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SLI Systems — Update 20 March 2016

SLI Systems — Update 20 March 2016

SLI Systems

Analyst avatar placeholder

Written by

SLI Systems

Pathway to profitability

Interim update

Software & comp services

21 March 2016

Price

NZ$1.15

Market cap

NZ$71m

NZ$1.51/US$

Net cash (NZ$m) at 31 December 2015

5.6

Shares in issue

61.6m

Free float

31%

Code

SLI

Primary exchange

NZX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

53.3

59.7

(0.9)

Rel (local)

43.4

49.5

(6.4)

52-week high/low

NZ$1.2

NZ$0.7

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 event

Full year results

July 2016

Analysts

Finola Burke

+61 (0)2 9258 1161

Dan Ridsdale

+44 (0) 20 3077 5729

SLI Systems is a research client of Edison Investment Research Limited

SLI Systems had a strong half in the six months to 31 December 2015, with annualised recurring revenue growing 23% (10% on a constant currency basis) to a record NZ$35.6m. Significantly, gross margin increased to 76.4% from 74.7% year-on-year (y-o-y), while the retention rate by value remained steady at 87%. SLI has mapped out a pathway to profitability, noting that it had been cash flow neutral in the first half and that its NZ$5.6m cash on hand was sufficient to bring the company to cash flow break-even.

Year end

Revenue
(NZ$m)

EBITDA
(NZ$m)

PBT*
(NZ$m)

EPS*
(c)

EV/sales
(x)

P/E
(x)

06/14

22.4

(5.4)

(5.4)

(8.5)

2.6

N/A

06/15

28.6

(6.5)

(6.7)

(10.7)

2.0

N/A

06/16e

36.6

(0.3)

(0.6)

(1.0)

1.8

N/A

06/17e

46.2

4.1

3.7

6.0

1.4

19.2

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

Record ARR and record gross margin

SLI Systems delivered record annualised recurring revenue (ARR) of NZ$35.6m despite some challenges in the Americas, which account for 64% of revenues. On a constant currency basis, ARR grew 10%, with the 34% generated by the Asia-Pacific and European markets offsetting the flat result from the Americas. The company also delivered a record post-IPO gross margin of 76.4% as it managed its costs in the period. SLI recorded neutral net cash flow for the six-month period, but noted that there may be further cash outflows in subsequent periods as it continues its growth objectives.

Clear near-term business objectives

CEO Chris Brennan has laid out some clear near-term business objectives including returning the Americas to growth and fine-tuning the sales processes, improving the retention rate from current levels of 87% to historical levels of 90% and carefully managing costs so that the company reaches cash break-even with no additional capital required from investors. The recent appointments of Chief Revenue Officer Martin Onofrio and Vice President of Customer Success Gary Schaumburg are key to Mr Brennan’s strategy to increase new recurring revenue while lifting the retention rate and driving better sales growth in the Americas.

Valuation: Discount to peers with strong upside

Despite recent share price strength, SLI is trading at a 48% discount to our DCF valuation of NZ$2.21/share (unchanged). If we were to apply SLI’s listed peers’ median EV/sales multiple of 2.2x, we would arrive at a valuation of NZ$1.61, which puts SLI at a 40% discount to its peers. A reverse DCF on the current NZ$1.15 share price suggests the market is pricing in an EV/sales multiple (12 months forward) of 1.5x and a compound annual growth rate of 16% for FY16 to FY21 revenues.

Review of results and estimate changes

SLI Systems demonstrated better than expected growth in both annual recurring revenue and operating revenue (for the six months to 31 December 2015), the latter rising 30.2% y-o-y as Exhibit 1 demonstrates. The growth in revenues was partly due to FX gains. Total costs were flat
y-o-y, delivering an 89% reduction in losses before tax to NZ$0.4m for the period. Gross margin jumped to a post-IPO record 76.4%.

Exhibit 1: Review of H116 results

NZ$000s

H115

H215

H116

H116 y-o-y % chg

H116 h-o-h % chg

Annual recurring revenue (ARR)

28,941

34,618

35,597

23.0

2.8

ARR on a constant currency basis

32,300

33,846

35,597

10.2

5.2

Operating revenue

13,342

14,784

17,367

30.2

17.5

Other income

409

231

75

(81.7)

(67.5)

Delivery costs

(3,376)

(3,835)

(4,094)

21.3

6.8

Growth costs

(9,822)

(10,392)

(8,631)

(12.1)

(16.9)

Other costs

(4,670)

(4,221)

(5,163)

10.6

22.3

Total costs

(17,868)

(18,448)

(17,888)

0.1

(3.0)

Profit (loss) before tax

(4,117)

(3,433)

(446)

(89.2)

(87.0)

Gross margin %

74.7

74.1

76.4

2.3

3.1

Source: SLI Systems’ accounts, Edison Investment Research

As Exhibit 2 highlights, net cash flows for the six months to 31 December were positive for the first time in several periods and demonstrated the tight cost control deployed by management both within its operations and in investing for growth. The company has flagged that it may have future cash outflows as it continues to invest in its growth plan, but that its existing cash reserves would be carefully managed to achieve cash flow break-even without additional capital required.

