA more than M2M, significantly in 2014.
Thad, can you just quickly go over the carriers that are in reload mode next year and just an update on that, and if you could try to help quantify what kind of effect that might have for you next year?
Thaddeus Dupper - Chairman of the Board, Chief Executive Officer and President
Yes, I mean, they are large. They are carriers that we've closed DSA projects with probably 1 year or 2 ago. They've moved into production and they've been in production probably for over a year as they used that initial tranche that I talked about. But they're large carriers. Three of them are very large. One of them is a smaller carrier, but their FUAs come in at a nice clip. Again, all the FUAs are virtually 100% gross margin. And the other thing that I would say, just to add color to the comments I made, is that we expect 2014 to be a bigger year for FUA revenue than 2013 was. And the fact that you can see how they can move the margin -- and I've made a comment on last quarter's call that the revenue contribution is nice that FUAs provide. But the adjusted EBITDA contribution they provide is a couple of times greater because, again, it's 100% margin revenue.
And I don't want to dig too far, but just as a percentage, if you were to compare this fiscal year to next fiscal year, what percentage of your revenue would you expect it to be?
Thaddeus Dupper - Chairman of the Board, Chief Executive Officer and President
A higher percentage.
The entirety of the increase from 69% to 74% gross margins during the quarter came from one customer moving into the FUA phase. Now EVOL management is saying that one customer just moved into FUA and two more are imminent. And they are large carriers. Furthermore, 2014 will be a bigger year for FUA revenues than 2013 was. This means increased margins and increased cash flow for EVOL going forward.
There is more. Check this out:
Earlier, I mentioned how FUAs will help EVOL migrate to more a recurring revenue model. The other important step for EVOL to transition to more of a recurring revenue model will be to migrate our products to assess our cloud-based model.
Today, Telespree generates 100% of their revenue from the SaaS model. And we see the addition of Telespree as an important step for EVOL's transition to more of a cloud-based model. As you know, we have been working to develop a SaaS version of DSA, which will make DSA accessible to a whole new tier of carriers, smaller carriers, those carriers who are not large enough to justify a premise-based version of DSA, but who, nevertheless, would benefit from the capabilities of DSA.
We estimate there are approximately 250 carriers worldwide that would be prime prospects for cloud-based DSA. And importantly, Telespree possesses significant expertise in the area of cloud-based solutions and operations. And this will be of value as we prepare to launch a SaaS version of DSA.
Additional highlights of the acquisition include today, 100% of Telespree's revenues comes from customers in the United States. As you know, prior to this acquisition, 100% of Evolving Systems revenue is from customers outside the U.S. So from a geographic customer footprint, this is a nice fit. Telespree counts Sprint as a major customer and activates over a million phones a quarter for them via their cloud-based activation solution.
One key takeaway from the Telespree acquisition and what it means going forward: What this acquisition will do is give them access to the cloud and more importantly, it buys them the engineering expertise of Telespree's team to develop applications that will benefit those 250 carriers mentioned by management. There is a whole untapped revenue source of smaller carriers that EVOL is preparing to tap into in 2014-2015 that will further accelerate earnings going forward.
Today's selling was squarely investors were focused on the year over year declines that were caused by a $500,000 contract that was pushed back. Otherwise, the company seems to be extremely well positioned for the first half of 2014, especially with FUAs coming into full swing.
