SLI Systems — Quality over quantity

SLI Systems — Quality over quantity

SLI’s financial performance in H1 reflected its current transitional phase with ARR remaining flat as the business is realigned to focus on value over volume through a number of initiatives. The key customer retention rate is reverting to historical levels and with an operationally geared model, we believe that only a modest recovery in new business momentum should support robust upside. Net cash stands at NZ$6m.

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SLI Systems

Quality over quantity

H1 results

Software & comp services

14 March 2017

Price

NZ$0.32

Market cap

NZ$20m

US$/NZ$1.399

Net cash (NZ$m) at 31 December 2016

6.0

Shares in issue

62.3m

Free float

40%

Code

SLI

Primary exchange

NZX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(25.6)

(28.9)

(71.9)

Rel (local)

(25.8)

(31.9)

(73.6)

52-week high/low

NZ$1.2

NZ$0.3

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 events

Full year results

July 2017

Analysts

Dan Ridsdale

+44 (0)20 3077 5729

Alasdair Young

+44 (0)20 3077 5758

SLI Systems is a research client of Edison Investment Research Limited

SLI’s financial performance in H1 reflected its current transitional phase with ARR remaining flat as the business is realigned to focus on value over volume through a number of initiatives. The key customer retention rate is reverting to historical levels and with an operationally geared model, we believe that only a modest recovery in new business momentum should support robust upside. Net cash stands at NZ$6m.

Year
end

Revenue
(NZ$m)

EBITDA
(NZ$m)

PBT*
(NZ$m)

EPS*
(c)

P/E
(x)

EV/sales
(x)

06/15

28.6

(6.7)

(7.0)

(11.1)

N/A

0.3

06/16

35.7

1.1

0.7

1.1

29.1

0.8

06/17e

32.3

(0.5)

(0.8)

(1.3)

N/A

0.5

06/18e

34.7

0.9

0.5

1.0

32.0

0.5

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

A period of transition

The six months to December were a period of transition for SLI, as management realigned the business to improve competitiveness, particularly with higher-value enterprise customers. Key initiatives included realigning and training the sales team, launching a new website and implementation of new CRM systems. Planned launches in H2 such as HTTP/2 and SSL should enhance sales efforts with larger enterprise customers.

Relatively solid through transitional period

Annualised Recurring Revenue (ARR), SLI’s key momentum indicator, was flat over the six-month period at NZ$31.1m with customer retention improving to 87% vs 84% for FY16. Revenues dropped to $15.5m from $17.4m (H116) due to currency (strong NZ$) and unavoidable customer losses in Q416. This led to a NZ$0.6m EBITDA loss over the period, vs a NZ$1m profit in H216, although the balance sheet remains solid with net cash of NZ$6m.

Ingredients for a recovery in momentum

With good execution, we believe the ingredients for a robust turnaround are in place. SLI is the market leader in a large and growing market, with plenty of scope to add new customers and upsell/cross-sell other services. Data points are still limited, but on the basis of revised sales initiatives bearing fruit and new product enhancements being brought to market, we forecast a return to growth in ARR in H2, returning to a low double-digit growth trajectory and EBITDA profitability in FY18. Two substantial US Enterprise client wins further bear this out.

Valuation: Modest uptick should drive upside

At 0.5x EV/Sales, SLI is trading at an acute recovery rating and a substantial discount to search/SaaS peers (typically 2x+). However, any recovery momentum should drive operationally geared growth in profitability and a re-rating upwards. Our DCF scenario analysis suggests that sustaining 5% growth in the mid-term should generate upside, while 7.5% mid-term growth and 20% EBITDA margins result in a DCF valuation of NZ$0.77, twice the current share price.

Investment summary

Company description: e-commerce optimisation

SLI Systems provides a suite of premium e-commerce optimisation products designed to increase online sales for its clients. This is achieved by search engine enhancement tools to maximise click-through rates (CTRs) to its clients’ websites from search engines, in addition to search and merchandising functionality on the clients’ websites to improve the conversion rate of site visitors to customers. SLI continuously adds to and develops its series of complementary products that enhance its core search functionality.

Financials: Investing in growth

One of SLI’s key differentiators is that is has very low implementation costs for its clients, as it uses its own staff for installation and set-up at minimal additional cost to the client. While this helps to win business, it also results in a net cash outflow for each new client acquisition, with a typical payback period of two years. Despite this trade-off between growth and profitability, cash at 31 December 2016 remains high at NZ$6m, so we do not foresee the need to raise additional operational capital. Operating revenues fell by NZ$1.9m y-o-y, attributable to FX fluctuations and the three largely unavoidable client losses in Q416 (as a result of insolvencies and change of ownership). Net losses for the period grew to NZ$1.3m (H116: NZ$446,000).

