SDS reported a y/y decline of 16%, and net sales amounted to SEK64m, below our expectations of SEK69m. Regarding the sales mix, New sales landed on SEK11.4m compared to our estimate of SEK16m, Recurring revenues amounted to SEK37.9m compared to our estimate of SEK36m, and Re-occurring revenues amounted to SEK14.9m, below our expectations of SEK17m. The Gross Profit amounted to SEK44m, corresponding to a gross margin of 69%, up from 64% in Q2 2022. The higher gross margin is mainly attributed to lower sales in SDD, which comes with a lower gross margin.

Looking at the profitability, SDS’s EBITDA landed on SEK12.7m, below our expectations of SEK21m. EBIT was SEK0.7m, lower than our estimate of SEK11m. The deviation is explained by the lower sales and higher Opex than expected.

Cash flow from operations amounted to SEK-0.87m, compared to SEK11.5m in Q3 2022. We expect a release in working capital in the coming six months, supporting the cash flow in the coming quarters.

Overall, the Q3 figures are relatively soft, with the top line falling 8% below our projections and Opex surpassing our estimates. Consequently, the EBITDA deviated significantly from our forecast. The decline in sales can be largely attributed to decreased new sales in SDS, coupled with a weaker quarter for SDD. However, it is worth noting that Recurring revenues continue to be on a positive trend, growing q/q and surpassing our expectations by 6%. Notably, this marks the third consecutive quarter with q/q growth in recurring revenues, which is impressive in this challenging market. We recognize the expressed confidence of the company's CEO, Eddy Cojulun, in anticipating an increase in the order intake during the current quarter, Q4, which serves as an encouraging sign. Moreover, when talking to the management team, we feel confident that the company is progressing in the right direction, where new orders are taken with a higher margin. Hence, although sales can be volatile between quarters, we expect margin improvements in 2024e and onwards.

Moving forward, it is important for the company to return to positive cash flow, further enhancing recurring revenues, and maintaining a prudent approach to managing costs.

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 the high level remained in Q2-Q3 with a y/y increase of 23% in the third quarter. Our understanding is that the higher recurring revenues stem from a heightened focus on supporting fees for new contracts, alongside a general increase in new sales. This could also indicate that the implementation of the new strategy, focused on offering more standardized products, is proving to be successful.

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.

Following SDS’s Q2 report, the company has announced two new order wins, totaling SEK9.2m in value. Among these two, the largest order amounts to SEK7.7m and involves developing customized software and services to enhance the customer’s product offering and is from an existing customer in Oman. Revenue recognition for this order is expected to be in H2 2023.

The second order, totaling SEK1.5m, is from an operator based in Benin and is related to SDS's new product, "SCC” (Smart Campaign and Commissions). This product simplifies commission management, addressing one of the most significant cost challenges faced by operators in the region, and is poised to deliver large cost savings for the customer. The pricing model involves a recurring license fee, in line with SDS’s outspoken strategy. Revenue recognition is set to commence in H2 2023 and will continue as long as the customer actively utilizes the product. We are pleased to observe SDS’s dedication to both product innovation and the implementation of a more robust pricing structure centered around recurring revenues.

As anticipated, SDS carried out an additional direct share issue of SEK20m just before the Q3 close, a move aimed at strengthening the company’s financial position in accordance with the new bond terms. Notably, it is gratifying to acknowledge that several representatives from the Company's board of directors and management collectively contributed SEK6.4m out of the total SEK20m raised.

Given that the new bond terms were contingent upon SDS securing capital injections from its existing shareholders, with a minimum commitment of SEK40m (the initial SEK20m having been raised in April 2023), we had already factored in this additional capital injection of SEK20m, and further dilution of outstanding shares. The subscription price was set at SEK7.55, corresponding to a dilution of 17%, which is somewhat higher than our initial estimate of around 14-15%, impacting our valuation negatively. Taking into account the SEK20m, along with the potential for postponing interest payments and increased profitability from further cost-savings, we believe the company possesses sufficient funding to achieve steady positive cash flows.

During a recent company presentation at Redeye, SDS's CEO, Eddy Cojulun, expressed a positive outlook regarding the company’s long-term potential, where he sees growth in new products and markets. Given Cojulun's impressive track record, we believe that exciting times lie ahead for SDS. The company’s transition towards recurring revenues, its strengthened financial position, and the forthcoming growth initiatives collectively position SDS as an increasingly appealing investment opportunity moving forward. Additionally, we maintain that the company is capable of meeting the sales targets outlined in discussions with bondholders, albeit with slightly lower projected profitability compared to communicated targets. These targets include reaching SEK216m in net sales and achieving an EBITDA of SEK72m (or SEK42m when excluding capitalized R&D) in 2023. It is worth noting that these figures do not take into account SDD.

This outlook can be compared to our own estimates, which project around SEK214m in sales and approximately SEK37m in EBITDA for the group, excluding SDD and inclusive of capitalized R&D.

On the back of the report, we have made minor adjustments to our sales estimates on an aggregate level. However, we have revised the sales mix, increasing recurring revenues while decreasing our assumptions for new sales. Given the higher-than-expected opex in the quarter, we have also revised our cost assumption upwards for Q4 2023e and 2024e-2025e, offsetting the more favorable margin profile associated with the recurring revenues. Overall, we have lowered our EBITDA estimates by 14% for 2023e, and by -1-0% 2024e-2025e, 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). Due to higher interest rates, we have increased the risk-free rate from 2.5% to 3% and our WACC from 12.5% to 13%. We have also taken down our long-term growth and margin assumptions somewhat, impacting our fair value range and base case negatively. However, we continue to see a healthy upside at current levels.

Sales CAGR 2023-2027e of -1% and 2027e-2032e of 0% (3%)
Avg. EBIT-m 2023-2027e of 13% (10%) and 2027e-2032e of 13% (20%)
Terminal growth of 2% and a terminal EBIT-m of 25%
WACC: 13%

Sales CAGR 2023-2027e of 1% and 2027e-2032e of 3% (4%)
Avg. EBIT-m 2023-2027e of 17% and 2027e-2032e of 22% (25%)
Terminal growth: 2% and a terminal EBIT-m of 30%
WACC: 13%

Sales CAGR 2023-2027e of 6% and 2027e-2032e of 4% (7%)
Avg. EBIT-m 2023-2027e of 22% (18%) and 2027e-2032e of 27% (30%)
Terminal growth: 2% and a terminal EBIT-m of 35%
WACC: 13%