Evolv Technologies Holdings, Inc. (EVLV) Earnings Call Transcript & Summary

All right. Thank you. I'm Sami Badri with Credit Suisse Equity Research, and today we're going to be hosting Evolv Technologies. We have Peter George, CEO; and Mark Donohue, the CFO. So thank you both for joining us today.

Thanks for having us.

So we did see this preview video about Evolv Technologies. But, Peter, maybe you could give us I guess the quick download just to preface some of the other questions I've planned for you guys.

Sure. So thanks, Sami. So we wanted to play that video because a picture speaks a thousand words. And you could see there we're the world leader in AI-based weapons detection. We've built a sensor platform, and we have machine-learning models that allow people to walk into a venue without divesting of their normal things, like you would going into an airport with a typical metal detector. And we can detect if you have a weapon on you. And if not, and most people don't, you walk right in without breaking stride at the pace of life, and it's completely transforming the physical security space and disrupting what was traditionally a metal detector technology is now AI-based weapons detection.

Got it, got it. So I think your company is very relevant and topical from a general security and public events or current events perspective, and there's also a lot of funds that have recently been made available to states and municipalities. Could we talk about how the connection between the rising gun violence and also the increased availability of funds for security have actually impacted Evolv or at least how it's starting to trend or flow in?

Yes. So we went public a couple of years ago behind some very strong secular tailwinds of rising gun violence, a lot of anxiety in the world, during COVID and post-COVID where people wanted to gather again, but they wanted to do it safely. They wanted to do it safe from COVID, which weaponized people, but also safe from people that had acts of violence on their mind. And so for the last couple of years, those secular tailwinds have continued. We have more guns in North America than we've ever had, more violence and gun violence, and more anxiety. As a result, a couple of years ago, during COVID, the federal government created some funds called ESSER Fund, which they held at the federal government level and then recently pushed it to the states, which was USD 175 billion designed to help schools in particular with COVID and safety. Now that COVID's kind of behind us, a lot of the schools are using those funds for safety reasons, and now safety has become the top priority for most educators. Learning is 2. Number 1 is keep kids safe and they're using those ESSER funds to do it. So between reallocating their original budgets and then having grants and ESSER funds, we're seeing a real increase in the education market, in particular, as parents want to keep their kids safe and so do teachers and administrators.

And then I was going to add a question for you about the education sector and where the sources of funds were coming from. Would you say ESSER funds are the main source or would you say even in this next ARPA federal funds program, that's where there's going to be a lot of future funds made available?

Yes, I think the latter. We're hoping that there will be a lot of future funds. To date it's about 25% to 30% of our customers are using ESSER funding. Mostly they're using funding, they're just reallocating their budgets because safety is so important. On the back of some tragic events that have happened in schools over the years, educators are saying, we got to keep our kids safe, and we're going to dedicate the dollars we have to do that. So it's coming from local funding but also future funding as well.

Got it. I wanted to ask about your transition to subscription effective January 1, 2023, and maybe, Peter, and also maybe Mark, as well, if you could tell us about basically a hard transition, right, a hard date [ spin ] or at least pivot, right.

Yes, it's a decision that we made probably in the middle of the summer. And if you look at our pipeline, we were really allowing it absorb that transformation. But we did make the decision going into January 1 to do a hard pivot, to make that the core business offering going forward. That should help us quite a bit in terms of the margins that we'll print and things like that. We're doing very good business across the board, but leading with SaaS is really where the company has -- where it's genesis is and where it wants to go.

And then if we were to just dissect revenue impact versus margin impact, what would you say investors should be expecting, how this hard pivot would manifest itself on the financials?

Well, I think the margins will benefit considerably. We gave guidance recently of 30% plus next year and a lot of that has to do with moving to the subscription model, and we expect it to improve over the coming years beyond that. From a revenue perspective, we think it'll be relatively neutral. We are transitioning also to ARR that will encompass the entire sale, will hold the fixed asset, and we have a debt structure coming out to help us offset that and keep our operating cash in play.

And then one thing that fits your company specifically is the equipment and the accounting treatment of that equipment. How do you guys intend on treating the equipment or the accounting elements of that once you do move to a subscription model?