We forecast a continuation of historic client retention levels of 87%, with a corresponding CAGR increase in ARR of 7.8% in FY16-19. We expect the company to exit FY17 at a cash flow-neutral run rate, with a return EBITDA profitability (NZ$928,000) in FY18 and EPS profitability the following year (NZ$0.26/share).

Sensitivities: Acquiring and keeping clients is key

The retention rate is the key sensitivity for mid- to long-term profitability. SLI attempts to mitigate the risk of client churn by investing heavily in customer support and having automatic renewal with a 90-day notice period for most of its customers.. However, the industry is very competitive and therefore it is likely that SLI (and its peers) will need to invest continually in R&D just to keep up with the crowd. This makes a close customer relationship even more important since it provides SLI with insight that its more standardised peers will miss. The success and growth of the e-commerce platforms may also have a substantial effect on the company.

Valuation: Significant discount to peers

Assuming mid-term CAGR revenues of 7.3% and matured EBITDA margins of 20%, our core DCF scenario using a WACC of 12% and a terminal growth rate of 1.5% yields a valuation of NZ$0.77/share. At EV/Sales of 0.5x, SLI is trading at an acute recovery rating and a substantial discount to search/SaaS peers (typically 2x+). While the current price is a reflection of the company’s loss-making status and the reduction in ARR y-o-y, any recovery momentum should drive operationally geared growth in profitability and a re-rating upwards. We believe that early signs of such a recovery are already apparent, as demonstrated by the recent uptick in client retention rates, in addition to the H117 recovery of ARR.

Operational review

Operational update

H116 was a transitional period for SLI, with CEO Chris Brennan implementing a number of changes aimed at reinvigorating growth and cementing a scalable business model. Changes are being implemented at a number of different levels. Investment in R&D has been increased to accelerate the rate of product innovation with a particular view to enhancing competitiveness for larger enterprise accounts. The sales structure and incentives have been changed to focus on lifetime value rather than volume and the company has invested in CRM systems to enable better targeting and tracking of these higher-value accounts.

It is early days yet, but we believe there were enough encouraging signs in SLI’s H1 performance (such as recent high-profile US client wins) to suggest that a recovery in momentum may be due.

Improving customer mix offsetting low end-churn

Management is seeking to improve its sales mix through improving its offering and sales approach to higher-value enterprise customers while moving out of bidding for smaller, less profitable accounts. Success should benefit the business in a number of ways including improving the scalability and margins of the business as larger accounts typically incur proportionately lower set-up costs and supporting the ability to drive sustainable growth as larger established customers tend to be less volatile and offer more scope for cross/up-selling.

There were signs of this strategy coming through in H1. While the company lost 69 customers and won 39 over the period, ARR remained flat, with the new customer average contract value (ACV) of NZ$40,000 (Exhibit 1) substantially higher than the ACV of NZ$31,000 for lost clients.

Exhibit 1: Six-month rolling initial average contract value

Exhibit 2: Average annual recurring revenue per customer (constant currency)

Source: SLI Systems, Edison Investment Research

Source: SLI Systems, Edison Investment Research

Exhibit 1: Six-month rolling initial average contract value

Source: SLI Systems, Edison Investment Research

Exhibit 2: Average annual recurring revenue per customer (constant currency)

Source: SLI Systems, Edison Investment Research

Enterprise wins offer encouragement

This growth in new client ACV was helped by winning two important US enterprise accounts over the period: Crate & Barrel, a housewares retailer with NZ$800m online sales and 8.8m monthly visits (Internet Retailer rated number 71) and Rocky Mountain ATV, the online auto parts retailer ranked in the top 50,000 global Alexa ranking. The Crate & Barrel client win is particularly encouraging in terms of demonstrating the company’s ability to compete in the enterprise space, given that it was won following a beauty parade against competitors including Endeca (owned by Oracle), which was the incumbent supplier. Both of these accounts will rank within SLI’s top 15% of contracts by ACV.

Customer retention recovers from trough

Customer retention over the H1 period was 87% on an annualised basis, compared to 84% for the 12-month period (Exhibit 3), which was affected by the largely unavoidable loss of three large customers late in FY16 (due to insolvencies or change of control). It is difficult to gauge how much this figure can be improved in the future. Whereas historically the company enjoyed higher retention rates (90%+ in 2013 and 2014), this churn was coming out of a substantially lower historic customer base. As churn typically happens when customers migrate to a new e-commerce or web platform, the customers decision to reassess their search provider is not necessarily a result of dissatisfaction, although a competitive offering is clearly key to retaining the business when these decisions are made.

