integrated research (iri) - wilsons | stockbroker · 2020. 6. 22. · important disclosures...

Wilsons Equity Research

Issued by Wilsons Advisory and Stockbroking Limited ABN 68 010 529 665 - Australian Financial Services Licence No 238375, a participant of ASX Group and should be read in conjunction with the disclosures and disclaimer in this report. Important disclosures regarding companies that are subject of this report and an explanation of recommendations can be found at the end of this document.

Theme

Initiating Coverage

Company

Integrated Research (IRI)

Date

06 June 2018

New SELL: H2 slippage and cash flow risk

We initiate coverage on Integrated Research (IR) with a SELL rating and a TP of $2.65. IR is a software provider whose revenues are derived from its primary product ‘Prognosis’. Prognosis covers Unified Communications (UC), IT Infrastructure and Payments. We are attracted to IR’s high-profile distribution partners, quality product backed by continual R&D investment, long term visibility and strong structural digital drivers. Conversely, we have some reservations about an acutely H2 weighted licence number, some cash-flow headwinds, risks around cloud migration and a de-rate given that we are below consensus in FY18/19/20. We believe IR could experience a de-rate given valuation is full versus peers (on an adjusted EBITDA basis). EV/EBITDA(adj.) of 19.6x FY19E compares to peers at 16.5x.

Key points

Quality product and distribution: 5-year embedded R&D of $106m represents

30% of total revenues over the same period and gives us confidence in product quality. IR’s strong distribution network including CISCO, Avaya, Microsoft, ACI and HP provides global reach. IR currently services 1,200 customers worldwide, 125 of which are Fortune 500 companies. Maintenance renewal rates at 97% are high. Despite this, the evolution to cloud-based solutions from on-premise does create some risks for IR’s product.

Term-based licence structure: IR is strongly moving towards term-based

licencing with the process accelerating since 2015. While this shift is a key long-term positive, it does result in weaker cash flow in the coming 24 months.

Structural drivers seem plentiful: Investment in global digital communication

channels is increasing. Particularly, Microsoft Skype is helping to drive market investment in UC product. Corporates are also having to manage infrastructure more efficiently. These are key drivers for IR and investment in Prognosis.

Forecast growth below consensus: While there are some clear structural

positives IR has an acute reliance on H2 licences. Similar to prior years, all of the licence fees are closed toward the end of H2 and FY18E is no different. Our forecasts sit below consensus by some -7.7% on NPAT in FY18E reflecting these H2 risks.

Cash flow likely to be muted: The combination of a relatively high level of R&D

capitalisation and a shift to term licences that are cash-settled on a deferred basis will mean FCF remains weak for c2 years.

Valuation: When compared on a like-for-like basis (i.e. adjusting for R&D

capitalisation schemes), IRI sits at a premium to peers. EV/EBITDA (adj.) FY19 at 19.6x versus peers at 16.5x. Our TP represents a blended mix of DCF, EV/EBITDA (adj.) and FCF yield analysis and points to -22.7% TSR.

Risks and catalysts

Catalysts: H2 licence sales are key catalyst and could trigger downside risk if forecasts are missed. Risks: rising competitive threats.

Recommendation SELL

12-mth target price (AUD) $2.65

Share price @ 06-Jun-18 (AUD) $3.51

Forecast 12-mth capital return -24.6%

Forecast 12-mth dividend yield 1.9%

12-mth total shareholder return -22.7%

Market cap $603m

Enterprise value $593m

Shares on issue 172m

Sold short 0.4%

ASX 300 weight 0.0%

Median turnover/day $0.5m Mark Bryan

[email protected]

Tel. +61 2 8247 6609

James Bradley

[email protected]

Tel. +61 2 8247 3162

12-mth price performance ($)

1-mth 6-mth 12-mth

Abs return (%) -12.8 -7.4 19.0

Rel return (%) -14.4 -10.7 4.1

Earnings forecasts

Year-end June (AUD) FY16A FY17A FY18F FY19F FY20F NPAT rep ($m) 16.0 18.5 18.5 22.2 25.5

NPAT norm ($m) 15.3 19.8 18.9 22.6 25.9

Consensus NPAT ($m) 20.5 25.2 30.4

EPS norm (cps) 8.9 11.5 11.0 13.1 15.0

EPS growth (%) 13.3 29.0 -4.8 19.0 14.8

P/E norm (x) 39.3 30.5 32.0 26.9 23.4

EV/EBITDA (x) 18.9 15.5 15.8 14.1 12.4

FCF yield (%) 2.0 3.7 1.9 3.5 4.5

DPS (cps) 6.5 6.5 5.9 7.1 8.1

Dividend yield (%) 1.9 1.9 1.7 2.0 2.3

Franking (%) 58 86 100 86 86

Source: Company data, Wilsons estimates, S&P Capital IQ

2.50

2.90

3.30

3.70

4.10

4.50

May-17 Sep-17 Jan-18 May-18

IRI XSI Rebased

06 June 2018

Software

Integrated Research Limited


Growth rates

Returns

Margin trends

Solvency

Free cash flow yield

Interims ($m)

1H17A 2H17A 1H18A 2H18E

Sales revenue 43.3 47.8 45.7 51.2

EBITDA 16.3 22.0 19.1 18.5

EBIT 10.2 16.8 13.6 13.1

Net profit 7.5 12.3 10.0 8.9

Norm EPS 4.3 7.2 5.8 5.2

EBIT/sales (%) 23.5 35.1 29.8 25.5

Dividend (c) 3.0 3.5 3.0 2.9

Franking (%) 70.0 100.0 100.0 100.0

Payout ratio (%) 69.2 48.7 51.5 56.7

Adj payout (%) 63.4 40.7 107.9 84.2

Key assumptions

FY15A FY16A FY17A FY18F FY19F FY20F FY21F

Revenue growth (%) 20.3 7.9 6.3 12.2 12.1 11.7

EBIT growth (%) 13.5 30.6 -1.0 16.8 14.9 14.4

NPAT growth (%) 12.5 15.5 -0.2 19.9 14.8 14.7

EPS growth (%) 13.3 29.0 -4.8 19.0 14.8 14.6

EBIT/sales (%) 25.9 24.4 29.6 27.6 28.7 29.4 30.1

Tax rate (%) 27.1 25.9 27.1 30.0 28.1 28.1 28.1

ROA (%) 23.9 23.2 27.1 24.5 24.8 24.8 24.7

ROE (%) 50.4 50.3 55.6 47.9 46.1 44.5 43.1

Financial ratios


PE (x) 43.1 38.1 29.5 31.0 26.0 22.7 19.8

EV/EBITDA (x) 21.7 18.9 15.5 15.8 14.1 12.4 10.9

Dividend yield (%) 2.2 1.9 1.9 1.7 2.1 2.4 2.7

FCF yield (%) 2.9 2.0 3.7 1.9 3.5 4.5 5.2

Payout ratio (%) 95.1 72.7 56.4 54.0 54.3 54.3 54.3

Adj payout (%) 58.4 97.1 50.4 95.5 51.5 48.6 48.2

Profit and loss ($m)


Sales revenue 70.3 84.5 91.2 96.9 108.7 121.9 136.2

EBITDA 27.3 31.3 38.3 37.6 42.1 47.8 54.4

Depn & amort 9.1 10.6 11.3 10.9 10.9 12.0 13.4

EBIT 18.2 20.7 27.0 26.7 31.2 35.8 41.0

Net interest expense -0.3 0.0 -0.2 -0.2 -0.2 -0.2 -0.3

Tax 5.0 5.4 7.4 8.1 8.8 10.1 11.6

Minorities/pref divs

Equity accounted NPAT

Net profit (pre-sig items) 13.5 15.3 19.8 18.9 22.6 25.9 29.7

Abns/exts/signif

Reported net profit 14.3 16.0 18.5 18.5 22.2 25.5 29.2

Cash flow ($m)


EBITDA 27.3 31.3 38.3 37.6 42.1 47.8 54.4

Interest & tax 0.0 0.1 0.1 0.0 0.0 0.0 0.0

Working cap/other -5.9 -15.2 -12.6 -21.7 -16.1 -15.3 -17.0

Operating cash flow 21.4 16.2 25.8 15.9 25.9 32.5 37.4

Maintenance capex -4.0 -4.0 -3.8 -4.3 -5.0 -5.6 -6.3

Free cash flow 17.4 12.3 22.0 11.7 20.9 26.9 31.1

Dividends paid -10.2 -11.9 -11.1 -11.1 -10.8 -13.1 -15.0

Growth capex -6.0 -5.9 -5.6 -6.4 -7.5 -8.4 -9.4

Invest/disposals -0.1 -1.4 -0.1 -0.2 -0.2 -0.2 -0.3

Oth investing/finance flows 0.3 0.0 0.2 0.0 0.0 0.0 0.0

Cash flow pre-financing 1.4 -6.9 5.4 -6.1 2.4 5.2 6.5

Funded by equity 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Funded by debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Funded by cash -1.4 6.9 -5.4 6.1 -2.4 -5.2 -6.5

