Vertiseit: Solid Top Line While High OPEX Hurt Profitability

Research Update

2023-07-20

06:45

Redeye retains its positive view despite lowering its Base Case and forecasts. We consider the Q2 report a mixed bag. The most important metric, ARR growth, was strong and slightly better than anticipated, while OPEX was substantially higher than we expected, hurting profitability.

FN

MS

Fredrik Nilsson

Mark Siöstedt

Contents

Review of Q2 2023

ARR: Solid Growth as Expected

Sales: Roughly Matching Our Forecasts

Gross Profit: Aligned with Estimate

OPEX: Cost Level Remained High – Significantly than Expected

Profit and Cash Flow: Hurt by High OPEX

Other Highlights from the Report

Estimate Revisions: Substantial Increases of OPEX Forecasts

Valuation

Investment thesis

Quality Rating

Financials

Rating definitions

The team

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High OPEX Hurting Sales and Cash Flow

The reduction in OPEX we expected did not occur. Instead, OPEX increased y/y and sequentially to SEK50m compared to our forecast of SEK40m. Although continuing finetuning of the new group-common IT systems and the annual Grassfish Summit somewhat inflated costs, probably SEK~2-2.5m, the underlying cost base is larger than anticipated. While the FCF ex NWC was positive, due to a substantially adverse effect from NWC, FCF was negative 17.8m. 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.

ARR Growth Remains Strong

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. Although seeing longer sales cycles in some areas, Vertiseit added several new customers with significant potential during the quarter and First Impression, the leading full-service provider in Benelux, as a partner to Dise. Thus, Vertiseit’s top line is doing fine, likely increasing its market share.

New Base Case SEK39 (46)

We lower our Base Case to SEK39 (46) following lowered forecasts and a slightly more cautious view of Vertiseit’s profitability prospects. Our EBITDA margin forecast for Q4 2024 is 20%, and despite having an estimate rather far from the target (30% in Q4 2024), we still expect margin increases from now on. Management focuses on profitability and cash flow and states the target is, indeed, challenging.

Key financials

SEKm20222023e2024e2025e2026e
Revenues314.7328.5367.0394.8429.0
Revenue Growth147%4.4%11.7%7.6%8.7%
EBITDA35.445.273.391.7103.6
EBIT13.619.644.460.869.2
EBIT Margin4.3%6.0%12.1%15.4%16.1%
Net Income9.39.230.643.650.3
EV/Revenue2.42.01.71.61.4
EV/EBIT54.534.014.510.28.6

Review of Q2 2023

Estmates vs. Actuals
SalesQ2E 2023Q2A 2023DiffQ2A 2022Q1A 2023
Net Sales85.784.1-2%78.980.0
Y/Y Growth (%)9%7%182%47%
ARR166.1166.90%140.0160.1
Q/Q Growth (%) (Annualized)15%17%297%16%
SaaS40.844.810%32.442.5
Y/Y Growth (%)26%39%151%91%
Consulting13.78.3-40%11.910.2
Y/Y Growth (%)15%-31%195%17%
Systems31.231.0-1%34.627.3
Y/Y Growth (%)-10%-10%213%16%
Gross Profit54.555.82%46.456.7
Gross Profit Margin (%)64%66%59%71%
OPEX
Other external costs-10.4-16.357%-17.3-13.7
Y/Y Growth (%)-40%-6%252%81%
Personnel expenses-29.2-34.016%-29.7-32.9
Y/Y Growth (%)-2%14%136%73%
Earnings
EBIT9.2-0.1nmf-5.74.5
EBIT Margin (%)10.7%-0.1%-7.2%5.6%
Diluted EPS0.27-0.20nmf-0.08-0.16

ARR: Solid Growth as Expected

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.

Source: Vertiseit

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.

Sales: Roughly Matching Our Forecasts

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.

Source: Vertiseit

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: Aligned with Estimate

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.

Source: Vertiseit

OPEX: Cost Level Remained High – Significantly than Expected

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.

Source: Vertiseit

Profit and Cash Flow: Hurt by High OPEX

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.

Source: Vertiseit

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.

Other Highlights from the Report

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.

Estimate Revisions: Substantial Increases of OPEX Forecasts

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.