Exhibit 3: Historical retention rate (by ARR)

Source: Company accounts, Edison Investment Research

Investment in R&D to boost competitiveness

The company has continued to invest in product innovation with R&D headcount increased by 25% over the period, despite costs reducing by c NZ$1m from H216 to H117 (reduction in sales expenditure and currency were the offsetting factors).

Key enhancements in H1 were the launch of SLI ESP (Enhanced Search Personalization), which improves real-time individualisation of the results returned on search and navigation pages using the SLI product, and a new tracking technology for JavaScript, which enables the provision of more comprehensive data for personalising the shopping experience.

Enhancements to speed and security should support enterprise drive

Management aims to further the capabilities in H2 with the roll-out of support for HTTP/2 (faster page loads through improved data compression) and the addition of the SSL certification (cryptographic web server protection), which will deliver speed and performance improvements for retailers and improve security levels, respectively. These measures should improve SLI’s competitiveness, particularly when pitching for larger clients, as both these aspects are increasingly being seen as necessary requirements for mid- to large-cap companies.

Expanding the envelope through corporate development

Licensing, partnerships and acquisitions all considered

Whereas SLI has to date followed a purely organic path, the announcement of a new corporate development function signals that the company is now looking at more expansive opportunities for growth. A range of opportunities will be considered here, including licensing or resale agreements (to strengthen the proposition and create cross-selling opportunities), partnerships or M&A. Should any substantial acquisitions take place, it is likely that management would need to raise additional capital. We see this scenario as unlikely, so do not build it into our forecasts.

Company description: e-commerce optimisation

Founded in 2001, SLI Systems provides a suite of premium e-commerce optimisation products designed to increase online sales for its clients. This is achieved by search engine enhancement tools to maximise CTRs to its clients’ websites from search engines, in addition to search and merchandising functionality on the clients’ websites to improve the conversion rate of site visitors to customers. Small increases to CTRs and conversion rates can have a significant accretive earnings impact for clients. SLI prioritises client services, which in our view is equally important to the technology solution due to the fragmentation of the market and the corresponding difficulty for companies operating in this space to be gauged against their peers.

SLI continuously adds to and develops its series of complementary products, which enhance its core search functionality. A complete list of SLI’s products and descriptions is shown in Exhibit 4.

Exhibit 4: Product list

Product name

Description

Learning Search

Learning Search is SLI’s core product and uses a number of techniques such as autocomplete and spell check to increase the sales conversion rates for its customers. Autocomplete attempts to guess what the customer is looking for as soon as they start typing and suggests a list of items and searches immediately as the customer types.

Learning Recommendations

When a user has searched for an item, SLI’s Learning Recommendations suggests similar products in which the user may be interested. This means the customer does not have to return to the search screen and alternative products are suggested on the same page.

Learning Navigation

Learning Navigation filters products by category to make it easier for users to find the product they are looking for. It automatically updates the ranking of products based on user behaviour.

Site Champion

Site Champion is SLI’s search engine optimisation (SEO) product. It works by automatically generating search engine-friendly pages based on customer behaviour. It helps to improve the ranking of customers’ websites on search engines such as Google, Bing and Yahoo!. There is no monthly fee for the use of Site Champion; instead, SLI charges per referral from internet search engines.

Merchandising

Merchandising (ie controlling how a product is presented to a potential customer) is key to increasing average spend and conversion rate. It has many different aspects, but can include adjusting which products are displayed alongside others and which products are placed on sale. SLI can use its search data and statistics across multiple companies to learn how best to merchandise products and its multivariate testing can provide an unbiased judge of which merchandising tools work best.

Dynamic product banners

Dynamic product banners help to suggest alternative products when people come to a website from an external search engine rather than through the site's internal search. External search engine data may be out of date and therefore it is an important to suggest alternative products when linked to from an external website. For many websites less than 20% of site visitors use internal product search and therefore it is important to have alternative product suggestion tools.

SLI Mobile

Mobile is increasingly becoming the dominant form of internet access. It accounts for 50% of traffic to websites and 37% of UK online retail (source: IMRG), yet Paul Smith* reports that cart abandonment rates for mobile-based shopping are 60-80%, which is much higher than for desktop. There is a 2% conversion rate for desktop compared to 1.75% for apps and 0.5% for mobile websites. The smaller screen on mobiles makes merchandising and effective search and navigation even more important and therefore it plays well to SLI’s competitive advantage. Paul Smith implemented SLI and experienced a 39% increase in conversion rate, 45% increase in customers using site search and an 11% increase in site search revenue.

Multivariate testing

Multivariate testing is a method for assessing the performance of different website designs and tools. SLI and its customers can use it to assess the performance of its products against its peers and different website designs against each other. It is useful to demonstrate the value of its products to customers and the return on investment they might expect from implementing a certain design.

