Evolv Stock: FTC/SEC Investigation Could Provide An Attractive Entry Point (NASDAQ:EVLV)

Introduction

Evolv Technologies (NASDAQ:EVLV) is an overhyped SPAC that merged in 2021 valuing the offering at around $1.7bn. The company is backed by Bill Gate’s VC firm “Gates Frontier” who remains the largest shareholder with a 12% stake. Today the business is valued at $530m running at ARR of $89m ($100m in revenue expected by year end), however the business is yet to be profitable.

So what does Evolv do?

Evolv provides physical security screens integrated with “AI” software (this could just be imaging software) to detect weapons like guns, knives and explosives. This is done through cameras & sensors as opposed to traditional metal detectors. Security personnel are alerted via a wireless monitor with a live 3D box that suggests were on the body a weapon could be.

This type of security screen requires less human capital and is particularly useful for large events as the screens can handle large volume vs metal detectors or metal wand screening. The system can handle ingress more efficiently at up to 2,000 people per hour per unit resulting in:

1. Less queuing and uncertain waiting for attendants which improves experience.

2. With significantly reduced queuing time, sports venues can increase average customer spend before games start.

Evolv is used mostly across sports stadiums, hospitals, schools & warehouses/large work places with New York City trialling the technology for potential use in subways. Although there is concern that this technology doesn’t work well in the transportation sector – the decision by NYC will soon shed light on this use case.

Evolv says there “Express” system integrates seamlessly with existing security infrastructure and can include API plug-in, video monitoring, mass notification, access systems etc. Evolv has over 800 customers with 5,323 units deployed in Q2 up from 3,386 in the same period last year, representing a 57% increase.

Evolv continues to add new customers consistently, as seen in the above quarterly metrics. You can also see “Remaining Performance Obligation” currently at $263m representing significant unearned contract revenue.

Sales agreements are typically 4-years and due to the young nature of the business, Evolv has yet to hit a big renewal year. Evolv had 12 Express systems for renewal in Q2 and renewed 9 of them (75%). Last year the company introduced a “distribution” sales model where customers pay for the Express system hardware upfront and then pay an annual or quarterly fee for the software across for 4-years. The other sales model is simply a “subscription model”, where the customer pays monthly for renting the hardware & software combined.

Sales via the new “distribution” model means CapEx on the physical Express machines won’t feed through to “Inventory” or “Assets” on the balance sheet. Also there will not be any manufacturing COGS on the P&L for these types of sales. Sales via this model means purchases are made with the contract manufacturer Columbia Tech who pay Evolv a license fee from for each unit sold.

The key here is the 4-year SaaS contract, which is high margin and will be indicated by increasing ARR. Reoccurring revenue and the low cost of suppling the software create a strong business model, but due to the young nature of the business, Evolv is yet to reach scale and profitability. The company has 50%+ gross margins but is negative EBITDA, management expect to reach EBITDA positive by Q2 2025.

SG&A expense as a % of revenue is a metric to watch QoQ to understand if the company is reaching scale. As you can see below, management’s long term target is SG&A (S&M + G&A) at 38% as a percentage of sales at the midpoint. 5 year revenue CAGR is 30-40% with long term adj EBITDA margin guidance of 10-15% which seems a bit low.

FTC / SEC Scrutiny Overhang

Early this year the SEC began a “non-public fact finding inquiry” into Evolv, likely related to FTC’s ongoing investigation which began in 2023 regarding Evolv’s marketing practices. This could be a concern as “AI” could’ve been overstated in marketing materials.

My personal opinion is that nothing too sinister has occurred, but rather the Evolv Express system is not 100% full proof at identifying concealed weapons which is true and the use of AI in marketing is overreaching. I say this as Evolv Express system has settings for different types of weapon detection, if they had a “real AI” why would the system need to be tuned or set for certain weapons?