Balance sheet summary ($m)


Cash 15.3 8.5 14.1 8.0 10.5 15.7 22.1

Current receivables 25.0 29.0 36.0 43.8 50.9 57.4 64.6

Current inventories 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net PPE 2.0 1.8 1.9 2.1 2.4 2.7 3.0

Intangibles/capitalised 0.2 4.2 3.8 3.8 3.7 3.7 3.7

Total assets 76.3 89.0 99.6 109.1 125.7 144.5 166.0

Current payables 7.2 8.5 9.6 10.2 11.0 12.0 13.0

Total debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total liabilities 40.1 47.9 51.0 53.3 58.1 64.0 70.7

Shareholder equity 36.1 41.0 48.5 55.8 67.6 80.5 95.2

Total funds employed 36.1 41.0 48.5 55.8 67.6 80.5 95.2

7.9% 6.3%

12.2% 12.1%

29.0%

-4.8%

19.0%14.8%

FY17A FY18F FY19F FY20F

Revenue Growth EPS Growth

40%

44%

36% 37%35%

54%56%

46%

42% 41%

FY16A FY17A FY18F FY19F FY20F

ROE ROIC

15%

20%

25%

30%

35%

40%

45%


EBITDA EBIT NPAT

-8

-6

-4

-2

0

-35%

-30%

-25%

-20%

-15%

-10%


Int.

Cov

er

(100

's x

)

Net

Debt/E

quity

(%)

Net Debt/Equity Interest Cover

1.5%

2.5%

3.5%

4.5%


Free Cash Flow Yield (%)

06 June 2018

Software



Table of contents

Investment thesis ..................................................................................................................... 4

Company overview ................................................................................................................... 5

Entrenched customer base .................................................................................................... 12

Commitment to R&D .............................................................................................................. 14

Cash flow headwinds ............................................................................................................. 15

Financials ............................................................................................................................... 17

Valuation: Impending de-rate ................................................................................................. 25

06 June 2018

Software



Investment thesis

IRI sells software licences across four modules: Unified Communications (UC), IT

Infrastructure, Payments and Contact Centre. These modules are available through its primary

product ‘Prognosis’. Revenues are derived from software licences, maintenance fees,

consulting fees and testing solutions.

Positives:

Global customer base and recognised product: Strong distribution channels, high-

quality customers and 87% recurring revenues are reassuring. IR’s Prognosis software

licences are sold through a handful of high-quality distribution partners: CISCO, Avaya,

HP and Microsoft. The partners increase the addressable market and revenue visibility.

Digitisation as a structural driver: An independent forecaster, Nemertes Research,

estimates that 70% of all companies are currently undergoing digital transformation. Out of

their sample, some 50% of companies planned to increase their FY18 unified

communications (UC) budget by 12% on average. IR’s focus on UC products versus larger

comps, which provide multiple services, puts them in a great position to leverage this trend.

Embedded R&D: Over the past 5 years, IRI has invested some $106 in gross R&D which

represents 30% of total revenues. We view this as a key positive for future years. This will

be crucial given an impending move to the cloud is required.

FedRAMP: In June 2016 CISCO purchased a number of Prognosis licences for the

administration of a cloud solution to 7m US Government users. IR has flagged that this

could generate $2.1m in revenues per month. There is scope for CISCO to add further

sales on the back of this contract which is not currently in numbers.

Shift to annual licensing: Since 2015 IR has been selling 3-5 year licences rather than

perpetual licences. This provides for more visibility. In the long run this is a positive move

adding to revenue visibility which we forecast materialising in FY20.

Negatives:

H2 weighting is significant: IR has always had a very H2-reliant business model. WILS

forecasts $32m software licences in H218E of which the majority, similar to previous years,

is closed toward the latter end of the half. This creates slippage risk. We also note that our

forecasts are assuming a decline in EBITDA in H218 on H217 – of around -16%.

WILS sits below consensus: We see an EBITDA margin decline of c.-3% in FY18E from

rising R&D and sales & marketing spend. Consensus full-year EBITDA is $40m – Wilsons’

forecasts assume $38m.

Cash flow headwinds: As IR continues to write deferred payments business and pushes

for annual licensing, we see headwinds materialising in the coming two years with cash

conversion rates continuing to trend lower. We forecast FCF/Revenue conversion of 5%

for FY18E and 12% in FY19E compared to FY17A at 18%.

Cloud technology and competitive landscape threat: IR has proven resilient to

technology shifts in the competitive landscape. We understand that the majority of

installations are on-premise and that a fairly small portion of R&D is being dedicated to the

cloud. Key competitors include global bellwethers such as Huawei, Vonage and Amazon.

The risk of technology shift and increased competition remains front of mind.

Valuation seems full versus peers and risks: Given the risks outlined above we see

scope for a de-rate. Our FY18E NPAT sits at $18.9m which is 7.7% below consensus.

Within our coverage universe, if we fully expense capitalised R&D through the P&L, IRI is

trading on an FY19E EV/EBITDA(adj.) of 19.6x – a c.19% premium to the median of 16.5x.

Notably, by our estimates IR trades on an unlevered FCF yield in FY19E of 2% versus

peers at 3.8%. We see downside risk.

Figure 1: Valuation

Source: Wilsons’ estimates

Valuation Methodology $/share % weight

DCF $2.98 33%

FCF Yield $2.03 33%

EV/EBITDA(adj.) $3.01 33%

Target price $2.65

06 June 2018

Software



Company overview

IR is a leading provider of systems performance management software across the Americas,

Europe and Asia Pacific through their primary product ‘Prognosis’. They service over 1,200

enterprise customers globally within a multitude of industries such as telcos, automotive,

financial services and many more.

Figure 2: Company overview

Source: Company disclosure

Product lines

IR’s Prognosis operates across four product lines which can be installed on premises or as

part of a hybrid environment. These modules include:

Unified Communications

Payments

Contact Center

IT Infrastructure

Figure 3: Product lines

Source: IRI annual report FY17

06 June 2018

Software



Figure 4: Product revenue breakdown


Unified Communications

UC is a product suite that enables a company’s communication software (think Skype for

business, IM, e-mail, telecoms, etc.) to be consolidated into a single dashboard. UC is

becoming increasingly necessary as companies continue to expand their digital platforms to

offer more forms of communication. The UC market is expected to grow at a 16.8% CAGR to

2024 reaching USD143bn.

One of the major drivers of UC investment is the adoption of Microsoft Skype for business.

Skype is now available as part of the Office 365 suite which has driven adoption. The

communication platform is attractive given a cost advantage. UC investment is required to

oversee all communications channels including Skype for business.

UC products have evolved to differentiate through offering services beyond single-platform-

consolidation such as real time systems analysis, data collection, real time quality

optimisation/streamlining methods and outage predictions. UC currently makes up the majority

of IR’s revenues at 61%.

Prognosis UC allows companies to:

Access and monitor an entire communication network from one dashboard.

Access and monitor communication networks before they are deployed. This is a

particularly powerful vertical because customers who transition to cloud solutions are

commonly unable to access their networks until the entire process is complete.

Upgrade and migrate UC solutions across different platforms and between on premises

and cloud.

Innovative call recording assurance.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY 13A FY 14A FY 15A FY 16A FY 17A FY 18E FY 19E FY 20E FY 21E

Unified Communications IT Infrastructure Payments Consulting

06 June 2018

Software



Figure 5: UC infrastructure example

Source: IR website

UC case study

BT, (British Telecom), is transitioning a number of customers from an on-site solution to the

cloud. During the transition, customers and BT service providers were able to monitor all

systems regardless of the disruption. Prognosis was used to provide a “streamlined dashboard”

that allowed these two parties to seamlessly transition to the cloud.

BT states that IR was chosen because it is “… scalable, multi-vendor capable and didn’t exist

in a silo.” BT is also a re-seller of IR product and industry contacts in the UK suggest a strong

pipeline through their re-sale channel.

Figure 6: UC case study snapshot

Source: IR website

06 June 2018

Software



Figure 7: UC Voice systems interface

Source: IR website

IT Infrastructure

The IT infrastructure module provides physical systems monitoring and server data analysis in

real time. This allows IT departments to anticipate possible outages, predict server loads and

better communicate issues to both customers and internal employees.

Infrastructure makes up 27% of group revenues but over the long term we see this vertical

declining as a percent of revenue due to flat industry growth conditions. In the short term the

division is cycling over some tough comps which could lead to weakness.

Prognosis’ IT infrastructure module enables:

Proactive troubleshooting through intelligent alerts and automation of the tasks involved

with fixing issues.

A top down view of an entire server from a single dashboard.

Real-time analysis of servers which allows IT staff to optimise their workflows.

Monitoring of firm-wide software updates, CPU balance and workloads and hardware

threshold breaches.