Landing Page Creator

The Landing Page Creator was launched by SLI Systems in 2015. It allows non-technical staff to easily and quickly create landing pages to optimise marketing messages and search engine ranking through a drag-and-drop interface.

Enhanced Search Personalization (ESP)

Real-time personalisation of the results shown on the search and navigation pages. Product launched in H117.

Product name

Learning Search

Learning Recommendations

Learning Navigation

Site Champion

Merchandising

Dynamic product banners

SLI Mobile

Multivariate testing

Landing Page Creator

Enhanced Search Personalization (ESP)

Description

Learning Search is SLI’s core product and uses a number of techniques such as autocomplete and spell check to increase the sales conversion rates for its customers. Autocomplete attempts to guess what the customer is looking for as soon as they start typing and suggests a list of items and searches immediately as the customer types.

When a user has searched for an item, SLI’s Learning Recommendations suggests similar products in which the user may be interested. This means the customer does not have to return to the search screen and alternative products are suggested on the same page.

Learning Navigation filters products by category to make it easier for users to find the product they are looking for. It automatically updates the ranking of products based on user behaviour.

Site Champion is SLI’s search engine optimisation (SEO) product. It works by automatically generating search engine-friendly pages based on customer behaviour. It helps to improve the ranking of customers’ websites on search engines such as Google, Bing and Yahoo!. There is no monthly fee for the use of Site Champion; instead, SLI charges per referral from internet search engines.

Merchandising (ie controlling how a product is presented to a potential customer) is key to increasing average spend and conversion rate. It has many different aspects, but can include adjusting which products are displayed alongside others and which products are placed on sale. SLI can use its search data and statistics across multiple companies to learn how best to merchandise products and its multivariate testing can provide an unbiased judge of which merchandising tools work best.

Dynamic product banners help to suggest alternative products when people come to a website from an external search engine rather than through the site's internal search. External search engine data may be out of date and therefore it is an important to suggest alternative products when linked to from an external website. For many websites less than 20% of site visitors use internal product search and therefore it is important to have alternative product suggestion tools.

Mobile is increasingly becoming the dominant form of internet access. It accounts for 50% of traffic to websites and 37% of UK online retail (source: IMRG), yet Paul Smith* reports that cart abandonment rates for mobile-based shopping are 60-80%, which is much higher than for desktop. There is a 2% conversion rate for desktop compared to 1.75% for apps and 0.5% for mobile websites. The smaller screen on mobiles makes merchandising and effective search and navigation even more important and therefore it plays well to SLI’s competitive advantage. Paul Smith implemented SLI and experienced a 39% increase in conversion rate, 45% increase in customers using site search and an 11% increase in site search revenue.

Multivariate testing is a method for assessing the performance of different website designs and tools. SLI and its customers can use it to assess the performance of its products against its peers and different website designs against each other. It is useful to demonstrate the value of its products to customers and the return on investment they might expect from implementing a certain design.

The Landing Page Creator was launched by SLI Systems in 2015. It allows non-technical staff to easily and quickly create landing pages to optimise marketing messages and search engine ranking through a drag-and-drop interface.

Real-time personalisation of the results shown on the search and navigation pages. Product launched in H117.

Source: SLI Systems. Note: *Paul Smith UK retailer.

Business model

SLI Systems typically charges customers monthly or quarterly in advance, with fees depending on their usage and the number of products they use. SLI differentiates itself by absorbing on-boarding costs for new clients by using its own staff to implement its systems on clients’ websites. This results in a net cash outflow for each new client acquisition, with a typical payback period of two years. However, the revenues are high margin, and are highly recurring due to both the efficacy of the technology offering and the company’s emphasis on customer service. A high retention rate is therefore critical to long-term profitability. The company generally pays its expenses in arrears (mostly salaries), thereby giving it a working capital-neutral model, with light capex requirements.

Market opportunity and competition

Structural growth market

The addressable market for SLI’s solutions is unquestionably very large and growing fast. eMarketer estimates worldwide retail e-commerce sales will rise to US$3.6tn by 2019 from US$1.7tn in 2015 (16% CAGR), while it further projects that retail e-commerce will still only represent a mere 12.8% of all retail purchases. These statistics indicate the growth opportunity available to SLI as its technology will continue to aid its customers to maximise their online revenues.

Competition

Competition for site search comes from three main sources. Alternative providers of dedicated site search solutions include Cetona, Nextopia, Adobe with Target and a number of others. In addition, there are suppliers of e-commerce platforms that include search functionality. This category includes companies such as Magento, WooCommerce, Shopify and PrestaShop. Finally, in-house platforms – often built on open-source building blocks – are still used by (typically larger) e-commerce sites (Exhibit 5).

