SDS reported a solid y/y growth of 10%, and net sales amounted to SEK69m, above our expectations of SEK63m. Regarding the sales mix, New sales landed on SEK 17m compared to our estimate of SEK13m, Recurring revenues amounted to SEK35m compared to our estimate of SEK32m, and Re-occurring revenues amounted to SEK17m, below our expectations of SEK18m. The Gross Profit amounted to SEK49m, corresponding to a gross margin of 70%, up from 64% in Q1 2022. At the end of March, SDS received a new order of SEK4.2m from an existing customer in Oman. The customer will hire a development team from SDS for a fixed period, and the revenues will be recognized throughout the project period.

All in all, SDS reported a very solid quarter across the board, where both sales and profitability exceeded our expectations. We are especially glad to see the strong growth in recurring revenues which increased 18% y/y and 17% q/q. We think the quarter was somewhat boosted by the order backlog from 2022, which primarily explains the beat of 21% in New sales. However, the cost-cutting program has had a bigger impact than expected, and we expect Opex to continue to decline q/q as the program has not reached full effect. Thus, we think SDS has a good chance of increasing profitability from Q1 levels in the coming quarters.

SDS's recurring revenues have stabilized at around SEK30m per quarter since Q3 2021, and for the full year of 2022, they amounted to SEK121m, representing approximately half of the company's total sales. However, recurring revenues experienced a notable surge in Q1 2023 and increased 18% y/y, reaching SEK35m. This is a positive development, as it reduces SDS's reliance on New sales revenues and provides stability for the future.

As the interest in Riaktr's products, Smart S&D, and Smart Capex continues to grow, along with continued New sales, we anticipate that recurring revenues will increase and make up a larger proportion of total revenues. As SDS's revenues increasingly shift towards recurring revenues, we expect to see improved margins and enhanced stability, which will make SDS a more attractive investment opportunity moving forward.

Since SDS’s Q4 report, all eyes have been on the company’s financial situation as the bond covenants were breached in conjunction with the weak result in the fourth quarter. The company has made progress, and the bond terms and conditions have been changed as of 12th April. Below, we have summarized some of the changes.

• The maturity date has been extended by one year, with the new maturity date set for May 5, 2025

• Covenant testing will not take place on the test dates of March 31, 2023, June 30, 2023, and September 30, 2023.

• The agreement includes adjustments to the leverage ratio and the covenant calculation, which now exclude all capitalized costs for research and development from the EBITDA calculation.

• The security in three companies, including Seamless Digital Distribution AB, can be released for potential future divestment or liquidation purposes. Guarantee commitments are provided through SDS subsidiary Buseam AB, and additional security may be provided.

• SDS can defer payment of the next three interest payments until the extended maturity date of the bond.

The changes are contingent upon SDS receiving capital injections from its existing shareholders, and the company has been assured at least SEK40m from certain shareholders, including the board and management team, whereas SEK20m was raised in April 2023, and the remaining is expected to be raised before the year-end. The subscription price of the directed share issue was SEK8.5 representing an 18% premium compared to the previous day’s closing price. The capital injection positively impacts our valuation, as we had calculated with a larger dilution.

In summary, the new bond terms and the capital injection are expected to give SDS some much-needed breathing room, allowing it to focus fully on its operations instead of having to deal with bondholders and shareholders. Coupled with the ongoing cost-cutting program and the strong Q1 results, we are optimistic about SDS's trajectory toward achieving positive net income.

SDS has announced that Eddy Cojulun has been appointed as the company’s new CEO. Eddy brings extensive experience to the company as his expertise spans over 25 years in the technology and telecom industries, where he has made significant contributions as an entrepreneur, executive, and sales leader. Throughout his career, Eddy has founded, developed, and successfully sold telecom-focused software companies, such as ICON Americas, which Ericsson acquired in 2015. In addition to his entrepreneurial experience, Eddy has held senior executive positions, including serving as the Chief Information Officer at Telefonica in El Salvador, and as the Global Head of Sales and Delivery of IT software development at Ericsson. Moreover, we are also pleased to note that Eddy has demonstrated his confidence in the company by purchasing 250,000 shares from an existing shareholder at a price of SEK9.5 per share, above the previous day's closing price.

We think it is important that SDS has finally found a permanent CEO, especially as it enters a new phase with a streamlined organization and standardized offerings. We also think that Eddy has an impressive track record and experience within the industry, which should favor the company.

In conjunction with discussion with bondholders, SDS also provided an outlook for 2023e where it has budgeted net sales of SEK216m and an EBITDA of SEK72m (SEK42m if capitalized R&D is excluded). The figures exclude SDD. SDS expects to have a net debt of approximately SEK147m at the end of 2023. The outlook can be compared to our estimates, where we expect SEK207m in sales and SEK71m in EBITDA for the group excluding SDD and including capitalized R&D.

On the back of the report, we have maintained our sales estimates at a similar level while revising our margin expectations upwards. This adjustment is primarily attributed to the lower-than-anticipated Opex during the quarter, where the ongoing cost-cutting program has had a bigger effect than expected. While the quarter exceeded our sales expectations by 9%, it is important to note that a portion of this growth can be attributed to the order backlog from 2022. Consequently, we do not extrapolate this relatively high growth rate into the future.

Instead, we maintain a prudent approach and forecast sales of SEK276m, with SEK207m contributed by the SDS segment. This forecast is slightly lower than the company's projection of SEK216m. Overall, we have increased our EBITDA estimates by 24% for 2023, and by 9-7% for the years 2024 and 2025, respectively.

Although the growth rate for 2024e-2025e may appear conservative, it is largely influenced by the anticipated negative growth of around 15% in the SDD business. However, we expect the growth in the SDS business to offset this decline. While SDD operates with relatively low margins, we anticipate that the sales from the SDS business will contribute to overall margins and offer scalability. As a result, we expect a gradual improvement in margins in the coming years, even with a flat top-line growth.

We derive our fair value range from a fundamental DCF framework for three scenarios, base case (most likely), bear case (pessimistic), and bull case (optimistic), using a WACC of 12.5% across all scenarios.

Sales CAGR 2023-2027e of -1% and 2027e-2032e of 3%
Avg. EBIT-m 2023-2027e of 10% and 2027e-2032e of 20%
Terminal growth of 2% and a terminal EBIT-m of 25%
WACC: 12.5%

Sales CAGR 2023-2027e of 1% and 2027e-2032e of 4%
Avg. EBIT-m 2023-2027e of 17% and 2027e-2032e of 25%
Terminal growth: 2% and a terminal EBIT-m of 30%
WACC: 12.5%

Sales CAGR 2023-2027e of 6% and 2027e-2032e of 7%
Avg. EBIT-m 2023-2027e of 18% and 2027e-2032e of 30%
Terminal growth: 2% and a terminal EBIT-m of 35%
WACC: 12.5%