EVLV: Our Favorite 2024 Black Friday Sale

A 95% gross retention, 35-40% ARR grower at a reasonable price -- a rarity in today's markets.

The FTC just announced the best Black Friday sale we see in the stock market.

EVLV is a high-growth, high-retention company whose sales effort has been marred by headwinds for the last 12 months. The FTC resolved the largest of those headwinds on Tuesday 11/26/24.

Evolv has >95% gross retention, >110% net retention, and trades at 3.4x ‘25e revenue for 35% ’25 ARR growth. We see strong potential to grow >40% for 2-4 years – with a ramping sales effort, a 40% COGS decrease to pass through to customers, and 2 new upsells to bundle.

We think the clearing price is >$4/sh by end of year, $5/sh when delayed filings go current & new CEO/CFO announced (likely Feb ’25), and $7/sh when the company starts hitting full quota attainment & targets a >20% FCF margin model (end ‘25/early ’26).

Evolv sells weapons detectors for entrances and doorways. The Evolv Express reliably detects mass casualty weapons (mostly non-ferrous guns) as people walk through the pylons, replacing airport-security-esque experiences. Security guards can see where weapons are located on an iPad, making it safer for guards to perform secondary screens. Evolv’s largest customers are schools, stadiums, hospitals, and warehouses – these markets traditionally haven’t purchased legacy metal detectors, which can’t match Evolv Express’s throughput & can’t show where weapons are located. Schools were the #1 market of the past few years, but we think hospitals, warehouses, & offices are the ones to watch going forward. All <5% adopted for weapons detectors, with some traditional metal detectors to replace.

In addition to the market-leading Express (walkthrough detector), Evolv has just released the Expedite (a high speed bag x-ray) and Eva (employee safety check-in software).

After the FTC set the stage for headwinds to clear, Evolv is positioned for an extremely strong 2025. The market has not yet begun to price this in.

Here are the headwinds Evolv needs to clear for the stock to work:

1. The Evolv 2021 deSPAC included contracts with unfavorable GAAP accounting, which has since been resolved by the “Distribution Model.” Gross margin should be >60% going forward.

2. Evolv’s “weapons-free” marketing campaign caught FTC and SEC attention. This is now resolved at likely <1% ARR impact (announced 11/26/24).

3. Evolv’s CEO+CFO were ousted over the “weapons-free” marketing campaign & for not immediately reporting 3 AEs backdating contract start dates by 45 days (4-6% of revenue will shift back 1 quarter). We think co-founder Mike Ellenbogen would be a great permanent CEO but expect a new CEO imminently (CEO announcement likely 12/24, 10-Q restatements est. 2/25).

4. Evolv faced sales attrition in 4q23 after a quota change & new CRO. Our bookings tracker suggests this resolved as of ~3q24 (when they won the Olympics) and is on track for at least 1.7k units/yr. If Evolv bundles the new upsells (Expedite Xray + Eva software) & passes through the 40% Express v2 cost-down, we think full quota attainment is 2.8-3k units/yr.

5. Evolv should end ’24 with ~5.8k units after the restatement. The company should grow ARR 35% in ’25 & hit FCF breakeven ~ 2q25 (’25 35% ARR growth = 30% organic + 5% shifted from ‘24). Evolv could grow materially >40% on full quota attainment.

6. Evolv has 95% gross retention, >110% net retention, and will print >20% FCF margin by 2028. This FCF potential is why we think new buyers will come in at $7/sh but is not necessary for the stock at today’s prices.

1. The Evolv 2021 deSPAC included contracts with unfavorable GAAP accounting, which has since been resolved by the “Distribution Model.” Gross margin should be >60% going forward.

Evolv was a 2021 deSPAC tagged as yet another overhyped, unprofitable tech company. They printed a measly 3% GAAP gross margin for 2022, creating the first headwind: “will this company’s business model work?”

Evolv sells a 4y non-cancellable Express lease for ~$100k/unit and $35k COGS in v1 (now ~$22.5k COGS with v2 unit as of 2h24).

--Evolv at deSPAC initially sold under a Purchase Model, which transfers ownership to customers. Pursuant to GAAP, a $100k sale creates in Q1 $30k purchase revenue, $35k purchase COGS, and $4.4k subscription & service revenue per quarter (which continues for 16 quarters @ ~65% gross margin). Purchase revenue might be toggled down to increase subscription revenue. So mid/late year sales would lead to negative GAAP gross margin for that year. The 2022 problem in a nutshell.

--Evolv then created a Subscription Model, which holds ownership at the company & leases to customers. Pursuant to GAAP, a $100k sale creates in Q1 $35k capex as Evolv holds the unit in PP&E, and $6.25k subscription & service revenue per quarter (which continues for 16 quarters @ ~65% gross margin).

--In 2023, Evolv created the Distribution Model, in which manufacturer Columbia Technologies maintains ownership of the unit & sells the unit to the customer. Nothing changes from the end customer’s perspective. Pursuant to GAAP, a $100k sale creates a $8k fee to CT for facilitating the deal and $57k to Evolv as $5k license revenue and $3.25k subscription & service revenue per quarter (which continues for 16 quarters @ ~75% gross margin). Note there is no $35k COGS or capex hit to Evolv here, and Evolv doesn’t need to front the $35k unit cost in cash.