Figure 8: IT infrastructure revenue

Source: IRI, Wilsons

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

H114A

H214A

H115A

H215A

H116A

H216A

H117A

H217A

H118A

H218E

H119E

H219E

H120E

H220E

H121E

H221E

IT Infrastructure %Revenue %Growth

06 June 2018

Software



Payments

Prognosis’ Payments solution helps customers to understand the performance of their

transactions systems and to analyse the issues which push performance down. Capabilities

include the monitoring of payment switches and fraudulent payment detection. The payments

solution makes up 8% of group revenue and we have a positive view on its growth going

forward. Our estimates assume that it will continue to grow at a 12.4% CAGR FY18E-21E.

Key product features include:

Real-time data feeds on the performance of ATM fleets and point of sale (POS) systems.

Insights on machine faults and fraudulent activity.

Minimisation of outages through real-time troubleshooting.

Automation and/or alerts on regulatory compliance protocols

Figure 9: Payments fraud detection

Source: IR website

Figure 10: Payments analytics dashboard

Source: IR website

06 June 2018

Software



Figure 11: Payments revenue


Consulting Services

IR’s consulting service offers customers expertise in optimising their IT solutions and is mainly

focused on the initial analysis and installation process. Consulting makes up 7% of group

revenue as at 1H18A.

Competitive landscape

Key competitive advantages:

According to Nemertes’ research, IR’s customers enjoy the lowest OPEX per user end-

point – 33% and 56% lower than direct comps Riverbed and Nectar respectively.

Having a laser focus on UC solutions (61% of revenue) allows the majority of IR’s

resources to be devoted into the depth of Prognosis. Competitors with a suite of revenue

streams are largely producing a “good enough” service.

Broad multi-vendor integration capability allows IR to manage complex hybrid

environments such as systems transitions or a particularly diverse client software base. IR

is the only provider to be certified across Microsoft, Avaya and CISCO networks.

Continual investment in key supplier networks increases their TAM and drives further

build-out of their relationships. This is particularly important given the positive feedback

loop between more customers, more data and better product.

Probe-less solution means that customers do not have to install physical probes into their

systems for monitoring. The advantage of this is that set-up becomes faster and less

intrusive.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

FY 13A FY 14A FY 15A FY 16A FY 17A FY 18E FY 19E FY 20E

Payments %Revenue %Growth

06 June 2018

Software



Figure 12: Competitive overview

Company Description Pros vs IRI Cons vs IRI

Nectar

Nectar is very close operationally to IR and operates out of Jericho, New York. Nectar is likely the most important competitor for IR.

Evolution quality of service (QoS) solution is market leading, having been named a winner in the 2017 UC Product of the Year award by TMC. Evolution is UC device agnostic.

Call Analysis is more fleshed out than IR’s and offers call stitching, vendor knowledge modules and Call Detail Records (CDRs).

Uses probes to monitor the digital landscape versus IR’s probe-less solution.

Higher OPEX cost per user endpoint.

Riverbed

Riverbed is San Francisco based and offers multiple software solutions globally across various verticals including UC.

A broad range of products on offer drives scale and cross sales capability.

Larger customer base across more geographies.

Riverbed’s UC product is not as “deep” as IR and could be viewed as a “good enough” solution.

Higher OPEX cost per user end point.


CISCO Prime

CISCO was founded in 1984 in San Francisco. Although CISCO is a distributer of IR’s product, CISCO Prime has maintained its own monitoring solution outside of IR’s.

Backed by CISCO which operates on a much larger scale than IR in terms of both revenues and customers.

More developed cloud offering allows them to address an additional market.

Appears to be a “good enough” solution versus IR’s more focused and deep Prognosis.

Mitel

Mitel focuses primarily on offering VoIP services globally and is based out of Canada. While Mitel’s services are more heavily slanted to the ‘platform provider’ space, they still do control the number 1 UC market share in Europe.

Mitel operates on a much larger scale than IR.

Currently controls the number 1 market share of UC in Europe.

More diversified product offering raises TAM.

UC cloud product gives Mitel access to the fast growing cloud vertical.


A larger product suite leads to a less focused UC solution where IR is able to focus all of its efforts in this space.

Does not control the same superlative distribution network as IR and while scale somewhat makes up for this, it does not provide a truly environmentally agnostic service.

NEC

NEC is a Japanese provider of IT services that operates on a global scale. NEC is a member of the Sumitomo Group.

Large-scale corporation with an expansive product range means that NEC operates on a much larger scale than IR.

Larger product suite drives TAM and cross sale opportunities.

IR is able to provide a probe-less solution.

NEC is primarily focused on the Japanese market with little footprint throughout Europe and America.

Source: Wilsons

Figure 13: Annual OPEX per end-point


06 June 2018

Software



Entrenched customer base

Prognosis solutions are offered across 16 million devices within 1,200+ enterprise customers

globally. Customers exist across a wide range of industries including automotive, banking,

telcos and many more.

Customers appear to be largely entrenched as evidenced by a 97% maintenance renewal

rate.

Prognosis is certified with and run across the Microsoft, Cisco and Avaya platforms which

widens the addressable market.

Of particular note is the Cisco partnership where Prognosis’ UC, Video and Contact Centre

modules are offered under the Cisco SolutionsPlus Program.

Figure 14: Recurring revenues


Figure 15: Global reach


55.165.8

76.3 78.790.3

102.8116.9

16.6

19.714.5

18.2

18.6

19.2

19.4

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

FY15A FY16A FY17A FY18E FY19E FY20E FY21E

Recurring Revenue Non-Recurring Revenue

06 June 2018

Software



Figure 16: Key customers

Distribution Partners Customers

Microsoft Hewlett Packard

CISCO BT

Avaya Wells Fargo

ACI Sprint

Hewlett Packard AMEX

Dell

Boeing


Continued customer base growth

Growing digitisation trends give us confidence in IR’s addressable market going forward. This

trend describes the continual adoption of software solutions to aid in the completion of day-to-

day tasks. Adoption arises due to perceived efficiency gains, medium-term cost savings and

increased functionality from the software employed. Additionally, increases in modules on offer

and further partnerships contribute to a growing TAM. Drivers for customer growth include:

Digital transformation: A study by independent researcher Nemertes points out that

nearly 70% of organisations are undergoing a digital transformation. This gives us

increased confidence in revenue visibility going forward and we forecast an 87% recurring

revenue mix.

UC budget growth: 50% of the companies observed by Nemertes plan to increase their

2018 UC budget by 12.3% on average. This has the potential to drive cross-sales going

forward.

Increasing modularity: Additional solutions are being added such as compliant call

recording and additional cloud capabilities. We see headroom for increased recurring

revenues and operational leverage in future years.

Competitive cost save: According to Nemertes’ research, IR customers enjoy the lowest

OPEX spend per user end point versus their closest operational competitors Event Zero,

Riverbed and Nectar. This should act as an attractive sales point to new customers.

Growing addressable market: IR’s most recent distribution partnership was struck with

CISCO on the 19th September 2017. As IR continues to add to this portfolio of distribution

partners their TAM will grow as well.

Figure 17: Customer trends

Source: Nemertes Research

06 June 2018

Software



Commitment to R&D

We see IR’s continuing commitment to R&D investment as a key positive.

R&D positives:

$106m of vested gross R&D for the past 5 years represents 30% of total revenue over the

same period.

Commitment to net R&D at 18% of sales going forward represents a return to the prior 5-

year average after a tough cash year in FY16.

We note that IRI has consistently upgraded Prognosis over time with new modules and

system streamlining.

Figure 18: R&D profile


42.2%41.9% 42.1%

41.3%36.6%

35.7%

24.7%23.1%

18.8% 16.6%

14.7%17.5%

22.1%

20.8%17.7%

16.1%

16.3%18.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

FY 13A FY 14A FY 15A FY 16A FY 17A FY 18E

Net R&D Capitalised R&D

% of R&D capitalised Gross R&D % of Total Revenue

Net R&D % Total Revenue

06 June 2018

Software



Cash flow headwinds

Figure 19: Perpetual licensing


Figure 20: Term-based licensing


We see a number of headwinds for cash in the coming 24 months caused by a combination of

the licensing structure change outlined in figures 19 and 20 and H2 slippage risks.

OpCF conversion as a percent of revenue should decline short term with a mixture of H2

risk and a larger accounts receivable balance. We forecast FY18E OpCF/Revenue at

16.4% which is down 12% pcp.

Cash receipts conversion should decline from historical levels due to higher term-based

Licences in the mix being recognised through the P&L similar to perpetual Licences but

having cash recognised in instalments.

Maintenance fees should decline as a percentage of revenues because of a continual

push (largely through pricing) towards term-based licensing versus perpetuals.

IR is writing deferred payments business which will materialise in a high accounts

receivables balance and could cause working capital headwinds.

P&L

Large, Upfront

Licence Fee

B/SC/F

Large, Upfront

Licence FeeNo Impact

Annual

Maintenance

Fee

Cash Every

Year

Yearly Deferred

Revenue

P&L

Term Licence

(3-5 Yrs.)

B/SC/F

Instalments

Over 3-5 Yrs.

Deferred

Revenue Over

3-5 Yrs.