Exhibit 2: Interim cash flows

NZ$000s

H115

H215

H116

Net cash (outflow) from operating activities

(3,979)

(1,659)

(154)

Net investing cash (outflow)

(273)

(199)

(60)

Cash from financing activities

222

81

238

Cash increase/(decrease)

(4,030)

(1,777)

24

Cash at end of period

7,359

5,582

5,606

Source: Edison Investment Research

The better than expected interim performance has prompted our earnings forecasts adjustments for FY16 and FY17. We have upgraded predominantly due to the good costs containment demonstrated by SLI in the first half, in particular its delivery and growth costs. This, we estimate, will assist in SLI securing a gross margin of 76.1% in FY16 and FY17, as Exhibit 3 demonstrates.

The company has outlined a number of growth-driving sales initiatives, spearheaded by its two recent appointments in the US. SLI has noted it plans to focus on improving sales conversion, improving the average sales price by selling the value of its suite of products and increasing the customer retention rate from the current 87% to its historical levels of 90%. We have trimmed our FY16 revenue assumptions on the basis that we do not expect the second half to have the same foreign currency benefits as the first half. However, as Exhibit 3 demonstrates, we have also reduced our expectations for growth and delivery costs, resulting in an upgrade to our EPS estimates for FY16. We expect the emphasis on tight costs to flow through to FY17 and have adjusted our forecasts accordingly. We are also introducing, for the first time, our FY18 forecasts, which assume revenue growth of 23% to NZ$56.9m and a gross margin of 76.2%.

Exhibit 3: Forecast adjustments

NZ$000s

FY16e new

FY16e old

Absolute movement

% chg

FY17e new

FY17e old

Absolute movement

% chg

ARR

39,541

40,489

(948)

(2.3%)

46,309

45,437

872

1.9%

Operating revenue

36,404

37,760

(1,356)

(3.6%)

46,048

45,745

303

0.7%

Other income

200

270

(70)

(25.9%)

200

200

0

0.0%

Delivery costs

(8,737)

(9,818)

1,081

(11.0%)

(11,052)

(11,894)

842

(7.1%)

Growth Costs

(19,712)

(20,922)

1,210

(5.8%)

(21,951)

(22,055)

105

(0.5%)

Other costs

(9,327)

(9,348)

20

(0.2%)

(10,085)

(10,097)

12

(0.1%)

Total Costs inc interest

(37,777)

(40,087)

2,311

(5.8%)

(43,087)

(44,046)

959

(2.2%)

Profit before tax normalised

(640)

(1,525)

885

(58.0%)

3,686

2,424

1,262

52.1%

EPS normalised (cps)

(1.04)

(2.47)

1.44

(58.0%)

5.98

3.93

2.05

52.1%

Gross Margin

76.1%

74.2%

1.9%

2.6%

76.1%

74.1%

2.0%

2.7%

Source: Edison Investment Research

Valuation

We use the DCF methodology as the primary valuation methodology for SLI. Our DCF valuation, using a WACC of 12% and terminal growth rate of 2.0% is NZ$2.21 (unchanged). This assumes a CAGR in revenues from FY16-21 of 16.8%. Exhibit 4 sets out our DCF valuation.

Exhibit 4: DCF valuation

WACC

12%

Terminal growth rate

2%

CAGR in revenues 2016-21

16.8%

PV of free cash flows (NZ$m)

67

Terminal value (NZ$m)

63

Enterprise value (NZ$m)

131

Plus cash (NZ$m) at 31 December 2015

6

Equity value (NZ$m)

136

Equity value per share

$2.21

Source: Edison Investment Research

The current share price of NZ$1.15/share is well below our valuation, so it is worth examining what the market is pricing into the stock. Adjusting the CAGR rate for revenue growth from FY16-21 to 15.9%, we arrive at the current share price. This also implies an EV/sales multiple of 1.5x.

Exhibit 5: Reverse DCF

CAGR in revenues 2016-21

15.9%

Implied enterprise value (NZ$m)

65

Plus cash (NZ$m) at 31 December 2015

6

Implied equity value (NZ$m)

71

Implied equity value per share

$1.15

implied EV/sales multiple (12 months fwd) x

1.5

Source: Edison Investment Research

Peer comparison

Earnings multiple analysis is not terribly meaningful at this stage in SLI’s development as it is not yet profitable at the EBITDA level. However, we are forecasting the company to be profitable at the EBITDA level from FY17 and we can still look at what valuation might be implied by the peer group’s median EV/sales multiple. Taking the median 12-month forward EV/sales multiple of 2.2x, as demonstrated in Exhibit 6, we would arrive at an implied valuation of NZ$1.61for SLI, which is at a 40% premium to the current share price. In comparison, on a 12 month forward basis using our forecasts, SLI is currently trading on an EV/Sales multiple of 1.5x.