Evolv will exit 2024 with almost no new Purchase Model deals, so the low gross margin concern is resolved. They should print >60% gross margin going forward.

Evolv’s gross margin fix should also resolve any concerns about reaching FCF breakeven & beyond.

2. Evolv’s “weapons-free” marketing campaign caught FTC and SEC attention. This is now resolved at likely <1% ARR impact (announced 11/26/24).

In the heady days of 2022, Evolv launched a marketing campaign called “weapons-free zones.” Evolv Express units detect non-ferrous metals and are aimed at mass casualty weapons (i.e. focused on guns, not knives). Express security levels range from A-G, with G aiming to catch smaller items (i.e. catch more knives). There’s a tradeoff here. A higher security setting = a higher false alarm rate. We think setting G was introduced to win NHL & NBA stadiums, where fans sit in close proximity to players. But no security product can catch everything at a 0% false alarm rate.

Security researchers at IPVM & Capitol Forum first flagged the impossibility of “weapons-free zones” without tradeoffs. In October 2023, the FTC launched an investigation for any consumer confusion, especially regarding small K-12 school boards. A related SEC investigation was launched for investor communication about this. (In our checks, we have not yet found a customer who thought a security device could catch 100% of weapons with 0% false alarms – if you do your own checks, you’ll see that virtually all customers do independent testing.)

On 11/26/24, the FTC and Evolv reached a settlement in which a few K-12 schools may rescind their contracts in the next 60 days if they purchased a unit from 1q22-2q23, excluding schools that (1) did a 30d pilot, (2) purchased >15 units, (3) purchased an additional Express unit>45d after the first one.

This sums up to 237 units or $3.9m of ARR at risk vs $89m ARR reported for 2q24. We think the ultimate impact will be <1% of ARR (<$1m ARR) because Evolv can just offer a free extra year / bundled upsell to upset customers. For reference, Evolv has posted 90% renewal rates so far.

We think the FTC rescission risk was the key headwind for investors & the key non-product selling point for competitors. No longer.

The related SEC inquiry has yet to settle, and we expect a similar outcome.

3. Evolv’s CEO+CFO were ousted over the “weapons-free” marketing campaign & for not immediately reporting 3 AEs backdating contract start dates by 45 days (~5% of revenue will shift back 1 quarter). We think co-founder Mike Ellenbogen would be a great permanent CEO but expect a new CEO imminently (CEO announcement likely 12/24, 10-Q restatements est. 2/25).

Evolv hired a new head of SEC reporting in early 2024 per LinkedIn. From later filings we know: In July 2024, someone internally flagged that some customer start dates differed from contracted start dates by 45-60 days. This led accounting to start revenue recognition half a quarter early on 4-6% of revenue. It’s possible that the sales reps and/or channel partners who offered the early start dates did so to earn a sales bonus.

Evolv’s board found out in September and launched an investigation. We can infer that CEO Peter George (formerly Evolv CRO) and CFO Mark Donohue knew about the rev rec issue and signed off on the 10-Q, perhaps thinking they could fix the minor restatement later. George was fired, and Donohue resigned.

On 10/25/24, the board panicked the market with the press release: “The Board of Evolv Technology Determines that Certain Financial Statements Should Not Be Relied Upon.” Evolv will restate 10-Qs and 10-Ks from 2q22 to 2q24 to fix the revenue recognition start dates & delay rev rec by half a quarter on the 4-6% impacted revenue. Deployed unit count will be similarly impacted. The stock fell from $4.50/sh to $2/sh in a week.

On 11/21/24, the board confirmed only 4-6% of revenue was impacted (i.e. recognized early), and co-founder / former CEO / chief product officer Mike Ellenbogen stepped back in as interim CEO.

This headwind is in the process of being resolved.

AlixPartners is restating the filings, which we think takes until Feb ’25, give or take.

A new CEO announcement is imminent – we think Ellenbogen would make a fantastic permanent Evolv CEO (as he was for 7 years), but it appears he prefers to stay on the product side. If possible, we’d love someone from industry heavyweights Axon or Motorola Solutions (both of whom have built strong product suites; both are also potential acquirers – MSI’s head of M&A is a current board member).

4. Evolv’s bookings motion is working again after the 4q23 sales attrition. Our bookings tracker suggests this resolved as of ~3q24 (when they won the Olympics) and is on track for at least 1.7k units/yr. If Evolv bundles the new upsells (Expedite Xray + Eva software) & passes through the 40% Express 2.0 cost-down, we think full quota attainment is 2.8-3k units/yr.

The biggest problem with the underlying business came in 4q23. According to former reps we have interviewed, management raised sales quotas, and a large number of sales reps quit. A new CRO was onboarded at the same time.