Annual

Maintenance

Fee

Cash Every

Year

Yearly Deferred

Revenue

06 June 2018

Software



Figure 21: FCF conversion


Figure 22: Deferred revenue


Light at the end of the tunnel

It is important to note that while cash will feel pressure in the coming 24 months, if IR is able

to stabilise through this timing disruption there should be no change to the cash generative

natures of the business in the long run. We look to FY20E as the year of stabilisation.

Additionally, in FY15 CISCO purchased a number of Prognosis Licences as part of a large US

Government cloud-solution contract. If CISCO returns for further licences, this could de-rail our

SELL rating by providing short-term cash support. The magnitude of CISO’s original Licence

purchase for 7m Government users is $2.1m per month – we note that under current

conversion rates this would equate to an additional $6m of OpCF in FY19E.

11.3

6.2

16.3

5.1

13.2

18.3

21.5

16.0%

7.3%

17.9%

5.2%

12.1%

15.0% 15.7%

41.2%

19.8%

42.5%

13.5%

31.3%

38.1%39.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

0.0

5.0

10.0

15.0

20.0

25.0


Free cash flow ($m) FCF as % of revenue

FCF conversion (% of EBITDA)

11.8 13.6

18.720.4 20.1

21.3

24.5

28.7

33.4

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

FY 13A FY 14A FY 15A FY 16A FY 17A FY 18E FY 19E FY 20E FY 21E

Deferred Revenue

06 June 2018

Software



Financials

Revenue model

IRI currently generates 85% of revenues through licence and maintenance fees – historically

this was 90%. IRI previously focused on long-term (c.10yr) term-based licences however

shifted towards perpetual licensing c.2009 where licence fees were recognised upfront through

revenue and maintenance fees were annually recognised as deferred revenue. More recently,

IR has been pushing for a larger portion of term-based business which should see maintenance

declining in the revenue mix.

The remaining 15% of revenue is derived from testing solutions and consulting fees which

fluctuate in the mix due to 50% of testing solutions being one-off and consulting fees being

entirely one-off.

Licence fees: This revenue stream is primarily derived from the sale of term-based

licences for Prognosis. IR takes 3-5 year licences to revenue initially and each year

recognises an annual fee. These annual fees are booked as deferred revenue and

materialise yearly. We forecast FY18E-21E CAGR of 17%.

Maintenance fees: Recognised rateably to the P&L over the contract term. Given an

increasing mix of term-based licensing where maintenance as a percentage of Licence

value drops, we forecast flat maintenance fees. We estimate FY18E-21E CAGR of 0.9%.

Consulting and Testing Solutions fees: Typically non-recurring sources which are

recognised over the service period as work is performed. We forecast consulting and

testing solutions revenue to grow at an FY18E-21E CAGR of 4% and 17% respectively.

Figure 23: Regional breakdown


IR’s group wide NPAT has a 4.8% delta to a one cent change in the AUD/USD rate and a

1.6% delta to a once cent change in AUD/GBP.

In future years we expect licences to increase as a percentage of revenues due to declining

maintenance fees in term based licensing and growing UC and payments verticals.

IT infrastructure posted -16% revenue growth in 1H18A which we forecast decreasing a further

-10% in 2H18E leading to a full-year estimate of $21m. This is largely driven by a slowing IT

infrastructure market.

67.9%

17.0%

14.7%

Americas % of Revenue Europe % of Revenue APAC % of Revenue

06 June 2018

Software



Figure 24: Revenue breakdown


P&L forecasts

Revenues: We see revenues being driven primarily by UC licence sales which are

currently growing at 25% at 1H18A with our forecasts assuming c.20% growth in 2H18E.

IT Infrastructure will likely struggle over the long term and we forecast -12% growth in

FY18E. We forecast solid growth in payments from FY19E onwards as the solution gains

further traction – we forecast 12% CAGR FY18E-21E. Recurring revenues should take a

hit short term with maintenance fees declining as a percentage of total revenue but as

more term-based licences come through this should begin to climb again.

EBITDA: Given that high margin licences make up the large majority of revenues, EBITDA

margins should remain relatively solid at c.39% over the coming years. That said, this is a

-3.4% decline from FY17 margins at 42% and is caused by increasing net R&D (FY17 was

low due to cash crunch in FY16) and increasing S&M with +45% FTEs in the UK and more

to come (c.4/5 per annum).

NPAT: We note that with a decrease in US tax rates, IR’s deferred tax assets will be de-

valued and lead to a higher effective tax rate of c.30% in FY18E. This will likely decrease

towards 28% in the coming years. This leads us to a normalised NPAT estimate of $18.9m

in FY18E which is -7.7% below consensus at $20.5. Consensus does not appear to have

catered for this re-evaluation followed up a declining tax rate long term.

Figure 25: Wilsons vs consensus


23.7 27.2 26.9 27.0 27.2 27.4 27.7

4.3 4.1 5.2 6.3 7.4 8.3

41.0

45.7 53.4 57.7 68.1

79.7 92.4

5.5

7.4 6.8

7.0

7.2

7.5

7.9

76.8%

77.0%

84.0%

81.2%

82.9%

84.3%

85.8%

70%

72%

74%

76%

78%

80%

82%

84%

86%

88%

0

20

40

60

80

100

120

140

160


Maintenance fees Testing Solution feesLicence fees Consulting fees% recurring revenue

Wilsons Est. vs Consensus

ASX:IRI

Wilsons Est. Cons % diff Wilsons Est. Cons % diff Wilsons Est. Cons % diff

Revenue 96.9 98.2 -1.3% 108.8 117.7 -7.5% 122.0 136.3 -10.5%

EBITDA 37.6 39.9 -5.7% 42.2 46.5 -9.2% 47.9 54.1 -11.4%

EBIT 26.7 28.5 -6.1% 31.3 34.6 -9.4% 36.0 41.6 -13.5%

NPAT 18.9 20.5 -7.7% 22.7 25.2 -9.9% 26.1 30.4 -14.1%

EPS 11.0 12.1 -9.3% 13.1 14.8 -11.3% 15.1 17.7 -14.9%

FY 18E FY 19E FY 20E

06 June 2018

Software



Figure 26: P&L summary


Figure 27: Revenue forecasts

Figure 28: EBITDA forecasts

Source: IRI, Wilsons Source: IRI, Wilsons

P&L (A$m)

Y/E: 30 Jun FY15A FY16A FY17A FY18E FY19E FY20E FY21E

Licence fees 41.0 45.7 53.4 57.7 68.1 79.7 92.4

% growth 46.3% 11.4% 16.9% 8.0% 18.0% 17.0% 16.0%

Maintenance fees 23.7 27.2 26.9 27.0 27.2 27.4 27.7

% growth 15.3% 14.6% -1.0% 0.5% 0.7% 0.9% 1.1%

Testing Solution fees 0.0 4.3 4.1 5.2 6.3 7.4 8.3

% growth - -5.0% 27.0% 22.0% 17.0% 12.0%

Consulting fees 5.5 7.4 6.8 7.0 7.2 7.5 7.9

% growth 19.7% 32.8% -7.9% 3.0% 3.5% 4.0% 4.5%

Revenue 70.3 84.5 91.2 96.9 108.8 122.0 136.3

% growth 32.0% 20.3% 7.9% 6.3% 12.3% 12.1% 11.7%

EBITDA (norm.) 27.3 31.3 38.3 37.6 42.2 47.9 54.5

margin 38.9% 37.0% 42.0% 38.8% 38.7% 39.3% 40.0%

% growth 46.5% 14.6% 22.3% -1.8% 12.2% 13.7% 13.6%

D&A 9.1 10.6 11.3 10.9 10.9 12.0 13.4

EBIT 18.2 20.7 27.0 26.7 31.3 36.0 41.1

margin 25.9% 24.4% 29.6% 27.6% 28.8% 29.5% 30.2%

% growth 64.1% 13.5% 30.6% -1.0% 17.2% 14.8% 14.4%

Net interest expense/(income) -0.3 0.0 -0.2 -0.2 -0.2 -0.2 -0.3

Profit before tax 18.5 20.7 27.2 27.0 31.6 36.2 41.5

Tax expense -5.0 -5.4 -7.4 -8.1 -8.8 -10.1 -11.6

NPAT (norm.) 13.5 15.3 19.8 18.9 22.7 26.1 29.9

margin 19.2% 18.1% 21.7% 19.5% 20.9% 21.4% 21.9%

% growth 44.8% 13.8% 29.0% -4.6% 20.4% 14.7% 14.6%

Abnormals 0.8 0.7 -1.3 -0.4 -0.4 -0.5 -0.5

NPAT (reported) 14.3 16.0 18.5 18.5 22.3 25.6 29.3

Diluted EPS (based on NPAT norm.) (cps) 7.9 8.9 11.5 11.0 13.1 15.1 17.2

% growth 44.0% 13.3% 29.0% -4.8% 19.6% 14.7% 14.6%

52.7 58.0 64.3 70.5

80.3 89.9

100.7 10.2

17.2 14.9

17.3

20.0

22.4

25.1

8.9

10.3 11.6

9.1

8.5

9.7

10.5

32.0%

19.1%

6.3%

6.7%

12.3%12.1%

11.7%

0%

5%

10%

15%

20%

25%

30%

35%

0

20

40

60

80

100

120

140

160


Americas Europe Asia Pacific Group revenue growth %

27.3

31.3

38.3 37.6

42.2

47.9

54.5

38.9%

37.0%42.0%

38.8%38.7% 39.3% 40.0%

64.1%

13.5%

30.6%

-1.0%

17.2%

14.8%

14.4%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

0

10

20

30

40

50

60


EBITDA ($m) EBITDA margin EBITDA growth

06 June 2018

Software



Figure 29: NPAT forecasts

Figure 30: R&D forecasts


Cash flow

We see material headwinds to cash flows in the coming 24 months despite having only c.15%

perpetual Licence customers left on the books to cycle through. This is for a number of reasons:

Accounts receivable: IR is writing deferred payments business which materialises in a

high accounts receivables balance. Receivables days in 1H18A were 267 compared to

237 at FY17 – we see this increasing going forward. This large increase in accounts

receivable materialises in significant working capital headwinds in FY18E.