Exhibit 5: US market share of top 1,000 US internet retailers

Source: SLI Systems

We believe that a crucial factor in the company’s success will be to sell into customers who currently that third-party e-commerce platforms. At present, many retailers use third-party platforms, which include all the web-based functionality retailers need to operate an online store, including product search. In our opinion, online search and merchandising will become more of a speciality because of its importance to revenue and we therefore believe SLI’s main competition in the long term will be direct independent search providers.

Financials

Review of H117 results

SLI Systems achieved a return to growth in its annual recurring revenue of 0.3% for the six months ending 31 December 2016 compared to the previous six-month period on a constant currency basis, as seen in Exhibit 6. Operating revenues fell by NZ$1.9m y-o-y, although approximately half of this fall was related to currency fluctuations, particularly in the recent weakness of sterling. Net losses for the period grew to NZ$1.3m (H116: NZ$446,000). Gross margins fell slightly to 74.4% for the six-month period, although this remains in line with the long term average.

Exhibit 6: Review of H117 results

NZ$000s

H116

H216

H117

H117 y-o-y
chg

H117 h-o-h
chg

Annual Recurring Revenue (ARR)

35,597

31,191

31,147

(12.5%)

(0.1%)

ARR on a constant currency basis

33,706

31,057

31,147

(7.6%)

0.3%

Operating revenue

17,367

17,639

15,482

(10.9%)

(12.2%)

Other income

75

571

273

264.0%

(52.2%)

Delivery costs

(4,094)

(3,864)

(3,965)

(3.2%)

2.6%

Growth costs

(8,631)

(9,000)

(7,850)

(9.0%)

(12.8%)

Other costs

(5,163)

(4,812)

(5,190)

0.5%

7.9%

Total costs

(17,888)

(17,965)

(17,005)

(4.9%)

(5.3%)

Loss before tax

(446)

284

(1,250)

180.3%

(540.1%)

Gross Margin %

76.4

78.1

74.4

(2.6%)

(4.7%)

Source: SLI Systems accounts, Edison Investment Research

Exhibit 7 shows net cash outflows of NZ$753,000 for the period, primarily driven by the reduction in operating revenues attributable to currency fluctuations, in addition to continued investment for growth. Net cash at the end of the period remains strong at NZ$6m, and management remains committed to continued operations without a further capital raise, as significant cost reductions could be made, if required, by the reduction of investment for growth. SLI’s model allows for a relatively smooth cash flow as inflows are generally billed in advance while outflows are paid in arrears.

Exhibit 7: Interim cash flows

H116

H216

H117

Net cash (outflow) from operating activities

(154)

962

(569)

Net investing cash flow (outflow)

(60)

223

(184)

Cash from financing activities

238

300

0

Cash increase/(decrease)

24

1,159

(753)

Cash at end of period

5,606

6,765

6,012

Source: Edison Investment Research

Geographical breakdown

Exhibits 8 and 9 show how North America remains the critical market for SLI. On both constant currency and reported currency bases, the North American market represents just under 60% of total annual recurring revenues. The degree of sales success and client retention rates in this market will hence go a long way to deciding the long term growth profile of SLI. The recent high profile client acquisitions of Crate & Barrel and Rocky Mountain ATV provide assurance that management is prioritising this highly important market. UK growth was strong, with ARR on a constant currency basis up 10% y-o-y, much of which was offset by currency. The effects of the loss of three major clients in South America in Q416 can also be seen, with a reduction in ARR of 45% on a constant currency basis y-o-y.

Exhibit 8: Annual recurring revenue by region (constant currency basis)

Exhibit 9: Annual recurring revenue by region (reported currency basis)

Source: SLI Systems accounts, Edison Investment Research

Source: SLI Systems accounts, Edison Investment Research

Exhibit 8: Annual recurring revenue by region (constant currency basis)

Source: SLI Systems accounts, Edison Investment Research

Exhibit 9: Annual recurring revenue by region (reported currency basis)

Source: SLI Systems accounts, Edison Investment Research

Forecasts

We reinitiate our forecasts, having suspended them in August. Data points are still limited, but on the basis of an improving contract base and new product enhancements being brought to market there are grounds to support a return to growth in ARR in H2 and continuing into FY18 and FY19. Our estimates assume that the client retention rate remains steady at the 87% H217 level, while the level of new business won steadily recovers (Exhibit 10). While we expect some increased investment to support growth, we forecast that operational gearing returns the business to EBITDA profitability in FY18 and EPS profitability in FY19.