Without sales capacity, sales pipeline couldn’t convert. In November 2023, management guided to >7k units in ’24 (>2.5k net new) and 12k units to exit ’25 (~5k net new). In May 2024, guidance was reduced to 1.7k net new units in ’24 & no talk of ’25. Management blamed the FTC investigation, but we think this was also a sales attrition issue.

We scrape public Evolv announcements to track bookings. We estimate 4q23 was the worst bookings quarter in 2 years and 1q24 bookings were -60% vs 1q23. 2q24 and 3q24 were approximately -10% yoy. 4q24 qtd is +40% vs 4q23.

We think the company is at least on pace for 1.7k net new units/yr. In the midst of this slowdown, Evolv sold the Olympics, the #2 cricket stadium in the world, Penn Medicine, multiple NBA + NHL stadiums, and dozens of schools. The NYC Subway and LA Metro are currently in demos. This product sells itself.

We think the company could hit 2.8-3k Express units/yr with the current sales team:

-Express’s biggest sales problem is a high price tag vs “dumb” detectors like Ceia Opengate (which don’t indicate where a weapon is located & don’t integrate with camera systems). Ceia Opengate competes especially well in budget-conscious schools that are fine with worse throughput & worse false alarm rates. Evolv just released Express 2.0, which is 40% cheaper to build. If Evolv passes through cost savings as a lower price, we think we’d see a large sales uplift for the same gross profit dollars.

-Evolv told investors they have ~25 AEs earlier this year.

-Former reps tell us 125 units/rep is quota at moderately lower prices & more channel engagement. We only model 90-100 units/rep until we see any sales changes.

-Evolv can now bundle 2 upsells: the Expedite Xray and Eva check-in software. Bundling the upsells can reduce unit prices & open up new markets. The high-speed Xray is particularly interesting because it enables Evolv to sell to bag-heavy venues (think offices). Expedite Xray should have LSD ARR impact in ’25.

We think the bookings issues are already resolved, but the market may not fully believe it until the new 10-Q is printed & 2025 guidance issued (currently estimate Feb ’25).

5. Evolv should end ’24 with ~5.8k units after the restatement. The company should grow ARR 35% in ’25 & hit FCF breakeven ~ 2q25 (’25 35% ARR growth = 30% organic + 5% shifted from ‘24). Evolv could grow materially >40% on full quota attainment.

We estimate that Evolv will grow ARR at least 35% in 2025:

- Evolv should end 2024 with 5.8k units, assuming conservatively 300 unit deployments are delayed & 100 K-12 units are rescinded.

-The 300 delayed units all deploy in ’25.

-We estimate 600 units up for renewal in ‘25, of which 120 churn. The company has had >90% renewal rates thus far, so we conservatively assume 80% renewal rates going forward.

-Gross unit bookings improves from 1.7k in ’24 to 1.85k in ’25 because of the lack of FTC headwind, price elasticity with higher embedded margins, and 2 upsells to bundle.

This pace translates to the company’s guided EBITDA & FCF breakeven in ~2q25. We think approximately 70-80% of EBITDA converts to FCF, depending on how many units are sold in the Subscription Model vs the Distribution Model (for your checks, a 4q23/1q24 inventory build masks the true conversion rate & will boost FCF through ‘25).

Evolv could grow ARR materially >40% with full quota attainment on this current team.

Maintaining that growth rate would require moderate AE hiring, which would be a welcome return toward the original May ‘23 analyst day plan.

6. Evolv has 95% gross retention, >110% net retention, and will print >20% FCF margin by 2028. This FCF potential is why we think new buyers will come in at $7/sh but is not necessary for the stock at today’s prices.

Evolv already has 95% gross retention and >110% net retention, even though they don’t disclose as such:

-3y average contract length * 90% renewal rate = >95% gross unit retention each year. Initial contracts have been 4y, and renewal contracts tend to be shorter.

-45% of deployments in a given quarter are expansions from existing customers. With units growing ~35% in 2024 including restatement, we see ~115% net retention. As smaller customers saturate, we estimate ~110% net retention in the mid-term.

Assuming we see net new units of 1.75k ’25, 2k ’26, 2.2k ’27 and ’28 & moderate opex growth, we think Evolv can print >20% FCF margin by 2028. In-period FCF margin will get pressured if Evolv hires more AEs to push growth, which we would welcome. Of note, the May 2023 analyst day 10-15% EBITDA margin target assumed the company would be adding far more sales reps to sell significantly more units (i.e. 10-15% EBITDA margin is not the steady state margin for a business with >95% gross retention and mid 60s gross margin).

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In sum, 35-40% ARR growers with 95% gross retention are scarce in today's public markets. Evolv's stock has been punished for the numerous headwinds listed above, which is why the opportunity exists. Post 11/26 FTC settlement, the worst is behind them. The company should see material bookings improvements going forward. We think the stock is extremely interesting from here.

Disclaimer: this is not financial advice or an offer of any kind. Do your own diligence. Any risk you take is your own, and we do not warrant the accuracy of anything written here. Assume we are invested in any securities mentioned & may make trading decisions without updating this note.

Please feel free to reach out here or on X @parisanalyst.