Deferred revenue: Deferred revenue is likely to increase in coming years which somewhat

cushions headwinds caused by accounts receivable. This is due to part of term-based

licence being booked as deferred revenue. We forecast deferred revenue increasing to

c.25% by FY21E versus 22% in FY17A.

Operating cash flow: We forecast operating cash flow well below consensus at $15.9m

for FY18E. The catalyst which may de-rail our thesis is FedRAMP where CISCO had

previously purchased Prognosis Licences in FY15 for a large government cloud contract.

If CISCO returns for further sales before FY20, IR could see some OpCF respite through

earnings.

Free cash flow: Given decreasing upfront recognition our FY18E FCF/Revenue sits at

5% – a material de-rate from 18% in FY17A. We see this recovering somewhat over the

coming years as the deferred revenue increases outpace accounts receivable driving a

less demanding WC cycle and subsequently higher FCF.

Cash receipts: Cash receipt conversion should continue to decline in the long term due

to the term-based licence structure.

13.515.3

19.818.9

22.7

26.1

29.944.8%

13.8%

29.0%

-4.6%

20.4%

14.7%14.6%

-10%

0%

10%

20%

30%

40%

50%

0

5

10

15

20

25

30

35


NPAT (norm.) ($m) NPAT growth

42.2%41.9% 42.1%

41.3%36.6%

35.7%

24.7%23.1%

18.8% 16.6%

14.7%17.5%

22.1%

20.8%17.7%

16.1%

16.3%18.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

FY 13A FY 14A FY 15A FY 16A FY 17A FY 18E

Net R&D Capitalised R&D

% of R&D capitalised Gross R&D % of Total Revenue

Net R&D % Total Revenue

06 June 2018

Software



Figure 31: FCF forecasts

Figure 32: OpCF ex. cap. R&D


Figure 33: Licence structure cash receipt effects

Figure 34: OpCF profile


11.3

6.2

16.3

5.1

13.2

18.1

21.6

16.0%

7.3%

17.9%

5.2%

12.1%

14.9% 15.8%

41.2%

19.8%

42.5%

13.5%

31.3%

37.8%39.6%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

0.0

5.0

10.0

15.0

20.0

25.0


Free cash flow ($m) FCF as % of revenue

FCF conversion (% of EBITDA)

32%

34%

36%

38%

40%

42%

44%

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0


OpCF ex. Cap. R&D OpCF % R&D Capitalised

104%

102%88%

88%

98%

87%

74%

62%

53%

0%

20%

40%

60%

80%

100%

120%

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY21E

Revenue Receipts Conversion %

21.4

16.2

25.8

15.9

25.9

32.4

37.578.4%

51.8%

67.3%

42.4%

61.5%

67.6% 68.9%

30.5%

19.2%

28.3%

16.4%23.8%

26.6%

27.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

5

10

15

20

25

30

35

40


Operating cash flow ($m) OpCF %EBITDA OpCF %Revenue

06 June 2018

Software



Figure 35: Cash flow summary


Cash flow summary (A$m)


NPAT 14.3 16.0 18.5 18.5 22.3 25.6 29.3

Non cash adjustments 9.5 24.4 40.5 56.9 67.3 86.3 109.0

Net change in WC -5.1 -11.2 -5.3 -14.8 -7.6 -5.6 -5.7

Others 2.8 -13.0 -28.0 -44.7 -56.0 -73.8 -95.0

Net operating cash flow (A$m) 21.4 16.2 25.8 15.9 25.9 32.4 37.5

Operating cash flow conversion 78.4% 51.8% 67.3% 42.4% 61.5% 67.6% 68.9%

Capitalised development costs -9.0 -9.6 -8.6 -9.7 -11.4 -12.8 -14.3

Payment for PPE -1.0 -0.3 -0.8 -1.0 -1.1 -1.2 -1.4

Others 0.2 -1.2 0.2 -0.2 -0.2 -0.2 -0.3

Net cash flow from investing (A$m) -9.9 -11.1 -9.2 -10.9 -12.7 -14.3 -15.9

Net cash flow from financing (A$m) -10.2 -12.0 -11.2 -11.1 -10.8 -13.1 -15.0

Net cash inflow/(outflow) 1.4 -6.9 5.4 -6.1 2.4 5.1 6.6

Opening cash balance 13.3 15.3 8.5 14.1 8.1 10.5 15.6

Fx impact 0.6 0.1 -0.2 0.0 0.0 0.0 0.0

Closing cash balance 15.3 8.5 14.1 8.1 10.5 15.6 22.1

Net operating cash flow 21.4 16.2 25.8 15.9 25.9 32.4 37.5

Less: capex and R&D -10.0 -9.9 -9.4 -10.7 -12.5 -14.0 -15.7

Free cash flow ($m) 11.3 6.2 16.3 5.1 13.2 18.1 21.6

FCF grow th (%) 55% -45% 163% -69% 160% 37% 19%

FCF as % of revenue 16% 7% 18% 5% 12% 15% 16%

FCF conversion (% of EBITDA) 41% 20% 43% 14% 31% 38% 40%

06 June 2018

Software



Balance Sheet

IR’s balance sheet has no debt and modest cash of $9.6m at 1H18A. We expect FY18E to be

a tough year for cash however this balance will likely increase in future years as WC tailwinds

from deferred revenues outpaces accounts receivable headwinds.

Figure 36: Cash forecasts


Deferred revenue improving: IR’s balance sheet contains a sizeable $20.5m of deferred

revenue at 1H18A. We forecast this increasing as the term-based model takes licence

fees to deferred revenues.

Tax liability and assets re-valuation: Due to a decrease in the US corporate tax rate, IR

should experience a net devaluation of tax assets and liabilities. This leads us to an

effective tax rate of 30% in FY18E which we see declining towards 28% into FY21E.

Accounts receivable investment: IR carries significant current and non-current accounts

receivable of $67m. This may increase even faster than we have forecast given the nature

of cloud Licences which may be an increasing mix of licence fees going forward. We

expect total accounts receivable of $76m for the full year ‘18.

Intangibles: Largely made up of capitalised R&D and ongoing goodwill from acquisition

of IQ services In FY15.

15.3

8.5

14.1

8.1

10.5

15.6

22.1

0

5

10

15

20

25


Net cash (A$m)

06 June 2018

Software



Figure 37: Balance Sheet summary


Balance Sheet (A$m)


Assets

Cash and cash equivalents 15.3 8.5 14.1 8.1 10.5 15.7 22.1

Trade and other receivables 25.0 29.0 36.0 43.8 50.9 57.4 64.6

Current tax asset 0.2 0.2 1.2 1.4 1.4 1.4 1.4

Other current assets 1.3 1.8 1.9 1.2 1.2 1.2 1.2

Total current assets 41.9 39.5 53.1 54.4 64.0 75.7 89.3

Receivables 13.3 23.4 23.3 31.9 37.1 41.8 47.1

Other f inancial assets 0.8 0.8 0.2 0.2 0.2 0.2 0.2

Property, plant and equipment 2.0 1.8 1.9 2.1 2.4 2.7 3.0

Intangible assets 17.0 22.0 19.9 19.7 21.3 23.3 25.5

Deferred tax assets 1.3 1.5 1.1 0.8 0.8 0.8 0.8

Total non-current assets 34.4 49.5 46.4 54.7 61.8 68.8 76.6

Trade and other payables 7.2 8.5 9.6 10.2 11.0 12.0 13.0

Provisions 2.3 2.6 2.6 3.1 3.5 3.7 4.0

Income tax liabilities 1.7 3.4 4.3 2.9 3.2 3.7 4.2

Deferred revenue 18.7 20.4 20.1 21.3 24.5 28.7 33.4

Other current liabilities 0.6 0.0 0.0 0.0 0.0 0.0 0.0

Total current liabilities 30.6 34.9 36.6 39.0 43.7 49.5 56.1

Deferred consideration for acquisition 0.0 2.0 1.5 0.0 0.0 0.0 0.0

Deferred tax liabilities 4.4 3.9 3.4 3.4 3.4 3.4 3.4

Provisions 0.9 1.0 0.9 0.9 0.9 0.9 0.9

Deferred revenue 3.8 5.6 8.4 9.3 9.3 9.3 9.3

Other non‑current liabilities 0.4 0.5 0.2 0.7 0.8 0.9 1.0

Total non-current liabilities 9.5 13.0 14.4 14.3 14.4 14.5 14.6

Net assets 36.1 41.0 48.5 55.8 67.6 80.5 95.2

Issued capital 1.7 1.7 1.7 1.7 1.7 1.7 1.7

Reserves 0.9 1.7 1.8 2.1 2.1 2.1 2.1

Retained earnings 33.5 37.7 45.1 52.1 63.9 76.8 91.5

Total equity 36.1 41.0 48.5 55.8 67.6 80.5 95.2

06 June 2018

Software



Valuation: Impending de-rate

We see significant risk to IR’s current valuation which trades at a premium to peers. The

following points drive our SELL rating:

