More routes to market

SLI Systems 26 September 2017 Update
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SLI Systems

More routes to market

FY17 results

Software & comp services

26 September 2017

Price

NZ$0.30

Market cap

NZ$19m

Net cash (NZ$m) as at 30 June 2017

5.6

Shares in issue

62.3m

Free float

40%

Code

SLI

Primary exchange

NZX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

15.4

7.1

(50.0)

Rel (local)

16.5

4.1

(51.8)

52-week high/low

NZ$0.6

NZ$0.2

Business description

SLI Systems’ core products are e-commerce site search and navigation tools that learn from customer behaviours to improve the relevance of search results and therefore increase sales conversion. Customers pay a monthly subscription based on the number of queries per month.

Next events

Interim results

February 2018

Analysts

Dan Ridsdale

+44 (0)20 3077 5729

Alasdair Young

+44 (0)20 3077 5700

SLI Systems is a research client of Edison Investment Research Limited

A recovery in growth remains stubbornly elusive, with falling revenues and rising losses in line with our forecasts. SLI Systems is treading water from a momentum perspective. However, operational metrics provide signs of encouragement, with ARR increasing slightly, and a substantial uptick in client retention rates. As of H218, SLI will employ a more indirect sales strategy, which could improve uptake of the solutions available. Double-digit revenue growth and 10% margins would imply 20% upside.

Year
end

Revenue (NZ$m)

EBITDA
(NZ$m)

PBT*
(NZ$m)

EPS*
(c)

EV/sales
(x)

P/E
(x)

06/16

35.7

1.1

0.7

1.1

0.3

27.3

06/17

32.0

(0.5)

(0.8)

(1.8)

0.4

N/A

06/18e

31.6

(0.9)

(1.3)

(2.2)

0.4

N/A

06/19e

33.4

0.0

(0.4)

(0.8)

0.5

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

FY17 results: Treading water

The FY17 results reflected SLI’s current transitional state. Revenues fell 10% to NZ$32m, while losses before tax increased significantly to NZ$1.6m. Net cash decreased 17% to NZ$5.6m, though the rate of cash burn was substantially lower in H2 than in H1. Operational metrics were more encouraging, with the key annualised recurring revenues (ARR) and customer retention rates nudging up to NZ$31.1m in constant currency and 93%, respectively (FY16: NZ$30.1m, 86%).

Changing sales strategy

Management is expanding its options for getting the SLI technology to market. This will be a two-step process: first, licensing and services revenues will be separated, thereby letting customers use the product without having to pay for maintenance; second, a new API will enable third parties (including channel partners, software resellers and integrators) to take up management of the SLI solutions for their customers. If successful, this should improve both scalability and adoption rates, though we do not expect to see the full effects until FY19.

Valuation: Growth is key for upside

At a mere 0.4x FY18e EV/sales, SLI continues to trade at an acute recovery rating, to the extent that it may become of a strategic interest. On a fundamental basis, the company clearly needs to return to generating positive earnings and cash flows to deliver upside. DCF analyses imply that the current depressed share price factors in sustained mid-term revenue growth of 10%, with matured EBITDA margins of 7.5%. A recovery to historical revenue growth with 12.5% EBITDA margins could generate more than 60% upside.

Business update: Self-service strategy

In light of the challenging results, SLI is making modifications to the way it commercialises its technology. Beginning in H218, SLI plans to migrate from being a proprietary (closed) software vendor to one that incorporates a more indirect sales strategy. A new pricing model will split software licensing and professional services revenue streams from one another, which have historically been bundled together. Furthermore, a new application program interface (API) ‘tool kit’ is currently in development, which will let customers install and maintain the SLI technology solutions themselves.

These changes will give customers more flexibility as to which SLI solutions they deploy; as they will be able to use their own (or third-party) software engineers to implement and maintain the SLI search functionality. In turn, this should reduce the costs of delivering the service for SLI, and lower total costs for customers. This would be expected to improve the company’s competitive positioning, especially as pricing has become an increasingly important differentiator, particularly in the mid-market and in the Americas.