Exhibit 10: Forecast summary

NZ$000s

2015

2016

2017e

2018e

2019e

Currency headwind (tailwind)

4,798

(3,489)

(134)

0

0

Retention rate

87%

84%

87%

87%

87%

ARR lost

(3,243)

(4,978)

(4,072)

(4,339)

(4,773)

ARR won

8,096

5,058

6,122

7,676

10,279

ARR

34,600

31,191

33,374

36,712

42,219

ARR Growth rate

39%

-10%

7%

10%

15%

Revenue

28,126

35,006

31,802

34,209

38,088

Other income (government grants)

466

646

500

500

500

Total revenue and other income

28,592

35,652

32,302

34,709

38,588

Cash opex

(35,276)

(34,516)

(32,784)

(33,781)

(35,094)

EBITDA

(6,684)

1,136

(482)

928

3,494

EBITDA Margin

N/A

3%

N/A

3%

9%

Reported profit/(loss) before tax

(7,550)

(162)

(1,683)

(359)

2,212

IFRS EPS (c)

(11.94)

(0.39)

(2.78)

(0.42)

2.58

Cash and cash equivalents

5,582

6,765

5,670

4,959

5,939

Source: Edison Investment Research

The company has a broadly neutral working capital model and we do not expect the business to pay tax in our forecast period, so the P&L profile should be broadly mirrored in the company’s cash performance. On the basis of our forecasts, cash should trough at c NZ$5m at end FY18.

Valuation

Recovery rating and significant discount to peers

At EV/Sales of 0.5x, SLI is trading at an acute recovery rating and a substantial discount to search/SaaS peers (typically 2x+). Revenues are highly recurring and we do not believe that this aspect is currently priced in by the market. This is understandable given the company’s recent flat ARR and loss-making status. However, any recovery momentum should drive operationally geared growth in profitability and a re-rating upwards. We believe that early signs of such a recovery are already apparent, as demonstrated by the recent uptick in client retention rates, in addition to the H117 recovery of ARR.

Exhibit 11: Peer comparison using forward consensus estimates

Company

Quoted currency

Price

Market cap (m)

EV in reporting currency (m)

EV/Sales
FY1 (x)

EV/Sales
FY2 (x)

EV/EBITDA FY1 (x)

P/E FY1 (x)

EBITDA Margin FY1 (%)

SLI Systems

NZ$

0.32

20.0

16.3

0.5

0.5

N/A

N/A

N/A

Alphabet Inc-CL A

US$

856.75

584,402.4

496,126.4

5.6

4.9

11.4

20.6

32.6

BazaarVoice

US$

4.20

351.3

302.2

1.5

1.5

18.4

N/A

N/A

International Business Machines Corp

US$

181.95

171,617.5

205,404.5

2.6

2.6

10.6

13.2

23.1

Oracle Corp

US$

42.92

176,073.0

172,577.0

4.6

4.4

10.4

16.7

43.8

Web.com Group

US$

19.80

997.0

1,640.7

2.2

2.1

8.7

6.8

21.7

Attraqt Group

p

0.49

13.1

12.0

2.3

1.8

N/A

N/A

N/A

Dotdigital Group

p

0.65

192.4

173.5

5.4

4.4

17.5

29.7

32.0

Intershop Communications

1.14

36.1

29.0

0.8

0.7

58.0

N/A

N/A

E-commerce companies

Median

302

2.3

2.1

10.6

6.8

21.7

Source: Bloomberg, Edison Investment Research.

NZ$0.77/share DCF valuation

Our core DCF analysis uses a WACC of 12% and a terminal growth rate of 1.5%, resulting in a DCF valuation of NZ$0.77. It further assumes a CAGR of revenues of 7.3% from 2017-23, and a matured EBITDA margin of 20% (Exhibit 12).

Exhibit 12: DCF valuation

WACC

12%

Terminal growth rate

1.5%

CAGR in revenues 2017-23

7.3%

Terminal value (NZ$m)

20,897

Enterprise value (NZ$m)

41,864

Plus cash (NZ$m) at 31 December 2015

6,012

Equity value (NZ$m)

47,876

Equity value per share

NZ$0.77

Source: Edison Investment Research

Our DCF scenario analysis (Exhibit 13) suggests that achieving and sustaining 5% growth in the mid-term should generate upside, while a DCF valuation equal to a doubling of the current share price is very achievable (7.5% mid-term growth and 20% EBITDA margins). This compares favourably with historical CAGR of revenues of 17.7% in 2012-16.