FY19E P/E of 23x is in line with peers at 24x however FCF yield at 2.2% is -42% below

peers at 3.8%. We do note that IR’s EPS growth is strong at 22% for FY19E versus peers

at 14% however we feel that the cash flow risk outweighs this. This view is reinforced by

the observation that on all multiples which fully account for capitalised development costs,

IR trades at a significant premium to peers.

Fully expensing capitalised R&D puts IRI on an FY19E EV/EBITDA (adj.) of 19.6x vs our

coverage at 16.5x. Applying the same method to OpCF, IR trades at an FY19E

EV/OpCF(adj.) of 43.7x times versus peers at 20.2x – greater than 100% more than a

sample space including Xero and ELO.

H2 leverage leading to slippage risk should demand some risk premium in our view given

that H2 trades through the Christmas period.

While recurring revenues are strong at 87%, this may be misleading as they do not capture

short-term renewal tenor which is a key litmus test for the business’ cash flow risk or safety

in future years. Given the shift to term-based licences this should drop in the short term

but naturally increase over time.

Cash flow headwinds over the coming 24 months decrease business optionality and

increase risk. The de-railing factor to this thesis is FedRAMP which may provide short-

term cash flows if this revenue stream mobilises swiftly – we ascribe a low probability to

this outcome.

We see a material risk for a consensus de-rate.

We use an even mixture of DCF, EV/EBITDA(adj.) and FCF yield to value IRI. We feel that a

DCF captures the short-term cash flow risk but does not ignore the longer-dated normalisation

of cash. EV/EBITDA (adj.) is selected because it allows us to compare IRI on a L4L basis to

relevant technology comps without a high R&D capitalisation rate colouring the output. FCF

yield is used because it effectively captures our short-term cash flow views and is an important

metric for technology companies with a lower revenue growth profile.

Figure 38: Valuation methodology


Valuation Methodology $/share % weight

DCF $2.98 33%

FCF Yield $2.03 33%

EV/EBITDA(adj.) $3.01 33%

Target price $2.65

06 June 2018

Software



Figure 39: EV/EBITDA (adj.) multiples


Figure 40: EV/OpCF(adj.) multiples


0.0x

5.0x

10.0x

15.0x

20.0x

25.0xE

ML

Pa

ym

en

ts L

imite

d

Recko

n L

imite

d

Me

lbo

urn

e IT

Lim

ite

d

MY

OB

Gro

up

Lim

ited

Cla

ss L

imited

Te

ch

no

log

y O

ne

Lim

ited

Bra

vura

So

lutio

ns L

imite

d

Inte

gra

ted

Re

sea

rch

Lim

ite

d

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

40.0x

45.0x

50.0x

Elm

o S

oft

ware

Lim

ited

EM

L P

aym

en

ts L

imite

d

Recko

n L

imite

d

AR

Q G

rou

p L

imite

d

MY

OB

Gro

up

Lim

ited

Cla

ss L

imited

Te

ch

no

log

y O

ne

Lim

ited

Inte

gra

ted

Re

sea

rch

Lim

ite

d

06 June 2018

Software



DCF Assumptions

Margins: We see margins improving slightly over time as operational leverage comes

through from declining costs and potential cross sales. We see operating margins climbing

to 31.4% over the long run.

Capex and D&A: IR’s D&A has been substantially above their Capex for the previous five

years and is largely driven by high R&D capitalisation and low PPE. We note that R&D

capitalisation may include growth or maintenance R&D.

WACC: We assume a WACC of 9.4% to reflect the more consolidated nature of the

business versus our remaining coverage universe. Despite short-term cash headwinds,

we do see headroom for cash stabilisation in future years. Of note is that ROIC has been

consistently high at 42% on average since FY15 compared to FCF ROIC at 30% on

average. This coupled with our more positive long-term view reinforces our choice of a

slightly lower WACC compared to our coverage.

Figure 41: DCF assumptions

Source: Wilsons

DCF Assumptions (30 June Y/E) 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E

Revenue grow th 6.3% 12.3% 12.1% 11.7% 12.2% 12.6% 12.9% 13.1% 13.2% 13.2%

Operating margin (EBIT) 27.6% 28.8% 29.5% 30.2% 30.4% 30.6% 30.8% 31.0% 31.2% 31.4%

EBITDA margin 38.8% 38.7% 39.3% 40.0% 40.1% 40.2% 40.2% 40.2% 40.2% 40.1%

D&A / Revenue 11.2% 10.0% 9.8% 9.8% 9.7% 9.6% 9.4% 9.2% 9.0% 8.7%

Capex / Revenue 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%

Capitalised R&D and intangibles capex / Revenue 10.2% 10.7% 10.7% 10.7% 10.6% 10.5% 10.4% 10.3% 10.2% 10.1%

Working capital grow th 179.0% -48.3% -27.9% 5.4% 12.2% 12.6% 12.9% 13.1% 13.2% 13.2%

Tax rate 30.3% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2%

DCF cash flows 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E TV

Revenue 96.9 108.8 122.0 136.3 152.9 172.2 194.4 219.9 248.9 281.8

Operating profit (EBIT) 26.7 31.3 36.0 41.1 46.4 52.6 59.8 68.1 77.6 88.4

% growth 17.2% 14.8% 14.4% 12.9% 13.3% 13.6% 13.8% 13.9% 13.9%

EBITDA 37.6 42.2 47.9 54.5 61.3 69.2 78.1 88.3 100.0 112.9

Tax benefit/(expense) (8.1) (8.8) (10.1) (11.6) (13.1) (14.9) (16.9) (19.2) (21.9) (25.0)

EBIT (1-t) 18.6 22.5 25.8 29.5 33.3 37.8 42.9 48.9 55.7 63.4

Add back D&A 10.9 10.9 12.0 13.4 14.8 16.5 18.3 20.2 22.4 24.5

Deduct capex (1.0) (1.1) (1.2) (1.4) (1.5) (1.7) (1.9) (2.2) (2.5) (2.8)

Deduct capitalised softw are development and intangibles capex (9.9) (11.6) (13.1) (14.6) (16.2) (18.1) (20.2) (22.6) (25.4) (28.5)

Change in net working capital (14.8) (7.6) (5.5) (5.8) (6.5) (7.3) (8.3) (9.4) (10.6) (12.0)

FCFF 3.9 13.0 18.0 21.1 23.9 27.2 30.8 34.9 39.6 44.7 782.3

Discount factor 0.1 1.1 2.1 3.1 4.1 5.1 6.1 7.1 8.1 9.1 9.1

Present value 3.9 11.8 15.0 16.0 16.6 17.2 17.8 18.5 19.2 19.8 346.1

06 June 2018

Software



Figure 42: ROIC forecasts


Figure 43: Peer comparison table

Source: S&P Capital IQ

ROIC 2015 2016 2017A 2018E 2019E 2020E 2021E

EBIT (norm.) 18.2 20.7 27.0 26.7 31.3 36.0 41.1

Tax expense/(benefit) 5.0 5.4 7.4 8.1 8.8 10.1 11.6

NOPAT 13.2 15.3 19.6 18.6 22.5 25.8 29.5

Free Cash Flow (m) 11.3 6.2 16.3 5.1 13.2 18.3 21.5

Net Working Capital 9.0 19.3 24.5 39.3 46.9 52.4 58.2

Fixed Assets 2.0 1.8 1.9 2.1 2.4 2.7 3.0

Intangible Assets 17.0 22.0 19.9 19.7 21.3 23.3 25.5

Invested Capital 28.0 43.0 46.3 61.1 70.6 78.4 86.8

ROIC 47.0% 35.6% 42.3% 30.5% 31.8% 32.9% 34.0%

FCF ROIC 40.2% 14.4% 35.1% 8.3% 18.7% 23.3% 24.7%

ROE 36.5% 37.3% 40.4% 33.4% 33.2% 32.1% 31.0%

Invested Capital Excluding Intangibles 11.0 21.0 26.4 41.4 49.3 55.1 61.2

ROIC Excluding Intangible Assets 119.9% 72.7% 74.3% 45.0% 45.6% 46.9% 48.2%

FCF (%) / Invested Capital 40.2% 14.4% 35.1% 8.3% 18.7% 23.3% 24.7%

FCF (%) / Invested Capital (ex intangibles) 102.3% 29.4% 61.7% 12.3% 26.8% 33.1% 35.0%