Exhibit 6: Peer comparison using 12-month forward consensus estimates

Company

Country

Currency

Price

Market cap
m (local)

Market cap (US$m)

EV/sales
(x)

EV/EBITDA (x)

EBITDA margin (%)

Operating margin (%)

SLI Systems

New Zealand

NZ$

1.14

70

46

1.5

24.6

5.6

4.8

Alphabet (Google)

US

US$

750.24

508,370

508,370

5.9

13.0

45.5

36.8

Attraqt Group

UK

£

35.50

10

14

2.2

N/A

N/A

N/A

Bazaarvoice

US

US$

3.51

286

286

1.2

N/A

N/A

N/A

Demandware

US

US$

38

1,443

1,443

4.5

101.5

3.7

N/A

Intershop Communications

Germany

€

1.31

42

46

0.8

8.9

9.0

0.8

IBM

US

US$

142.78

137,195

137,195

2.2

8.6

24.9

20.1

Oracle Corp

US

US$

38.70

162,587

162,587

3.9

8.9

44.1

37.8

SDL

UK

£

411.50

334

475

1.2

12.8

9.5

6.6

Web.Com

US

US$

17.98

903

903

1.9

7.6

25.0

20.2

E-commerce companies

Median

903.2

2.2

8.9

25.0

20.2

Source: Bloomberg, Edison Investment Research. Note: Prices at 15 March 2016.


Exhibit 7: Financial summary

2014

2015

2016e

2017e

2018e

Year end 30 June

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

PROFIT & LOSS

Revenue

22,396

28,592

36,604

46,248

56,889

Delivery costs

(5,618)

(7,211)

(8,737)

(11,052)

(13,545)

Gross Profit

16,778

21,381

27,867

35,196

43,344

EBITDA

(5,412)

(6,498)

(280)

4,073

11,066

Operating Profit (before amort. and except.)

(5,860)

(6,880)

(647)

3,686

10,660

Intangible Amortisation

0

0

0

0

0

Exceptionals

0

0

0

0

0

Other

(525)

(525)

(525)

(525)

(525)

Operating Profit

(6,385)

(7,405)

(1,172)

3,161

10,135

Net Interest

472

174

7

1

8

Profit Before Tax (norm)

(5,388)

(6,706)

(640)

3,686

10,668

Profit Before Tax (FRS 3)

(5,913)

(7,231)

(1,165)

3,161

10,143

Tax

191

101

0

0

(2,840)

Profit After Tax (norm)

(5,197)

(6,605)

(640)

3,686

7,828

Profit After Tax (FRS 3)

(5,722)

(7,130)

(1,165)

3,161

7,303

Average Number of Shares Outstanding (m)

61.0

61.6

61.6

61.6

61.6

EPS - normalised (c)

(8.5)

(10.7)

(1.0)

6.0

12.7

EPS - (IFRS) (c)

(9.4)

(11.6)

(1.9)

5.1

11.8

Dividend per share (c)

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

74.9

74.8

76.1

76.1

76.2

EBITDA Margin (%)

N/A

N/A

N/A

8.8

19.5

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

N/A

N/A

N/A

8.0

18.7

BALANCE SHEET

Fixed Assets

2,062

2,182

2,339

2,475

2,593

Intangible Assets

115

98

88

83

80

Tangible Assets

1,589

1,582

1,748

1,890

2,011

Investments

358

502

502

502

502

Current Assets

16,391

12,213

10,004

13,303

21,296

Stocks

0

0

0

0

0

Debtors

5,002

6,631

5,562

7,675

9,481

Cash

11,389

5,582

4,442

5,628

11,815

Other

0

0

0

0

0

Current Liabilities

(6,933)

(8,976)

(8,089)

(8,363)

(9,172)

Creditors

(6,933)

(8,976)

(8,089)

(8,363)

(9,172)

Short term borrowings

0

0

0

0

0

Long Term Liabilities

(57)

(17)

(17)

(17)

(17)

Long term borrowings

0

0

0

0

0

Other long term liabilities

(57)

(17)

(17)

(17)

(17)

Net Assets

11,463

5,402

4,237

7,398

14,701

CASH FLOW

Operating Cash Flow

(4,550)

(5,892)

(623)

1,710

9,543

Net Interest

445

246

7

1

8

Tax

(91)

8

0

0

(2,840)

Capex

(699)

(472)

(524)

(524)

(524)

Acquisitions/disposals

0

0

0

0

0

Financing

902

303

0

0

0

Dividends

0

0

0

0

0

Net Cash Flow

(3,993)

(5,807)

(1,140)

1,186

6,186

Opening net debt/(cash)

(15,382)

(11,389)

(5,582)

(4,442)

(5,628)

HP finance leases initiated

0

0

0

0

0

Other

0

0

0

(0)

0

Closing net debt/(cash)

(11,389)

(5,582)

(4,442)

(5,628)

(11,815)

Source: Edison Investment Research, SLI Systems accounts

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