Apivio Systems Inc. (APV-V, $0.29)

Transcription

1 November 17, 2015 Apivio Systems Inc. (APV-V, $0.29) Rating Buy Target Price $1.00 Return 245% Pardeep Sangha, MBA Nicholas Mersch Source: Apivio Systems, Inc. Redefining the Future of Enterprise Phones Overall Risk Rating High Investment Brief We are initiating coverage of Apivio Systems Inc. ( Apivio or the Forecast Risk (High) 8 Company ) with a BUY recommendation and 12-month target price of $1.00. We like Financial Risk (High) 7 Apivio because of the Company s new Android based smart desktop phone, strong Valuation Risk (High) 9 Political Risk (Moderate) 5 relationship with NEC, improving margins, and a stable growing business in Korea. 52-Week High/Low $0.65/$0.29 YTD Performance -17% Dividend Yield 0% Shares O/S 52.8M (basic)/ 69.6M (F/D) Market Capitalization $15.3M Cash Debt $3.5M $7.7M Enterprise Value $19.5M Daily Volume (3-month 58.8K avg) Currency C$ unless noted Fiscal Year End December 31 '13A '14A '15E '16E '17E Revenue (mm) Gross M argin 15% 18% 19% 20% 22% Adj. EBITDA Adj. EBITDA margin 4% 4% 3% 4% 6% EPS - FD ($0.07) ($0.00) $0.01 $0.03 $0.07 Company Profile Industry Communications Equipment CEO Rob Bakshi Website Apivio Systems Inc. designs, develops, manufactures, and sells voice over Internet protocol (VoIP) communication equipment and software primarily for use in small and medium sized enterprises, and home offices in South Korea and internationally. Price Performance Disruptive product beginning to roll out. Apivio has a partnership distribution deal with NEC (a top 3 vendor globally), committing to 20,000 units of Apivio s Monet Series smart desktop phone, with the opportunity for additional purchase orders on the horizon. Apivio has already ship 10,000 units in FY15 to NEC, which we are expecting to ramp up to ~40,000 units in FY17 representing $7.6M in annual revenue. As NEC distributes Apivio s Monet Series product across numerous geographies, unit sales per month can ramp rapidly beyond these estimates. Legacy business funds growth opportunity. Apivio, through its subsidiary in South Korea, has been developing and selling IP phones for more than 10 years, and has sold 4.5M VoIP phones to date. The Company s products and services are designed primarily for use by small- and medium-sized enterprises and home offices. Apivio has increased R&D spending in order to bring an Android-based desktop smartphone (Monet Series) to market. Own the ecosystem. As Apivio s install base expands, the Monet Series provides a platform for which the Company can monetize value-added applications on a recurring revenue stream basis. Apivio and NEC are aligned with the medium-term goal of selling the hardware product at lower costs in order to capture and effectively monetize the app revenue stream once critical mass is reached. Forecast We are forecasting 16% revenue growth in FY15 to $54.0M, followed by 14% revenue growth in FY16 to $61.6M and 17% revenue growth in FY17 to $72.2M. Apivio strengthened its gross margin from 9.8% in FY12 to 18.3% in FY14, which we expect will continue as higher margin software revenue turns on in the medium term, estimating 18.6% in FY15, 20.2% in FY16, and 22.3% in FY17. Valuation Apivio is currently trading at 0.3x EV/Revenue multiple of our CY16 forecast, well below the average of its industry and Canadian software peers. Our target price represents an EV/Revenue multiple of 0.6, and an EV/EBITDA multiple of 11 applied to our FY17 estimates. Catalysts 1) Additional purchase orders from NEC (Q4FY15); 2) Development of Apps on the Android-based phone (Q4FY15); 3) Launch of L2 Wi-Fi phone in North America (mid-2016); and 4) Partnerships with additional telecommunications equipment vendors. Risks 1) Competition squeezes margins; 2) New product adoption; 3) Reliance on large telecom equipment partners; and 4) Limited liquidity and market capitalization. Member of the Canadian Investor Protection Fund Please see page 26 for Analyst Certification, Important Information, and Legal Disclaimers, page 27 for Risk Profile Definitions, and pages for Rating Structure, Disclaimers, and Notes.