Equally importantly, the shift also enables the software to be sold via channel partners, which could provide revenues with a boost, albeit at the cost of reduced gross profit margins. This indirect delivery mechanism has the potential to be highly scalable, as the channel partners and software integrators themselves can be responsible for the client relationship, using the ‘tool kit’ API provided by SLI. This is significant because software resellers often have much stronger relationships with their potential clients than might be the case for SLI, as they may provide other (potentially non-e-commerce related) software to the same company, or have pitched to them in the past. In removing itself from the client relationship/maintenance aspects (for some clients), SLI would be able to achieve substantial cost savings, while revenues could grow quickly due to the increased number of routes to market.

Review of FY17 results

SLI reported a mixed set of full year results. On the one hand, management has successfully returned ARR to growth, albeit slow, and the retention rate (see Note in Exhibit 1) has also nudged up 7pp. However, in line with our forecasts, total revenues for the period declined 10% y-o-y to NZ$32m, losses before tax rose to NZ$1.6m (FY16: NZ$0.2m), and loss per share was NZ$0.03. These numbers include a non-recurring restructuring charge of NZ$0.3m, the bulk of which was a result of changes to the US executive team, in addition to a currency headwind as the NZ dollar appreciated slightly relative to both the US dollar and the UK pound. Arguably, much of the deterioration in the headline P&L numbers in FY17 was a result of the ‘glide down’ in ARR between FY15 and FY16, as opposed to any continued weakness in FY17, which saw ARR stabilising.

Exhibit 1: Review of FY17 results

 NZ$000s

FY15

FY16

FY17

Change y-o-y

ARR

34,618

31,191

31,093

0%

ARR (constant currency)

 

30,186

31,093

3%

Operating revenue

28,126

35,006

31,546

-9%

Other income

466

646

489

-24%

Total revenue

28,592

35,652

32,035

-10%

Operating costs

(35,997)

(35,853)

(33,631)

-6%

Loss before tax

(7,231)

(162)

(1,569)

868%

EPS (NZ$)

(0.12)

(0.00)

(0.03)

668%

Net cash

5,582

6,765

5,646

-17%

Retention rate (%)

90

86

93

7pp

Source: SLI Systems accounts, Edison Investment Research. Note: SLI has altered the way it calculates its retention rate. Under the old calculation, the numbers would have been 87%, 84% and 86% for FY15, FY16 and FY17, respectively. The difference is made up from the inclusion of revenues from upselling to pre-existing customers in the new calculation.

Exhibit 2: Summary of cash flows

 NZ$000s

FY15

FY16

FY17

Net cash inflow/(outflow) from operating activities*

(5,638)

808

(792)

Net cash flow from investing activities

(472)

(163)

(327)

Net cash inflow/(outflow) from financing activities

303

538

0

Net increase/(decrease) in cash and cash equivalents

(5,807)

1,183

(1,119)

Cash and cash equivalents at the beginning of the year

11,389

5,582

6,765

Cash and cash equivalents at the end of the year

5,582

6,765

5,646

Source: SLI Systems accounts, Edison Investment Research. *Note: Includes net interest and tax.

Net cash outflows (Exhibit 2) were NZ$1.1m over the whole year, of which 67% happened in H1 (NZ$0.75m), indicating that SLI exited the year with a lower level of cash burn. Period end cash balances remain strong at NZ$5.65m, in line with our forecasts of NZ$5.67m. Management reiterates that its new strategy (see below) can be funded from existing cash, and it will not need to resort to additional funding.

Upselling is increasingly important

We also highlight that a larger proportion of ‘new’ ARR over the period came from upselling to pre-existing customers (NZ$3m) than from winning new corporate entities as clients (NZ$2.5m). The potential implications of this are twofold:

1.

Customers obtain great value from the SLI offering – once a customer has been won and has used the software for some time, they see even more utility in the software than they did during the sales process, which in turn leads them to subscribe to a wider range of products.

2.

It was slow period for new client wins, principally as a result of increasing pricing pressures.

Outlook and changes to forecasts

Exhibit 3 below summarises the revisions to our forecasts.

Exhibit 3: Changes to forecasts

NZ$000

FY17

FY18e

FY19e

Actual

Estimate

Variance

Old

New

Variance

Old

New

Variance

ARR

31,093

33,374

7%

36,712

31,039

-15.5%

42,219

34,764

-17.7%

Revenue

32,035

32,302

1%

34,709

31,566

-9.1%

38,588

33,401

-13.4%

EBITDA

(473)

(482)

2%

928

(882)

-

3,494

39

-98.9%

Operating profit (before GW and except.)