Estimate Revisions
SalesFYE 2023OldChangeFYE 2024OldChange
Net Sales328.5337.9-3%367.0362.81%
Y/Y Growth (%)4%7%12%7%
ARR179.4178.60%206.4205.60%
Q/Q Growth (%) (Annualized)16%16%15%15%
SaaS179.8169.36%204.9192.17%
Y/Y Growth (%)32%24%14%13%
Consulting38.347.0-18%47.551.7-8%
Y/Y Growth (%)-4%17%24%10%
Systems110.4121.6-9%114.7119.0-4%
Y/Y Growth (%)-20%-12%4%-2%
Gross Profit223.4222.60%249.1244.12%
Gross Profit Margin (%)68%66%68%67%
OPEX
Other external costs-55.0-43.925%-50.4-41.920%
Y/Y Growth (%)20%-4%-8%-5%
Personnel expenses-126.0-117.57%-125.8-117.27%
Y/Y Growth (%)13%5%0%0%
Earnings
EBIT19.638.2-49%44.458.3-24%
EBIT Margin (%)6.0%11.3%12.1%16.1%
Diluted EPS0.411.13-64%1.351.83-26%
Forecasts
SalesQ1A 2023Q2A 2023Q3E 2023Q4E 2023FYE 2023FYE 2024FYE 2025FYE 2026
Net Sales80.084.176.787.7328.5367.0394.8429.0
Y/Y Growth (%)47%7%-7%-11%4%12%8%9%
ARR160.1166.9172.9179.4179.4206.4235.4267.4
Q/Q Growth (%) (Annualized)17%18%15%16%16%15%14%14%
SaaS42.544.845.547.0179.8204.9232.9263.4
Y/Y Growth (%)91%39%16%11%32%14%14%13%
Consulting10.28.38.711.238.347.553.058.9
Y/Y Growth (%)17%-31%5%0%-4%24%12%11%
Systems27.331.022.629.4110.4114.7109.0106.8
Y/Y Growth (%)16%-10%-35%-35%-20%4%-5%-2%
Gross Profit56.755.853.257.7223.4249.1282.0313.2
Gross Profit Margin (%)71%66%69%66%68%68%71%73%
OPEX
Other external costs-13.7-16.3-11.5-13.5-55.0-50.4-55.2-59.7
Y/Y Growth (%)81%-6%35%8%20%-8%10%8%
Personnel expenses-32.9-34.0-27.0-32.1-126.0-125.8-135.5-150.4
Y/Y Growth (%)73%14%-9%-3%13%0%8%11%
Earnings
EBIT4.5-0.18.45.519.644.460.869.2
EBIT Margin (%)5.6%-0.1%10.9%6.3%6.0%12.1%15.4%16.1%
Diluted EPS-0.160.480.240.140.411.351.932.22

Valuation

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

Peer Valuation

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.

Investment thesis

Case

The platform first strategy allows for scalable growth as retail digitalizes

As the number one In-store Experience Management (IXM) platform in the DACH region and among the top five globally, we believe Vertseit is set for solid and profitable growth over the coming years as the retail-sector digitalizes its stores. We believe its platform first strategy, focusing on software and consulting, lowering the share of hardware, will gradually make Vertiseit a “true” SaaS business. We believe upcoming reports highlighting how well the recent acquisitions are integrated, along with ARR growth will be the main catalysts in the owner-operate company.

Evidence

Impressive customer list and solid SaaS growth track record

With over 40 quarters of consecutive ARR growth, a strong position within automotive, which is at the forefront of digital in-store, and an active M&A agenda, Vertseit has established itself as a major player within digital in-store. BMW, Volvo, Volksvagen and Porsche are all found on Vertiseit’s customer list. The company has self-financed its organic growth for several years and the SaaS metrics (regarding Dise) are solid, indicating the potential for high profitability going forward.

Challenge

Must have or nice to have?

While the automotive and QSR sectors, for example, embrace the digitalization of physical stores, for good reasons, in our view, the fashion retails are seemingly unwilling to invest in digital in-store except for prime location stores. Today, we get the impression that digital in-store is rather a nice to have than a must have in some segments. However, we would not rule out that new solutions make digital in-store as import for fashion as we believe it is for automotive today. Also, the automotive and QSR sectors alone are huge markets from Vertiseit’s perspective.

Challenge

The Big Four Remains in Charge

The Big Four, ZetaDisplay, Trison, Stratacache, and M-Cube, generally favor a full-service strategy, offering in-house software, consulting, and installations. This model dominates today and might continue to do so, which contradicts Vertiseit's vision of one leading platform. However, Trison focuses on integration, working together with Grassfish and its platform in the BMW project. Although, we do not expect the other Big Four to mimic Trison's platform-agnostic approach.

Valuation

Fair Value SEK 39

Based on our DCF model we see a fair value of SEK 39, which is also supported by a peer valuation. While Vertiseit has rather low profitability currently, following integrations of acquisitions and growth investments, considering its high share of SaaS revenue with strong metrics, we believe strong profitability will come, making EV/EBIT multiples attractive a few years out.