And we have the subscription model today. So anytime we do a subscription, we capitalize it as a fixed asset. In fact, a lot of our fixed assets, just the accounting rules alone, make us move inventory into fixed assets. So you'll see more and more of our inventory and our fixed assets in one bucket, and that will be offset against the debt structure that's really there to help us support that business model going forward.

Got it. Also around 3Q '22 earnings, you guys also announced Evolv Express 3.0 and 5.0, right. The one thing is maybe you could tell us a little bit more about this introduction.

Yes, sure, I'll take that. So as everyone knows, we have a sensor platform. And then as part of the subscription model, so every one of our customers, whether they buy the hardware or are part of the subscription, we do major software releases to keep our customers current. So we just came out with a new release, Express 5.0 and Insights 3.0, which dramatically change both the accuracy and detection rate of the product, so really excited about that. We added some mobility elements to the system. We've created some tagging features. So we detected 100,000 weapons coming into venues in 2022 so far. We have the ability now for the operators of the system to actually tag was it a gun, what kind of weapon? Was it a gun, a large tactical knife, or a bomb, or was it a nuisance alarm because sometimes those happen as well, so that tagging is really important to understand what we're finding and what we're stopping. And then finally, we added an assist, alert assist capability. So, for example, in our schools, many of the teachers operate the system. If somebody came in with a gun, they can hit assist and then the Security Resource Officer or SRO can come and then deal with the issue. So we're adding lots of software capabilities for detection rate, for speed, and then for mobility, and then the 3.0 is Insight. So you saw on the video that we have the capability within an hour of doing a game to send the analytics to our customers so they understand the arrival rates of their fans or their employees or their students, when they came, what they were carrying, and it gives our customers situational awareness around what's going on in their venue in a way that nobody else can. So we've been very happy with that. And we continue as part of the subscription to do 2 major software releases a year to make sure we stay on the cutting edge of the security issues in the industry.

And then do you plan on integrating Evolv Express with other devices or vendors to leverage the new technologies or at least the new API capability that it comes with?

Yes. That's a huge part of our strategy as a company. So think about us doing the digital transformation in the entry ways of venues all over the world. And when you do -- when you make an analog dumb device a digital device, you can open it up and integrate with whatever's there. So, for example, you saw in the video, we've done the integration with most of the major VMS systems, so the Avigilon through our partnership with Motorola, but also Milestone and Genetec, we've integrated with mass notification companies like Titan and then Everbridge who presented before. We want to be part of the security infrastructure that customer has, including access control, and our customers want us to do that. So that will be a big part of our strategy going forward, making sure that we can integrate to whatever is already there and then integrate to whatever they want to have, so they can build depth of defense in their security posture, which is obviously a best practice in both physical security but also cyber.

Got it. Last quarter, I think you guys also discussed potentially redesigning your product, or at least the hardware form factor. Could we go through the puts and takes for why you guys want to do that? And is this also going to be tying into Evolv Express as well, like enabling some of these other kind of capabilities?

I can probably start. What we're really driving right now is more reliability, mobility, and quality into the system. So it's really a bill of materials reduction. We're targeting about a 33% reduction in the costs moving from, let's say, 15 printed circuit boards down to 6 inside the system. It's just really a different way of approaching the same problem. We're taking advantage of this time to probably add a few more bells and whistles to it, another maybe 5% or so, but the majority of it is a cost-down effort.

Got it. Do you guys have a general idea on when the redesign would be available?

Well, right now, we've seen that taking probably the next 12 months, and we should be in a pilot phase by Q4 of 2023 and really benefiting from that entering 2024.

And then when we think about just the existing product and the existing supply chain dynamics that you guys have seen as a company, how has that affected Evolv?

Well, it's affected us like everyone else. We're chasing the world for component parts. We have 30 discrete semiconductors and a lot of other peripheral parts inside the system. At any one time, 5% to 10% of them are just hard to get and you never know which ones they're going to be, you really don't. So we do our best to stay ahead of it. The supply lead times are still in the 9- to 12-month range. So we plan as far ahead as we can. Whenever we're seeing a delay in anything, we really drive to try to find that part. Lucky for us, we're not buying 500,000 units of a semiconductor. We're buying 3, so we're pretty nimble, and we can usually figure it out. Worst case, we're redesigning the part. And that can take 1 to 2 months, really just takes our sustaining engineering team to really do that, and we don't like to do it a lot, but we can certainly protect ourselves from a supply chain perspective by going down that model.