(1,596)

(1,708)

7%

522

(1,289)

-

3,072

(383)

-

% margin

-

-

1.50%

-

7.96%

-

EPS – IFRS (c)

(3.0)

(2.8)

-6%

(0.4)

(3.4)

713.6%

2.6

(2.0)

-

Closing net cash

5,646

5,670

0%

4,959

4,448

-10.3%

5,939

3,051

-48.6%

Source: SLI Systems accounts, Edison Investment Research

We forecast more or less flat FY18 financials, with the benefits of the new channel strategy coming into fruition a year later. Dependent on improving sales numbers, and maintaining the current retention rate, operational gearing should return the business to EBITDA profitability in FY19, with positive returns to EPS in the following year (not shown).

We expect further cash outflows over FY18 and FY19, though SLI will reach a run rate of cash flow profitability in H219. Net cash will trough at c NZ$3m at this point, a reduction of NZ$1.5m vs our previous estimates, with the timing of this minimum also pushed out by a year.

Valuation: Acute recovery rating

New strategy is key

Ultimately, the degree of success of the new strategy will go a long way to determining the mid- to long-term prospects of the business. Improvements in the number of new clients won are essential, while churn of current (and more profitable) clients must also be minimised. The latter of these criteria has been reverting to historically low levels after a downturn in FY16.

The shares have declined by 53% over the past 12 months and by 38% ytd, and currently trade on a mere 0.4x FY18e EV/sales multiple. This compares with a peer average of 2.3x (Exhibit 4). Evidently the decline is a function of the stagnant ARR and continuing loss making status, and on a cash flow basis, the company must return to growth (or substantially cut costs) for investors to see upside. However, should management achieve a return to growth in earnings, we believe the shares will look increasingly attractive.

Exhibit 4: Peer multiple analysis

Name

Reporting currency

Ytd perf. (%)

Current price

Market cap (m)

EV/sales 1FY (x)

EV/sales 2FY (x)

EV/EBITDA 1FY (x)

EV/EBITDA 2FY (x)

P/E 1FY (x)

P/E 2FY (x)

SLI Systems

NZ$

(27)

0.30

19

0.4

0.5

N/A

397

N/A

N/A

ATTRAQT Group

£

(4.4)

46.00

49

3.1

2.3

46.2

14.6

46.0

23.0

Bazaarvoice

US$

0.0

4.85

415

1.7

1.6

15.1

11.9

60.6

31.7

dotDigital Group

£

22.6

70.00

207

5.9

4.7

18.9

15.5

31.8

25.9

Intershop Communications

€

59.7

1.75

55

1.2

1.1

15.5

12.9

175.0

43.8

SDL

£

4.2

461.25

379

1.2

1.2

13.0

10.0

21.3

16.8

Web.com Group

US$

13.7

24.05

1,240

2.5

2.4

9.6

9.0

8.3

7.8

Mean

2.3

1.9

47.0

11.2

33.6*

21.0*

Source: Edison Investment Research, Bloomberg. Note: Prices as at 26 September. Note: *P/E averages exclude outlier Intershop Communications.

Exhibit 5 below implies that the current share price of NZ$0.30 factors in 10% revenue growth over the mid-term, and a matured EBITDA margin of 7.5%. By way of comparison, historical revenues have grown at a CAGR of 11.1% between 2013 and 2017, and average EBITDA margins for mature software businesses are also higher than this (c 15-20%). Achieving double-digit revenue growth and 10% EBITDA margins could generate more than 20% upside, while a return to historical growth rates could see a DCF valuation almost twice the current share price.

Exhibit 5: DCF scenario analysis (12% WACC)

NZ$/share

Mid-term growth

5%

7.5%

10.0%

12.5%

15.0%

Matured EBITDA margin

5.0%

0.19

0.19

0.21

0.24

0.26

7.5%

0.23

0.26

0.30

0.32

0.36

10.0%

0.28

0.34

0.37

0.42

0.45

12.5%

0.30

0.41

0.46

0.51

0.55

15.0%

0.30

0.46

0.54

0.59

0.65

Source: Edison Investment Research

Exhibit 6: Financial summary

NZ$000s

2014

2015

2016

2017

2018e

2019e

Year end 30 June

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

PROFIT & LOSS

Revenue

 

 

22,396

28,592

35,652

32,035

31,566

33,401

Delivery costs

(5,618)

(7,211)

(7,958)

(7,571)

(7,397)

(7,708)

Gross Profit

16,778

21,381

27,694

24,464

24,169

25,693

EBITDA

 

 

(5,412)

(6,684)

1,136

(473)

(882)

39

Operating Profit (before amort. and except.)

