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Rocky Self-Funding Pathway For Elmo Software

Australia | Aug 10 2021

This story features ELMO SOFTWARE LIMITED. For more info SHARE ANALYSIS: ELO

While FY21 results and forward guidance appear rosy for Elmo Software, a weather eye should be kept on cash burn and overall liquidity.

-Breakeven for Elmo Software's earnings may occur sooner than the market expects
-Potential for a further capital raise
-Second half cash burn was greater than expected
-Cost growth has outpaced revenue growth for the past five years.

By Mark Woodruff

Longer-term shareholders in technology company Elmo Software ((ELO)) would have been hoping FY21 results could provide the catalyst for a recovery. The current share price of around $5 is around 25% higher than the extreme 2020 covid-lows though a long way from the $8 mark, which has been surpassed a few times since 2018.

The company has around 97% recurring SaaS revenue, and modular functions which cover the entire human resources lifecycle from recruitment to payroll.

Jarden believes the FY21 result was solid and now expects breakeven for earnings to occur sooner than the market expects, with operating leverage coming through as investment as a percentage of revenue declines. This is partially offset by the higher than expected churn in the mid-market segment and larger free cash outflow than expected during the period.

However, it’s this cash outflow that has some brokers less optimistic. Morgan Stanley cautions investors to be wary of a further potential capital raise and highlights management’s forward guidance lacked clarity on the pathway to cash flow profitability.

While annual recurring revenue (ARR) guidance signaled re-acceleration and beat Morgan Stanley’s forecast, second half cash burn missed expectations.

Meanwhile, by its forecasts, Shaw and Partners places little store in management’s FY22 guidance. FY22 ARR of $83.7m is estimated versus guidance for $105-111m, while revenue of $69.1m is expected compared to guidance of $90.5-95.5m.

The broker notes cost growth has outpaced revenue growth for the past five years.

FY21 results

The company experienced revenue growth of 38%, while ARR was up by 52% and underlying earnings (EBITDA) sneaked into the positive at $0.4m.

The customer retention rate fell to 84.2% from 90.2% in the previous corresponding period, which was lower than Jarden expected, due to covid-impacted customers. However, management expects this to be temporary in nature.

FY21 results versus expectations

Revenue was in-line with the guidance range of $68-70m and Jarden’s estimate of $69.7m.

ARR was also in-line with the guidance range of $83-85m, with 21% organic ARR growth in the (mid-market) business and strong 52% organic annualised ARR in Breathe, which has also launched in A&NZ.

Meanwhile, underlying earnings (EBITDA) of $0.4m were ahead of the guidance range of -$2.5m to -$3.5m and Jarden’s estimate of -$2.5m. This implies to Shaw a better performance on costs. It should be noted earnings include government stimulus receipts of $1.8m and a -$2m impairment of receivables from covid-impacted customers.

The broker highlights key cash movements included -$39m of cash burn, $4m in grant income, -$50m incurred in M&A and a $30m debt drawdown.

The cash burn and churn issues

Morgan Stanley estimates the company should have circa $30m in total liquidity at the end FY22. Assuming the maintenance of a $20m buffer, this only implies a runway until the second half of 2023, even if cash burn were to halve to -$1.1m per month.

The company is considered to be still deep in the investment phase, with a wide range of possible outcomes.

The market has focused on the short-term spike in mid-market ARR churn rate to 11.6% from 7.8% in FY20 and 9.3% in the first half of FY21. Jarden feels this discounts an emerging operating leverage and considers it actually points to an improvement in the free cash flow outlook over the mid-term.

Performance of acquired businesses

Webexpenses, the global business expense management platform that was acquired in December, 2020, grew by around 20% over FY21 versus the 30% historical run-rate and total cash costs were higher than Shaw’s forecast.

Another UK acquisition (October 2020) — the self-service HR platform for small business called Breathe — had a strong second half, according to Shaw, adding $2.1m in ARR. The mid-point of ARR guidance for Breathe implies $4m will be added in FY22, which is considered quite achievable versus the second half run-rate.

FY22 outlook

Pleasingly for Shaw, FY22 guidance implies acceleration in organic growth and a slower rate of cost growth versus FY21. However, FY22 implied total cash costs look likely to be slightly higher than the broker’s prior forecast.

The broker’s FY22 revenue forecasts have increased by 3-13% though total estimated operating expenses increase by -8-17%, including total cash costs estimates, which have increased by -7-15%. As a result, FY22 forecasts are for ARR of $83.7m versus guidance of $105-111m and revenue of $69.1m versus guidance $90.5-95.5m.

The broker, not one of the seven stockbrokers monitored daily on the FNArena database, maintains its Buy rating and its $8.50 12-month price target.

On the other hand Jarden sees a better-than-expected FY22 outlook at both the revenue and earnings level and notes management’s revenue guidance is just slightly ahead of the broker’s estimate and consensus of $91.9m at the midpoint.

FY22 earnings guidance of $1m-$6m is well ahead of consensus at -$0.6m and in-line with Jarden’s forecast earnings breakeven in FY22. Also not one of the seven stockbrokers monitored daily on the FNArena database, Jarden maintains its Overweight rating and increases its target price to $6.02 from $5.89.

The outlook, generally speaking

Jarden sees the company as well-positioned for market share expansion in a structurally growing industry, driven by rising operating efficiency requirements and demand for digital workforce management as organisations shift towards greater remote work arrangements.

As mentioned previously, cost growth has outpaced revenue growth for the past five years. With cash operating margins of -55% in FY21, Shaw and Partners feels the path of least resistance is now operating leverage, and a material reduction in negative operating margins.

If sales efficiency does not improve, and/or the company is required to invest substantially more into key modules and acquisition integration than the broker currently expects, then cost growth may be higher than forecast. Improving operating margins are considered a likely re-rating event for the stock.

The company is covered by only Morgan Stanley, from a potential seven stockbrokers that are monitored daily by FNArena. The broker maintains its Overweight rating and lowers its target price to $7.80 from $9.70, suggesting 58.5% upside for the current share price.

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