Got it. In your video, you showed, I think, 3 main segments, maybe even more in the industrial use case for your customers' industries in education, health care, entertainment stadiums, I think there was even an enterprise on-premise type of end market as well. When you think about the next couple of years of growth, which customer vertical or industry really is going to provide the biggest piece of growth to your business?

Yes. So we saw a big shift in our business this year towards education. So we see education and health care as 2 really big pillars of verticals that have a problem that we can help with. So we see those big pillars. We see professional sports. There's about 90 arenas today in professional sports that require some technology as a big opportunity. As you know, we've already done a lot of work with the NFL and MLB and MLS, and we want to continue with that. We also -- places where people gather in cities like museums or houses of worship, performing arts venues, those will be focuses. And then finally, you saw it there with the rolling of the dice, casinos are places that people want to come to and know they can enjoy being in the casino and be safe. So the 2 big pillars will be education and healthcare. They represent very, very big TAMs for the company. We estimate that by prioritizing the top 550 big school districts, it represents about 23,000 schools in North America. And on the healthcare side, which by the way, 68% of workplace violence is happening in healthcare and hospitals. It represents about 2,400 hospitals, all which want their doctors and nurses and patients to be safe, and we have technology that can really help with that. So we're going to narrow our focus and double down on serving those big verticals, and we think we're going to be real busy for the next couple years extending our first-mover advantage in those markets.

And then maybe following up on the education sector. So you've seen tremendous success right now or at least significant traction. How repeatable is similar types of execution in other industry categories? I think in education, you saw a surge in gun violence, a lot of attention, and you saw an ecosystem of funds become available, and this was a unique sequence of circumstances. But based on the technology set that you've described, it's probably very applicable to other industries. But how repeatable do you think the same sequence is in other industries?

Yes. It's a great question. So when we think about this problem, it requires 3 things. It requires world-class technology, process that we call CONOPS, how you operate it. And then there's a human factor. It requires somebody to operate the system. Those 3 things coupled together can dramatically improve your security posture. So regardless of where you are, we're still trying to do the same thing for all these different verticals. We're trying to make sure that if somebody has a weapon of mass casualty, it doesn't go in the venue. And that's the fundamental reason why people choose us. And regardless of your vertical, that's exactly what they need from us. So we think that is really applicable. How they use it can sometimes be different. I mentioned to you the teachers are the ones who operate it in schools, normally in theme parks and large venues, it's security guards. But in every case, they're all -- they all want the same thing to happen, make sure weapons don't get in their venue, and that's one of the things we do quite well.

And then maybe interrelated to the repeatability of your business, but thinking about leveraging your channel partners, right. I think as of 3Q '22, 70% of deals were actually executed with your channel partners. Maybe to give us an idea what is typically the contract structure or the terms or the margin profiles of these channel partner sales? Are they accretive, dilutive? How do you guys treat them? How should we think about those partner or channel partner transactions?

Go ahead. Why don't you...

Yes. Well, for our standard channel partners, we're generally in the range of about 20% to 30% discount. But I think what's important to know is that these are value-added resellers. They are really helping us with the installation and the management of the customer. So a lot of costs that we have, they can bear if they take on that deal.

I see. Do you guys expect the 70% mix to actually go up even higher over time, at least the channel partner mix of your business?

I think right now we're thinking of approximately 70%. There are some areas in some markets where direct is still preferred by the customer base. So we have that mix. But I think 70% is probably what we're thinking right now.

Got it.

Today, we have approximately 20 to 25 quota-carrying salespeople that are [ channeling ] and different in terms of how we deliver that to the products. They sell direct to some customers and with channel partners and others, and then we have a channel team that's responsible for enabling the channel. So getting -- we're going to invest in both of those next year, both more channel people and more channels so we can get more operational leverage from the channel from that enablement. We have some channel partners today, Motorola is 1 of them, that can do deals without our help, right? Because they know how to sell, they add install, they add a support and lots of other channel partners as well. So we want to get the operational leverage from the channel but also make sure we have a direct touch approach to our customers because it's our brand, and we know our product as well as anybody. In fact, more than anybody.