 

 

(5,860)

(7,198)

687

(833)

(1,289)

(383)

Intangible Amortisation

0

0

0

0

0

0

Exceptionals

0

0

0

0

0

0

Other

(525)

(526)

(888)

(763)

(763)

(763)

Operating Profit

(6,385)

(7,724)

(201)

(1,596)

(2,052)

(1,146)

Net Interest

472

174

39

27

8

28

Profit Before Tax (norm)

 

 

(5,388)

(7,024)

726

(806)

(1,281)

(355)

Profit Before Tax (FRS 3)

 

 

(5,913)

(7,550)

(162)

(1,569)

(2,044)

(1,118)

Tax

191

190

(77)

(284)

(57)

(139)

Profit After Tax (norm)

(5,197)

(6,834)

649

(1,090)

(1,338)

(494)

Profit After Tax (FRS 3)

(5,722)

(7,360)

(239)

(1,853)

(2,101)

(1,257)

Average Number of Shares Outstanding (m)

61.0

61.6

61.6

61.6

61.6

61.6

EPS - normalised (c)

 

 

(8.5)

(11.1)

1.1

(1.8)

(2.2)

(0.8)

EPS - (IFRS) (c)

 

 

(9.4)

(11.9)

(0.4)

(3.0)

(3.4)

(2.0)

Dividend per share (c)

0.0

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

74.9

74.8

77.7

76.4

76.6

76.9

EBITDA Margin (%)

N/A

N/A

3.2

N/A

N/A

0.1

Operating Margin (before GW and except.) (%)

N/A

N/A

1.9

N/A

N/A

N/A

BALANCE SHEET

Fixed Assets

 

 

2,159

2,369

2,056

1,809

2,559

2,661

Intangible Assets

115

99

65

139

80

78

Tangible Assets

1,589

1,582

1,316

1,202

2,011

2,115

Deferred Tax assets

455

688

675

468

468

468

Current Assets

 

 

16,391

12,213

12,641

11,987

10,709

9,307

Stocks

0

0

0

0

0

0

Debtors

5,002

6,631

5,876

6,341

6,261

6,256

Cash

11,389

5,582

6,765

5,646

4,448

3,051

Other

0

0

0

0

0

0

Current Liabilities

 

 

(7,278)

(9,641)

(8,870)

(9,143)

(10,076)

(10,063)

Creditors

(7,278)

(9,641)

(8,870)

(9,143)

(10,076)

(10,063)

Short term borrowings

0

0

0

0

0

0

Long Term Liabilities

 

 

(57)

(17)

(29)

(28)

(28)

(28)

Long term borrowings

0

0

0

0

0

0

Other long term liabilities

(57)

(17)

(29)

(28)

(28)

(28)

Net Assets

 

 

11,215

4,924

5,798

4,625

3,164

1,876

CASH FLOW

Operating Cash Flow

 

 

(4,550)

(5,892)

747

(763)

(633)

(732)

Net Interest

445

246

111

25

8

28

Tax

(91)

8

(50)

(54)

(57)

(139)

Capex

(699)

(472)

(163)

(327)

(516)

(554)

Acquisitions/disposals

0

0

0

0

0

0

Financing

902

303

538

0

0

0

Dividends

0

0

0

0

0

0

Net Cash Flow

(3,993)

(5,807)

1,183

(1,119)

(1,198)

(1,397)

Opening net debt/(cash)

 

 

(15,382)

(11,389)

(5,582)

(6,765)

(5,646)

(4,448)

HP finance leases initiated

0

0

0

0

0

0

Other

0

0

0

0

0

0

Closing net debt/(cash)

 

 

(11,389)

(5,582)

(6,765)

(5,646)

(4,448)

(3,051)

Source: SLI Systems accounts, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by SLI Systems and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. 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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by SLI Systems and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. 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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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