Quality Rating

People: 5

Vertiseit receives a high rating for people, as both management and owners have favorable characteristics. CEO Johan Lind is one of the co-founders Vertiseit, and we get the impression that he has a good understanding of digital signage. CFO Jonas Lagerqvist has a banking background, and we believe that Vertiseit's extensive reporting indicates that Lagerqvist knows what KPI:s are important. The board has a good mix of people, with experience predominantly in finance, retail, and entrepreneurship, which we like. We also find the ownership structure favorable, as the top ten is dominated by insiders in management and board, holding the top five and number ten.

Business: 4

Vertiseit's business receives a 4/5 rating. The recurring SaaS revenues generate the majority of Vertiseit's gross profit, resulting in a stable and predictable business. We believe there are significant switching costs related to Vertiseit's offering, especially for the more extensive solutions that are integrated into e-commerce, for example. Also, we believe that the cost/benefit-ratio for Vertiseit's solutions are attractive, which the growth in ARR, so far during the Corona crisis, supports. According to market forecast, management, and our field studies, the penetration of digital signage solutions is still low in Sweden, allowing for strong growth for years to come.

Financials: 2

Vertiseit receives an average rating for Financials. Vertiseit has shown profitable growth for several years, but the margins remain at <10% at the EBIT level as management favors growth. Due to Vertiseit's scalable business, we assume margins will increase gradually as the company grows. Also, Vertiseit has a positive net cash position.

Financials

Income statement
SEKm20222023e2024e2025e2026e
Revenues314.7328.5367.0394.8429.0
Cost of Revenue123.1105.1118.0112.8115.8
Operating Expenses156.2178.2175.8190.3209.7
EBITDA35.445.273.391.7103.6
Depreciation1.31.63.14.05.4
Amortizations8.19.611.112.314.4
EBIT13.619.644.460.869.2
Shares in Associates0.000.000.000.000.00
Interest Expenses-4.7-7.3-5.8-5.8-5.8
Net Financial Items4.77.35.85.85.8
EBT3.712.338.654.963.3
Income Tax Expenses5.6-3.1-8.0-11.3-13.0
Net Income9.39.230.643.650.3
Balance sheet
Assets
Non-current assets
SEKm20222023e2024e2025e2026e
Property, Plant and Equipment (Net)3.14.26.79.010.5
Goodwill283.6295.2295.2295.2295.2
Intangible Assets85.096.9114.0133.3153.2
Right-of-Use Assets19.245.645.645.645.6
Other Non-Current Assets12.09.29.29.29.2
Total Non-Current Assets402.9451.1470.7492.2513.6
Current assets
SEKm20222023e2024e2025e2026e
Inventories21.816.43.73.94.3
Accounts Receivable75.678.888.194.8103.0
Other Current Assets14.013.114.715.817.2
Cash Equivalents35.046.470.492.3121.0
Total Current Assets146.5154.8176.8206.8245.4
Total Assets549.4605.9647.5699.0759.1
Equity and Liabilities
Equity
SEKm20222023e2024e2025e2026e
Non Controlling Interest9.50.000.000.000.00
Shareholder's Equity252.4275.4306.0349.7399.9
Non-current liabilities
SEKm20222023e2024e2025e2026e
Long Term Debt121.9107.3107.3107.3107.3
Long Term Lease Liabilities15.339.139.139.139.1
Other Long Term Liabilities12.26.76.76.76.7
Total Non-Current Liabilities149.5153.2153.2153.2153.2
Current liabilities
SEKm20222023e2024e2025e2026e
Short Term Debt43.075.475.475.475.4
Short Term Lease Liabilities5.48.28.28.28.2
Accounts Payable26.627.931.233.636.5
Other Current Liabilities62.865.773.479.085.8
Total Current Liabilities137.8177.3188.3196.2206.0
Total Liabilities and Equity549.2605.9647.5699.0759.1
Cash flow
SEKm20222023e2024e2025e2026e
Operating Cash Flow34.734.872.574.484.5
Investing Cash Flow-166.7-37.5-33.8-37.9-41.2
Financing Cash Flow66.214.0-14.6-14.6-14.6

Rating definitions

The team

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Contents

Review of Q2 2023

ARR: Solid Growth as Expected

Sales: Roughly Matching Our Forecasts

Gross Profit: Aligned with Estimate

OPEX: Cost Level Remained High – Significantly than Expected

Profit and Cash Flow: Hurt by High OPEX

Other Highlights from the Report

Estimate Revisions: Substantial Increases of OPEX Forecasts

Valuation

Investment thesis

Quality Rating

Financials

Rating definitions

The team

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