IRI Comparable Company Analysis

Data as at: 06/06/2018

Company Name Ticker Currency Year-end Mkt cap

(m) FY18 FY19 FY20 FY18 FY19 FY20 FY18 FY19 FY20 FY18 FY19 FY20 FY18 FY19 FY20 FY18 FY19 FY20

Domestic Software

MYOB Group Limited ASX:MYO AUD 31-Dec 1,689 10.8x 10.2x 9.2x 4.5x 4.1x 3.8x 16.5x 15.8x 14.1x 77% 5% 12% 42% 41% 42% 6.2% 6.2% 7.5%

Xero Limited ASX:XRO NZD 31-Mar 5,846 75.3x 42.0x 27.8x 10.6x 8.2x 6.5x NM 115.8x 63.9x -160% 432% 82% 14% 20% 23% 0.4% 0.8% 0.3%

Altium Limited ASX:ALU USD 30-Jun 2,922 48.4x 38.7x 32.2x 16.0x 13.5x 11.5x 58.2x 47.2x 39.4x 149% 24% 20% 33% 35% 36% 1.7% 2.4% 2.9%

Hansen Technologies Ltd ASX:HSN AUD 30-Jun 847 13.4x 12.4x 11.9x 3.7x 3.5x 3.4x 20.6x 19.0x 18.3x 86% 8% 4% 27% 28% 28% 5.1% 5.3% 5.8%

Class Limited ASX:CL1 AUD 30-Jun 285 16.6x 13.7x 11.5x 7.7x 6.5x 5.6x 34.0x 27.1x 22.5x 16% 26% 20% 46% 47% 48% 2.3% 3.4% 4.6%

IRESS Limited ASX:IRE AUD 31-Dec 1,842 15.8x 14.3x 13.1x 4.3x 4.1x 3.8x 24.1x 21.2x 18.7x 53% 13% 14% 27% 28% 29% 4.4% 5.2% 5.5%

Isentia Group Limited ASX:ISD AUD 30-Jun 168 6.8x 6.2x 5.9x 1.6x 1.6x 1.5x 10.3x 9.3x 8.8x 58% 11% 6% 24% 26% 26% 13.1% 12.5% 13.1%

Infomedia Ltd. ASX:IFM AUD 30-Jun 284 9.7x 7.9x 6.9x 3.7x 3.3x 3.0x 23.1x 18.5x 15.5x 24% 25% 20% 38% 42% 44% 2.6% 4.9% 7.3%

Wisetech Global Limited ASX:WTC AUD 30-Jun 4,548 59.6x 43.4x 33.1x 20.9x 16.0x 13.1x 105.2x 71.8x 50.8x 58% 47% 41% 35% 37% 40% -2.8% 0.1% NM

Technology One Limited ASX:TNE AUD 30-Sep 1,366 18.9x 16.4x 14.4x 4.4x 4.0x 3.5x 27.4x 23.6x 20.8x 16% 16% 15% 23% 24% 24% 3.7% 3.9% 4.6%

Bravura Solutions Limited ASX:BVS AUD 30-Jun 696 18.1x 15.6x 14.1x 3.2x 2.9x 2.7x 27.0x 24.7x 22.1x 114% 9% 12% 18% 19% 19% NM NM NM

GBST Holdings Limited ASX:GBT AUD 30-Jun 153 13.7x 11.5x 9.2x 1.6x 1.5x 1.4x 23.7x 20.6x 14.7x 105% 15% 40% 11% 13% 15% 4.7% 5.4% 7.3%

Median 16.2x 14.0x 12.5x 4.4x 4.0x 3.7x 24.1x 22.4x 19.7x 58% 16% 17% 27% 28% 28% 3.7% 4.9% 5.6%

Average 25.6x 19.4x 15.8x 6.8x 5.8x 5.0x 33.6x 34.6x 25.8x 50% 53% 24% 28% 30% 31% 3.8% 4.5% 5.9%

International Software

The Sage Group plc LSE: SGE GBP 30-Sep 7,238 14.9x 13.7x 12.5x 4.3x 4.0x 3.7x 20.2x 18.7x 17.1x 41% 8% 10% 29% 29% 29% 4.3% 4.9% 5.6%

Intuit Inc. Nasdaq:INTU USD 31-Jul 53,429 23.8x 21.6x 19.4x 8.8x 7.9x 7.2x 37.5x 31.8x 28.0x 69% 18% 14% 37% 37% 37% 3.2% 3.6% 4.4%

Workday, Inc. Nasdaq:WDAY USD 31-Jan 27,801 51.2x 38.1x 28.9x NM NM 6.4x 101.4x 76.9x 58.9x NM 32% 31% 19% 21% 22% 1.5% 2.0% 2.3%

Atlassian Corporation Plc Nasdaq:TEAM USD 30-Jun 15,602 62.9x 49.2x 40.6x 17.2x 13.4x 10.8x 135.4x 96.7x 74.1x NM 40% 30% 27% 27% 27% 1.8% 2.3% 3.0%

Adobe Systems Incorporated Nasdaq:ADBE USD 01-Dec 124,447 29.8x 24.6x 21.4x 13.6x 11.5x 9.9x 39.3x 34.6x 28.9x NM 13% 20% 46% 47% 46% 2.8% 3.4% 4.3%

salesforce.com, inc. NYSE:CRM USD 31-Jan 99,639 32.3x 26.5x 21.5x 7.3x 6.1x 5.2x 57.5x 49.2x 38.4x NM 17% 29% 23% 23% 24% 2.6% 3.3% 4.2%

Mitel Netw orks Corporation Nasdaq:MITL USD 31-Dec 1,339 8.3x 7.9x NM 1.4x 1.4x NM 10.4x 9.4x NM 527% 10% NM 17% 18% NM 7.7% 12.1% 0.0%

NEC Corporation TSE:6701 JPY 31-Mar 792,303 7.6x 5.9x 5.1x 0.4x 0.4x 0.4x 22.4x 12.6x 9.4x NM NM NM 5% 7% 7% 9.1% 11.7% 16.2%

Huaw ei Culture Co., Ltd. SZSE:002502 CNY 31-Dec 5,004 NM NM NM 3.6x 3.0x NM 10.8x 8.8x NM NM NM NM NM NM NM NM NM NM

Vonage Holdings Corp. NYSE:VG USD 31-Dec 2,767 15.3x 14.3x 12.6x 2.9x 2.7x 2.5x 29.2x 29.7x 26.7x 194% -2% 11% 19% 19% 20% 4.2% 3.3% 1.1%

Oracle Corporation NYSE:ORCL USD 31-May 192,399 9.8x 9.3x 8.8x 4.6x 4.5x 4.3x 15.3x 14.1x 13.0x NM 9% 9% 47% 48% 49% 6.7% 7.1% 7.7%

SAP SE DB:SAP EUR 31-Dec 117,550 14.0x 13.1x 11.8x 4.8x 4.5x 4.1x 22.7x 20.5x 18.3x NM 11% 12% 34% 34% 35% 3.3% 3.7% 4.5%

Median 15.3x 14.3x 16.0x 4.6x 4.5x 4.7x 26.0x 25.1x 27.4x 131% 12% 14% 27% 27% 28% 3.3% 3.6% 4.3%

Average 24.5x 20.4x 18.3x 6.3x 5.4x 5.5x 41.8x 33.6x 31.3x 208% 16% 18% 28% 28% 30% 4.3% 5.2% 4.8%

Integrated Research Limited ASX:IRI AUD 30-Jun 584 14.4x 12.4x 10.6x 5.8x 4.9x 4.2x 28.1x 23.0x 19.2x 28% 22% 20% 41% 39% 40% 0.8% 2.2% 3.0%

Group Median 15.8x 14.3x 12.9x 4.4x 4.1x 4.0x 24.1x 22.4x 21.4x 63% 14% 15% 27% 28% 28% 3.5% 3.8% 4.6%

Group Average 25.1x 19.9x 16.9x 6.6x 5.6x 5.2x 37.9x 34.1x 28.3x 89% 36% 21% 28% 29% 31% 4.0% 4.9% 5.3%

EV/EBITDA P/E (norm.) EBITDA marginEV/Revenue uFCF YieldEPS growth

06 June 2018

Software



Figure 44: Fully expensed R&D comps


Figure 45: Last reported major shareholders

Source: Bloomberg

IRI Comparable Company Analysis

Data as at: 06/06/2018

Company Name Ticker Currency Year-end Mkt cap

(m) FY18 FY19 FY20 FY18 FY19 FY20 FY18 FY19 FY20

Coverage

Elmo Softw are Limited ASX:ELO AUD 30-Jun 322 87.2x 37.9x 25.2x NM 78.1x 42.7x 110.4x 30.6x 32.0x