Exhibit 13: DCF scenario analysis at WACC of 12%

Mid-term growth

0.77

5%

7.5%

10.0%

12.5%

15.0%

Matured EBITDA margin

5%

0.22

0.29

0.35

0.42

0.49

10%

0.38

0.46

0.55

0.64

0.73

15%

0.52

0.64

0.74

0.86

0.98

20%

0.54

0.80

0.94

1.08

1.22

25%

0.54

0.86

1.13

1.29

1.47

Source: Edison Investment Research

Sensitivities

Retention rate: a high retention rate is critical to the success of the business. There is a typical payback period of 24 months before a client becomes profitable and retaining clients for at least as long as that is therefore critical to reaching profitability. Having reviewed case studies and spoken to some of SLI’s clients, we are confident that customers receive a very high quality of service and display an impressive level of praise for the quality of service they receive.

Currency movements: SLI has suffered from a weakening US dollar/NZ dollar exchange rate since the end of 2015. This headwind would reduce should the currencies stabilise, and may return to a beneficial impact in the medium to long term if the NZ$ returns to historic levels relative to the US$.

Competition: there are a number of platforms and technologies that provide embedded site search and other companies that provide customised search. Sales and marketing, as well as continual R&D, will be important in ensuring that existing and potential customers are informed about SLI’s products and that those products live up to the client’s expectations.

Funding: there is a short-term trade-off between growth and profitability and therefore, while we currently forecast that SLI will reach profitability without having to raise further funding, it may mean that investment in growth needs to be cut back in the short term to conserve cash. We currently forecast profitability in 2019, although it could occur sooner if management chooses to cut back on growth costs. Should management see an opportunity to acquire a complementary product offering as part of its new corporate development programme, it is possible that additional capital would need to be raised to fund this purchase.

Return on investment on growth costs: SLI is currently investing heavily in growth. So far it appears this investment is generating substantial returns, but this may change over time. It may become more costly to win and retain clients, or that the return on each client may fall as a result of lower retention rate or subscription fees.

Exhibit 14: Financial summary

NZ$'000s

2014

2015

2016

2017e

2018e

2019e

30-June

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

PROFIT & LOSS

Revenue

 

 

22,396

28,592

35,652

32,302

34,709

38,588

Delivery costs

(5,618)

(7,211)

(7,958)

(7,633)

(8,145)

(8,924)

Gross Profit

16,778

21,381

27,694

24,670

26,564

29,665

EBITDA

 

 

(5,412)

(6,684)

1,136

(482)

928

3,494

Operating Profit (before amort. and except.)

 

 

(5,860)

(7,198)

687

(820)

522

3,072

Intangible Amortisation

0

0

0

0

0

0

Exceptionals

0

0

0

0

0

0

Other

(525)

(526)

(888)

(888)

(888)

(888)

Operating Profit

(6,385)

(7,724)

(201)

(1,708)

(366)

2,184

Net Interest

472

174

39

25

8

28

Profit Before Tax (norm)

 

 

(5,388)

(7,024)

726

(795)

529

3,100

Profit Before Tax (FRS 3)

 

 

(5,913)

(7,550)

(162)

(1,683)

(359)

2,212

Tax

191

190

(77)

(33)

100

(619)

Profit After Tax (norm)

(5,197)

(6,834)

649

(828)

630

2,481

Profit After Tax (FRS 3)

(5,722)

(7,360)

(239)

(1,716)

(258)

1,593

Average Number of Shares Outstanding (m)

61.0

61.6

61.6

61.6

61.6

61.6

EPS - normalised (c)

 

 

(8.5)

(11.1)

1.1

(1.3)

1.0

4.0

EPS - (IFRS) (c)

 

 

(9.4)

(11.9)

(0.4)

(2.8)

(0.4)

2.6

Dividend per share (p)

0.0

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

74.9

74.8

77.7

76.4

76.5

76.9

EBITDA Margin (%)

N/A

N/A

3.2

N/A

2.7

9.1

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

N/A

N/A

1.9

N/A

1.5

8.0

BALANCE SHEET

Fixed Assets

 

 

2,159

2,369

2,056

2,648

2,766

2,868

Intangible Assets

115

99

65

83

80

78

Tangible Assets

1,589

1,582

1,316

1,890

2,011

2,115

Deferred Tax assets

455

688

675

675

675

675

Current Assets

 

 

16,391

12,213

12,641

11,413

10,661

12,287

Stocks

0

0

0

0

0

0

Debtors

5,002

6,631

5,876

5,742

5,701

6,348

Cash

11,389

5,582

6,765

5,670

4,959

5,939

Other

0

0

0

0

0

0

Current Liabilities

 

 

(7,278)

(9,641)

(8,870)

(9,543)

(9,206)

(9,400)

Creditors

(7,278)

(9,641)

(8,870)

(9,543)

(9,206)

(9,400)

Short term borrowings

0

0

0

0

0

0

Long Term Liabilities

 

 

(57)

(17)

(29)

(29)

(29)

(29)

Long term borrowings

0

0

0

0

0

0

Other long term liabilities

(57)

(17)

(29)

(29)