It could be the case that “Evolv Cortex AI” is an experimental system using imaging and video data to potentially create a use-case. A security consulting firm IPVM has been a factor in prompting these inquires. IPVM requested an Express system from Evolv to do their own testing but was turned down.

While I’m not 100% certain, I’d argue these investigations bare little impact on the businesses fundamentals but there may be fines for the misuse of AI technology in marketing claims. Despite these regulatory bodies publicly voicing their actions, Evolv continued to add 84 customers in Q2.

Many of these customers have been sold to via a channel partnership with companies like Motorola Solutions (MSI). Both the channel partner and end customers conduct their own due diligence and testing – it’s hard to imagine security personnel using screening equipment simply due to misleading marketing materials. Rather like I said, a problem stems from the fact the system isn’t 100% full proof – which is why airport security in western countries use a combination of metal detectors and other advance screening equipment (not Evolv Express). It wouldn’t make sense for Evolv to be used in airports.

Valuation Hard to Pinpoint, but Double Digit Growth

Analysts aren’t providing FCF or EBITDA figures for FY26 or FY27 which are potentially target years for an exit of this investment. However revenue estimates are $132m, $170m and $219m for FY25, FY26 and FY27 respectively. Headline YoY growth on these figures are 30%, 29% and 29%.

In the years ahead what would be the possible EBITDA on circa $219m of revenue?

I think 20% EBITDA margins aren’t unreasonable long-term despite managements lower EBITDA guidance, therefore we could see EBITDA numbers of around $44m in 3 years. Based on the market growth rate and unique positioning of Evolv’s offering such a valuation could be between $660-$880m at a 15-20x multiple, representing 25%-66% upside in 3 years.

Around these levels Evolv could join the Russell 2000 or S&P 600 later down the line thereby increasing liquidity and valuation. This is dependent on the market pricing the company similarly to other growing SaaS businesses that are leaders in their sub-sector.

However with unprofitable SaaS businesses such as Evolv, investors are instead likely to look at EV/Revenue or EV/ARR comps in the market. In public markets the 1st to 3rd quartile EV/Revenue multiples range from 10x to 4x with the median being 6.2x as of August.

Based on FY24 revenue guidance of $100m this implies $620m in EV, assuming net debt of zero once Evolv adds leverage. If we look forward 3 years and assume Evolv is still growing double digit and achieved $219m in revenue, at a 6.2x sales multiple the EV could be $1.36bn indicating 159% upside.

However if growth slows leading to single digit growth from 2027 onwards, the multiple could be closer to 4x indicating $880 in EV which is quite a disappointing return over 3 years.

The shares traded up in August due to two directors buying shares after earnings, one was a decent size of 5,000 shares @$3 per share. Early in August shares traded around $2.90 representing a market cap of $455m and a few months ago shares traded around $2.40 for several weeks representing a $475m valuation.

Conclusion

If the FTC/SEC probes indicate significant malicious practices and defrauding of customers (and/or investors), why are security vendors and end-user decision makers choosing to purchase Evolv Express systems?

I’d argue customers aren’t buying the system because Evolv’s sales people say so, end users conduct their own testing or visit existing sites. Maybe I’m wrong but I wouldn’t think security heads aren’t the type of people to be careless when picking security screening equipment.

While Evolv’s use of AI is certainly questionable, the business shows massive potential in terms of unit economics with its SaaS contracts. The valuation is okay (hard to pinpoint though) but isn’t hyper attractive and requires the company to meet guidance consistently for 3 years. With Evolv’s unique offering, their proven ability to win customers and the drive from customers to prevent violence (especially gun violence) it’s hard to imagine how Evolv doesn’t continue growing.

Circa $219m revenue in 3 years with a EV/Revenue multiple of at least 5x would be the minimum expectation here. Ideally the upside in this scenario would further accelerate via small cap indexation in the Russel 2000 and S&P 600. A $530m valuation is somewhat attractive but this is no means a screaming deal and requires several factors to run smoothly. Additionally it could be interesting for traders who might want to trade the SEC/FTC catalyst.