Review of Q2 2023

ARR growth remains strong, with a y/y growth of 20.7% and an annualized q/q growth of 20.2%. The absolute increase q/q was SEK6.8m, somewhat above our forecast of SEK6.0m. Thus, the solid momentum in organic ARR growth continues despite softer macroeconomics. Note that we include SEKc16m in ARR related to businesses Vertiseit wants to divest. Hence, the SEK16m difference from Vertiseit’s number. Thus, the solid momentum in organic ARR growth continues despite softer macroeconomics. Considering that the digital signage-market expert firm, Invidis, believes market growth to be roughly flat, we believe Vertiseit is gaining market share.

Management states that the market is more cautious with longer sales cycles in several customer segments. However, we get the impression that it is mainly related to new initiatives and that the solid ARR growth can continue to be boosted by current customers and projects. For example, while some customers are reducing the development of new concepts (decreasing Consulting sales), they typically continue to roll out to new locations, increasing ARR.

The ARR and its growth rate is the most important metric to follow in Vertiseit. The ARR is a leading indicator of SaaS revenue growth, the major driver of profit growth in Vertiseit and essential to the investment case. As Vertiseit historically has grown its ARR by acquistions, partly funded by share issues, we believe ARR per Share is the most relevant metric.

Total sales roughly matched our forecast of SEK86m and amounted to SEK84m (79), corresponding to 7% growth y/y. The sales mix largely matched our forecasts, when adjusting for us underestimating the SaaS revenue and overestimating the Consulting revenue as we base our SaaS revenue forecast on ARR. However, from now on, we will adjust our methodology to better align with Vertiseit’s moving some revenue from consulting to SaaS (despite not being included in the ARR).

According to management, Consulting revenue was negatively affected by some customers reducing their investments in new projects. However, management expects a rebound in H2 and has thus decided to keep its capacity despite the downturn during the quarter.

Vertiseit has three kinds of sales: SaaS, Consulting and Systems. SaaS revenue is 100% recurring revenue from software and related service & maintenance sold as a subscription with high gross margins. Consulting constitutes revneues from consulting or professional service. While the gross margin on paper is high, growing this revenue typically demands additional employees roughly 1:1, resulting in a modest "ture" gross margin. Systems is revenue from hardware, typically screens, sold to new or expanding customers. As Vertiseit's current business model wants partners to provide the hardware, we expect Systems to decline as a percentage of sales.

Gross profit roughly matched our forecast of SEK55m and amounted to SEK56m (46), corresponding to 20% growth y/y. The gross margin beat our forecast by two percentage points, mostly due to a slightly higher gross margin in Consulting than expected. Overall, the gross profit has a solid development with a growth of 20% y/y, in line with SaaS revenue and ARR. The weak spots in this report are the OPEX and cash flow.

Overall, OPEX came in above our forecast of SEK40 and was SEK50m (47). Other external costs exceeded our expectations as we likely underestimated the continuing finetuning of the new group-common IT systems. Also, the annual Grassfish Summit resulted in slightly higher costs than usual. Personnel expenses came in above our forecasts as the cost per employee was slightly higher than we expected and due to a slightly larger net recruitment.

Management sticks to its 30% EBITDA margin target by the end of 2024, although admitting it will be challenging. While our forecasts consistently have been more defensive than that (our previous forecast was 25.3% for Q4 2024), considering the cost level in Q2 2023, we believe reaching the target will be very challenging. Assuming an absolute quarterly ARR growth of SEK6-7m, ~20% growth in consulting and somewhat declining System sales, (-20% 2023, +4% 2024), Vertiseit need to reduce its cost base by approximately SEK35m on an annual basis relative to our forecasts to reach the target. Note that our forecasts assume a somewhat lower cost base than this quarter's. For 2024 we expect an OPEX of SEK176m. A simple 1H 2023 times two for comparison equals SEK194 in OPEX. Our EBITDA margin forecast for Q4 2024 is 20%, and despite having an estimate rather far from the target, we still expect margin increases from now on.

While the target includes M&A, Vertiseit’s financial room for M&A is currently limited. A share issue could be one option, though. However, given Vertiseit’s current valuation, we believe Vertiseit has to find something very attractive to pursue an acquisition.

EBIT was SEK-0.1m (-5.7), and our forecast was SEK9.2m. The miss was due to higher OPEX, while gross profit, as mentioned, came in as expected. Free cash flow (including leasing payments) was SEK-17.8m, and excluding changes in net working capital, free cash flow was SEK2.3m. The accounts receivables stayed high after some continuing delays in implementing the new group-common IT systems. SEK-17.8m is a high number compared to Vertiseit’s total cash and credit facilities of SEK21.9m. However, considering the likely upcoming sale of the Transportation segment combined with the positive FCF ex NWC, we believe the risk of Vertiseit needing additional financing is low.

By the end of the quarter, Vertiseit’s net debt was SEK161m, equal to 3.7x EBITDA 2023e. By the end of the quarter, Vertiseit’s net debt was SEK161m, equal to 3.7 EBITDA 2023e. We consider that a high level. However, we expect it to decline over the coming quarters due to increasing EBITDA and positive cash flow.

As for any SaaS business capitalizing R&D, EBITDA and EBITDA margin are unsuitable metrics for Vertiseit. This, as EBITDA discards a large portion of the company’s R&D costs totally. R&D is typically a high cost for most SaaS businesses. Instead, EBIT (where the capitalized R&D is amortized over time) or EBITDA – capitalized R&D/EBITDA – capex are better measures of the underlying profitability as it concerns the company’s full R&D spend. However, as Vertiseit has some amortizations related to M&A, the underlying profit generation is somewhere between EBIT and EBITDA.

As mentioned in our last Update, we do not want to make any major statements about the SaaS metrics after only two quarters, and we will increase our focus on the SaaS metrics in our Updates as we get more historical data to compare with. Overall, the metrics are healthy and in line with the numbers seen in Q1, with churn of below 8%, an NRR of ~108%, and a CAC/Payback of 8 months.

We leave our sales forecasts roughly unchanged for 2023 and 2024, although we are changing the mix somewhat. As mentioned, from now on, we will adjust our methodology to better align with Vertiseit’s moving some revenue from Consulting to SaaS (despite not being included in the ARR).

Also, the gross profit estimates are largely unchanged. However, we raise our OPEX forecasts substantially, especially regarding Other external costs. In total, we raise our OPEX forecast by 11% for 2024.

Note that while Vertseit excludes the SEK~16m in ARR related to MultiQ Transport ITS, we include it all in our forecasts as long as the operations remain in Vertiseit. Thus, we expect the reported ARR to be SEK ~16m below our forecast. Also, for our SaaS forecast to make sense, we need to include the SEK~16m in our forecasts. Vertiseit expects to divest MultiQ Transport (ITS) during this year for SEK10-20m.

As mentioned, we forecast a 20% EBITDA margin in Q4 2024, lower than the company’s target of 30%, which management admits will be somewhat challenging.

We lower our Base Case to SEK39 (46) following lowered forecasts and a slightly more cautious view of Vertiseit’s profitability prospects.

Vertiseit is trading below the average and median for both EV/sales and EV/EBIT for 2024/25e. While Vertiseit has a lower share of SaaS revenue than the average company, it has a strong position within its niche, and the ~15.5% EBIT margin estimated for 2025e is likely far below its potential levels (and management’s target of >30% on the EBITDA level post-2024). Thus, we believe Vertiseit constitutes an attractive risk/reward at these levels, despite our somewhat more cautious view towards its profitability prospects.