(29)

(29)

Net Assets

 

 

11,215

4,924

5,798

4,489

4,191

5,725

CASH FLOW

Operating Cash Flow

 

 

(4,550)

(5,892)

747

(563)

(256)

2,153

Net Interest

445

246

111

25

8

28

Tax

(91)

8

(50)

(33)

100

(619)

Capex

(699)

(472)

(163)

(524)

(563)

(583)

Acquisitions/disposals

0

0

0

0

0

0

Financing

902

303

538

0

0

0

Dividends

0

0

0

0

0

0

Net Cash Flow

(3,993)

(5,807)

1,183

(1,095)

(711)

980

Opening net debt/(cash)

 

 

(15,382)

(11,389)

(5,582)

(6,765)

(5,670)

(4,959)

HP finance leases initiated

0

0

0

0

0

0

Other

0

0

0

0

(0)

0

Closing net debt/(cash)

 

 

(11,389)

(5,582)

(6,765)

(5,670)

(4,959)

(5,939)

Source: Company accounts, Edison Investment Research

Contact details

Revenue by geography

SLI Systems
78-106 Manchester Street
Christchurch 8011
New Zealand
+64 (0)3 5208 029
www.sli-systems.com

Contact details

SLI Systems
78-106 Manchester Street
Christchurch 8011
New Zealand
+64 (0)3 5208 029
www.sli-systems.com

Revenue by geography

Management team

Chairman: Greg Cross

CEO: Chris Brennan

Greg is executive chairman of PowerbyProxi, a wireless power company he co-founded in 2007. He joined SLI's board in July 2003 and has been chairman since 2005. He has previously been MD of Microsoft New Zealand and CEO of Advantage Group (an NZX-listed company).

Chris brings 30 years’ experience in technology management, from running pre-IPO start-ups to multinationals. He is former founder, CEO and chairman of SaaS security vendor Net Authority and presently sits on the board of MarketLive, an e-commerce merchandising solutions provider.

VP Corporate Development: Dr Shaun Ryan

CFO: Rod Garrett

Shaun was one of the original founders of Global Brain, which developed the search technology used at SLI. It was then sold to NBC in 2000, before being bought back by Shaun and the other SLI founders in 2001 after the dot-com crash. Before Global Brain, Shaun worked as a software developer. He has a PhD in artificial intelligence from the University of Canterbury.

Rod worked for PwC in New Zealand and London in insolvency and corporate recovery. He joined SLI in 2006, before which time he was CFO of Eaton Power Quality. He has an honours degree in accounting and finance from the University of Otago.

Management team

Chairman: Greg Cross

Greg is executive chairman of PowerbyProxi, a wireless power company he co-founded in 2007. He joined SLI's board in July 2003 and has been chairman since 2005. He has previously been MD of Microsoft New Zealand and CEO of Advantage Group (an NZX-listed company).

CEO: Chris Brennan

Chris brings 30 years’ experience in technology management, from running pre-IPO start-ups to multinationals. He is former founder, CEO and chairman of SaaS security vendor Net Authority and presently sits on the board of MarketLive, an e-commerce merchandising solutions provider.

VP Corporate Development: Dr Shaun Ryan

Shaun was one of the original founders of Global Brain, which developed the search technology used at SLI. It was then sold to NBC in 2000, before being bought back by Shaun and the other SLI founders in 2001 after the dot-com crash. Before Global Brain, Shaun worked as a software developer. He has a PhD in artificial intelligence from the University of Canterbury.

CFO: Rod Garrett

Rod worked for PwC in New Zealand and London in insolvency and corporate recovery. He joined SLI in 2006, before which time he was CFO of Eaton Power Quality. He has an honours degree in accounting and finance from the University of Otago.

Principal shareholders

(%)

Shaun Ryan

10.83

Pioneer Capital Management

9.77

ANZ New Zealand Investments

9.43

Marder Media Group

6.91

Grant James Ryan

6.29

Lynnwood Holdings

4.28

First NZ Capital Group

3.29

Companies named in this report

Oracle (ORCL:NYQ), Adobe (ADBE:NSQ), Alphabet (GOOGL:NSQ), Yahoo (YHOO:NSQ), BazaarVoice (BV:NSQ), Web.com (WWWW:NSQ), Attraqt (ATQT:AIM), Dotdigital (DOTD:AIM), Intershop Communications (ISH2:ETR), International Business Machines (IBM:NYSE), Shopify (SHOP:NYSE).

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by SLI Systems and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205, 95 Pitt Street,

Sydney NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205, 95 Pitt Street,

Sydney NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by SLI Systems and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205, 95 Pitt Street,

Sydney NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205, 95 Pitt Street,

Sydney NSW 2000, Australia

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