EML Payments Limited ASX:EML AUD 30-Jun 304 13.2x 10.0x 7.9x 14.1x 10.6x 8.3x 19.7x 14.8x 10.4x

LiveTiles Limited ASX:LVT AUD 30-Jun 205 -15.8x -16.9x -52.9x NM NM NM NM NM NM

Reckon Limited ASX:RKN AUD 31-Dec 120 10.6x 10.4x 10.1x 10.6x 10.4x 10.1x 37.2x 11.5x 11.1x

ARQ Group Limited ASX:ARQ AUD 31-Dec 388 9.9x 8.7x 7.6x 9.9x 8.7x 7.6x 19.3x 11.8x 10.0x

BluGlass Limited ASX:BLG AUD 30-Jun 151 -50.6x -92.1x 15.6x NM NM 15.6x NM NM 44.5x

MYOB Group Limited ASX:MYO AUD 31-Dec 1,689 11.5x 10.4x 9.3x 14.6x 13.2x 11.9x 18.1x 19.3x 18.2x

Xero Limited ASX:XRO NZD 31-Mar 5,846 134.2x 65.0x 41.0x NM 418.0x 113.4x 180.2x 85.7x 110.1x

Class Limited ASX:CL1 AUD 30-Jun 285 16.5x 14.7x 13.0x 21.6x 19.1x 17.1x 30.1x 24.8x 22.0x

Technology One Limited ASX:TNE AUD 30-Sep 1,366 19.1x 16.5x 14.3x 19.1x 16.5x 14.3x 24.2x 21.2x 17.5x

Bravura Solutions Limited ASX:BVS AUD 30-Jun 696 18.3x 15.6x 13.9x 23.7x 19.7x 17.2x NM NM NM

Integrated Research Limited ASX:IRI AUD 30-Jun 584 15.3x 13.6x 12.0x 22.0x 19.6x 17.1x 127.6x 43.7x 31.5x

Group Median 13.2x 10.4x 13.0x 14.6x 16.5x 15.0x 27.1x 20.2x 18.2x

Group Average 23.1x 7.3x 9.5x 16.2x 66.0x 25.8x 54.9x 27.5x 30.6x

EV/EBITDA EV/EBITDA(adj.) EV/OpCF(adj.)

Name %

Killelea Stephen John 39.72

Rutherford Andrew Rhys 1.97

Morningstar Investment Management 0.97

Retrella 0.89

Dimensional Fund Advisors LP 0.72

Poole Gary Ronald 0.60

Custodial Services 0.41

The Vanguard Group 0.39

Cairns Kevin John 0.34

Barttelot Robin 0.30

Cornish Group Investments 0.29

Investors Mutual/Australia 0.26

Beebee Holdings 0.21

Perennial Investment Management 0.16

Baxter Alan Ross 0.11

Smith & Williamson Holdings 0.05

BlackRock 0.04

Purdue David C 0.03

Cuenin Andre 0.03

Pow er Corp of Canada 0.02

Baburin Alex 0.02

Manulife Financial 0.02

New York Life Insurance 0.01

Principal Financial Group 0.01

Adams Peter 0.01

Eaton Vance 0.01

Brandling Paul 0.01

Alaska Permanent Fund 0.01

State Street 0.01

Source: Bloomberg

06 June 2018

Software



Integrated Research (IRI)

Business description

Integrated Research (IRI) designs, develops, implements, and sells systems and applications management computer software for business-critical

computing, unified communication networks, and payment networks in the Americas, Europe, and Asia Pacific. The company offers Prognosis, an

integrated suite of monitoring and management software designed to give an organisation’s management and technical personnel operational insight

into IT infrastructure, unified communications, payment environments, and the business applications that run on these platforms. IRI was founded

in 1988 and is headquartered in North Sydney.

Investment thesis

Integrated Research’s (IR) core product Prognosis offers a high quality and scalable software solution for unified communications (UC) needs. While

we appreciate the product quality, strong R&D investment, relevant structural drivers and superlative customer and distribution base, we do see a

material risk for consensus de-rate in the short term. Our reservations lie with cash flow headwinds over the coming 24 months, H2 leverage leading

to slippage risk and a valuation mis-match when considering IR on a like-for-like basis (i.e. fully expensed R&D).

Revenue drivers Balance sheet

Accelerating growth in the payments and infrastructure space

Strong Unified Communications (UC) pipeline

R&D investment expanding Prognosis for UC products driving

increased addressable market and revenue potential

High renewal rate of >95%

Cash: $9.6m (1H18A)

Intangible assets: $20.7m

Deferred revenue (current + non-current): $29.8m

Total Assets: $102.6m

Total Liabilities: $50.5m

Total Equity: $52.1

Margin drivers Board

Greater recurring revenue growth

Operating leverage through solutions cross sales

Steve Killelea – Non-Executive Director and Chairman

Nick Abrahams – Non-Executive Director

Paul Brandling – Independent Non-Executive Director

Garry Dinnie – Independent Non-Executive Director

Peter Lloyd – Non-Executive Director

David Purdue – Company Secretary

Key issues/catalysts Management

Strong and consistent R&D investment

Release of Prognosis version 11.3

Potential for strategic acquisitions

John Merakovsky – CEO

Peter Adams – CFO

Jason Barker – VP, Asia Pacific, Middle East & Africa

Andre Cuenin – President, Americas & VP, Europe

Kevin Ryder – CMO

Risk to view Contact details

Product concentration risk in Prognosis

Highly competitive enterprise software industry

Significant cash flow headwinds short-term

H2 leverage leading to slippage risk

Address: Level 9, 100 Pacific Hwy, North Sydney, NSW 2060

Phone: +61 2 9966 1066

Website: http://www.ir.com/

06 June 2018

Software



Disclaimers and disclosures

Recommendation structure and other definitions

Definitions at wilsonsadvisory.com.au/Disclosures.

Disclaimer

This document has been prepared by Wilsons Advisory and Stockbroking Limited (ACN 010 529 665: AFSL 238375) (“Wilsons”). This document is a communication to

intended recipients and is not intended for public circulation. This communication is not to be disclosed in whole or part or used by any other party without Wilsons’ prior

written consent.

This document is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this document. Any advice contained in

this document is general advice only and has been prepared by Wilsons without taking into account any person’s objectives, financial situation or needs. Any person,

before acting on any advice contained within this communication, should first consult with a Wilsons investment adviser to assess whether the advice within this

communication is appropriate for their objectives, financial situation and needs. Those acting upon such information without advice do so entirely at their own risk.

Wilsons has not independently verified all of the information given in this document which is provided at a point in time and may not contain all necessary information about

the company or companies covered in this report (“Companies”). Accordingly, no representation or warranty, express or implied, is made as to the accuracy or completeness

of the information and opinions contained in this document. To the fullest extent permitted by law Wilsons, its related bodies corporate and their respective officers,

directors, employees or agents, disclaim any and all liabilities for any loss or damage howsoever arising in connection with the use of this document or its contents. Any

projections contained in this document are indicative estimates only. Such projections are contingent upon matters outside the control of Wilsons (including but not limited

to economic conditions, market volatility and company-specific fundamentals) and therefore may not be realised in the future. Past performance is not an indication of

future performance.

This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever.

Wilsons and Wilsons Corporate Finance Limited (ABN 65 057 547 323: AFSL 238 383) and their associates may have received and may continue to receive fees from the

Companies in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons disclosures at

wilsonsadvisory.com.au/Disclosures.

Neither Wilsons nor its research analysts received any direct financial or non-financial benefits from the Companies for the production of this document. However, Wilsons’

research analysts may attend site visits and/or meetings hosted by the Companies. In some instances the costs of such site visits or meetings may be met in part or in

whole by the Companies if Wilsons considers it is reasonable given the specific circumstances relating to the site visit or meeting.

Wilsons advises that at the date of this report, its directors, associates and employees may have relevant interests in the Companies.

Wilsons and its related bodies may trade securities in the Companies as principal.

Regulatory disclosures

This report was prepared solely by Wilsons Advisory and Stockbroking Limited. ASX did not prepare any part of the report and has not contributed in any way to its content.

The role of ASX in relation to the preparation of the research reports is limited to funding their preparation, by Wilsons Advisory and Stockbroking Limited, in accordance

with the ASX Equity Research Scheme. ASX does not provide financial product advice. The views expressed in this research report may not necessarily reflect the views

of ASX. To the maximum extent permitted by law, no representation, warranty or undertaking, express or implied, is made and no responsibility or liability is accepted by

ASX as to the adequacy, accuracy, completeness or reasonableness of the research reports.

Wilsons contact

Phone: 1300 655 015. Website: wilsonsadvisory.com.au.

http://www.wilsonsadvisory.com.au/Disclosures

http://www.wilsonsadvisory.com.au/

integrated research (iri) - wilsons | stockbroker · 2020. 6. 22. · important disclosures...

Documents