Got it. And then I'll open up to the audience for question after this next question I'm going to ask. So just looking at your deal pipeline, which vertical generates the greatest amount of deal volume?

Yes. I think exiting this year, we're going to look back and see education as being a significant part of the both rearview mirror results, but also forward-looking pipeline. What once was a summer thing when schools bought technology to get ready for the new year, now is an all-time thing, which is we need to keep our kids safe, and we want technology whenever we can get it throughout the year to make sure kids can come to school and worry about learning and not worry about any gun violence. So we see that as being a big market for us. Hospitals is going very strong. But there's rising gun violence everywhere, and we see all verticals -- opportunity in all verticals, and we'll continue to see that. We like to have 5x the pipeline as we look forward on the forward quarters, and that pipeline comes from our marketing team developing channels, bringing pipeline to it, and then our direct sales team. And right now, that balance has been 1/3, 1/3, 1/3, and we like what the pipeline development looks like.

Got it. I'm going to pause to see if there's a question from the audience. Are there any questions? One thing I want to ask is you've announced -- you've obviously announced new software capabilities. You guys have some strong channel partners. What's like next from an ecosystem or integration perspective for Evolv? Is there like another channel partner that you guys are trying to acquire, integrate into? Is there another technology that you guys want to integrate or deploy? What's next in like the product lifecycle? Not that you guys have saturated what you currently have, but like what -- how should we be thinking about your corporate lifecycle, at least from here?

So our main priority is to focus on the North American markets and particularly the verticals I mentioned. We verticalized our sales organization, so we know how they go to schools, how they buy, what their sales cycle is like. We know the speak in hospitals, right? So our team is doing a really good job with that. So I see those verticals as being key to the company going forward.

And then you used to disclose number of USD 1 million plus deals on your conference call. Remind me if you guys did it for 3Q '22, but did -- you guys did do that?

We did.

Do you expect these start to really inflect higher in 2023 as the solution set becomes a bit more clear to your end market customers?

Well, I think, first of all, we're going to be – we'll start -- we will see deals of that nature, whether or not they go higher, we already have some deals that are quite rich at this point. When you talk about the Charlotte-Mecklenburg school, they're buying 160 systems. We'd be happy if someone did that again. So it isn't so much bigger numbers, but I think it's just more routine, more volume of what we've been seeing. There's just -- there's a lot of opportunity. We're focused on approximately 2,000 major areas that cover about USD 650 million in ARR. Next year, that will be our major focus.

And what changed for us last quarter that we're seeing in the future quarters is we used to sell individually to schools and principals. That changed and now superintendents are buying systems for their entire district, which is one of the reasons why we had a record USD 7 million deals in Q3. And as we look in the pipeline, the deals are bigger because superintendents are saying, I'm not just going to put it in my high schools, but my middle schools and all the schools need to be safe, too. So we're focused on approaching the biggest districts and the superintendents. Same thing with hospitals. There's 2,400 hospitals that represent the big major hospitals that need [ high flow ], but they're represented by 107 hospital systems. We're approaching the people that are responsible for the hospital systems. So we think by very nature, I think the deals are going to stay pretty big.

Got it. And then as we wrap up, I want to ask you each like what keeps you awake at night going into 2023. You're probably in an industry that is a little bit more immune to economic shocks and your funding sources are a little bit more straightforward. But if there was something that would potentially cost you a night's worth of sleep, what would that actually be?

There are 2 things that keep me awake at night all the time. One of them is making sure we can capture the demand in the market right now, scaling the business to capture the demand is a unique opportunity for us. So that keeps me at night as the CEO. The other thing is trying to prevent the next mass shooting because that's what we're here to try to do. And there's no perfect prevention out there. But every new system we put in a place that can keep kids safe and keep people safe and keep venue safe, it keeps me awake at night that we can get as many out there as possible so that people can be safer again. And to date, in 2022, there's been 607 mass shootings. That's just tragic. It's an awful thing and making sure that our systems are out there to potentially reduce that is what keeps me awake at night.

Got it. All right. Well, Peter, Mark, thank you very much for joining me today. And everyone else in this room, thank you for joining us.

Thank you, Sami.

Thanks, Sami.

All right.