2 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Gross Profit ($M) Gross Margin (%) Operating Expenses ($M) Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Price Volume(in millions) Revenue, Adj. EBITDA ($M) Adj. EBITDA Margin (%) Apivio Systems Inc. (APV-V) 11/17/15 Source: Capital IQ and Haywood Securities Apivio Systems Inc. Ticker TSXV:APV Price $0.29 Rating: BUY 17-Nov-2015 Shares O/S (mm) 52.8 Market Cap ($mm) $15.3 Target: $1.00 Return 244.8% Description: Apivio develops, markets and supports a portfolio of VoIP telephone solutions, including a range of wired and wireless devices and integrated advanced software applications. Apivio, through its subsidiary in South Korea has been developing and selling IP phones for more than 10 years, and has sold 4.5 million VoIP phones to date. Graphs Price/Volume Graph Revenue, Adj. EBITDA, Adj. EBITDA Margin $16.0 $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0 $(2.0) 40% 30% 20% 10% 0% -10% -20% -30% -40% TSXV:APV Price Volume Revenue Adj. EBITDA Adj. EBITDA Margin $16.0 $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0 25% 20% 15% 10% 5% 0% $1.6 $1.4 $1.2 $1.0 $0.8 $0.6 $0.4 $0.2 $0 Gross Profit Gross Margin R&D SG&A FINANCIAL SUMMARY Annual Quarterly Cap Structure FY13 FY14 FY15E FY16E FY17E Q1FY15 Q2FY15 Q3FY15E Q4FY15E Income Statement Haywood Estimates Haywood Estimates Last Price 0.29 Revenue W High (Apr 24, 2015) 0.65 Growth 52W Low (Oct 26, 2015) 0.29 Gross Profit Common Shares 52.8 Gross Margin 15.5% 18.3% 18.6% 20.2% 22.3% 19.0% 17.7% 19.0% 19.0% Market Cap. (mm) 15.3 Total OPEX Plus: Total Debt (mm) 7.7 As % of Revenue 18.2% 17.9% 17.1% 16.8% 16.5% 20.1% 15.3% 16.1% 17.5% Less: Cash (mm) (3.9) Adj. EBITDA Enterprise Value (mm) 19.2 Adj. EBITDA Margin 4.0% 3.5% 3.2% 4.4% 5.9% 0.8% 3.9% 4.4% 3.2% Significant Shareholders Diluted EPS (0.0) (0.0) (0.00) Rob Bakshi 10% Cash Flow Statement C.W. Lee 7% Friends and Family Cash from Operations 0.9 (1.9) (1.4) of Rob Bakshi 7% Cash from Investing (0.3) (0.2) (0.2) (0.1) (0.1) (0.1) (0.1) Other Board & Mgmt 2% Cash from Financing (0.2) Change in Cash 1.7 (1.0) (1.6) FCF (excluding NCWC) 2.3 (1.1) (1.2) FCF (0.5) (2.9) (1.8) MULTIPLES VALUATION - EBITDA REVENUE Current Price FY14 FY15E FY16E FY17E FY2017 Adj. EBITDA 4.2 FY2017 Rev 72.2 EV-to-Revenue Multiple 11.0x Multiple 1.0x EV-to-EBITDA Implied EV 46.7 Implied EV 72.2 P/E NMF NMF NMF NMF Net cash, 12m out 6.7 Net cash, 12m out 6.7 P/S Implied MCap 53.4 Implied MCap 78.9 FD Shares O/S 52.8 FD Shares O/S 52.8 Valuation $1.01 Valuation $1.49 Target Price FY14 FY15E FY16E FY17E COMPARABLE COMPANIES EV-to-Revenue CY2015 CY2016 EV-to-EBITDA Industry EV/Rev EV/EBITDA EV/Rev EV/EBITDA P/E NMF NMF NMF NMF Canadian Comparables 1.0x 10.0x 0.9x 5.6x P/S VoIP Companies 1.1x 7.2x 1.1x 6.8x Average 1.0x 8.6x 1.0x 6.2x Source: Company Reports, Capital IQ, Haywood Securities Inc. Pardeep Sangha, MBA psangha@haywood.com Page 2

3 Investment Thesis Apivio develops, markets and supports a portfolio of VoIP telephony solutions, including the next generation Android based smart desktop phone developed for NEC Corp. Apivio, through its subsidiary in South Korea, has a long history of developing and selling IP phones for more than 10 years, and has sold 4.5M VoIP phones to date. The Company s products and services are designed primarily for use by small- and medium-sized enterprises and home offices. We like Apivio because the smart desktop phone that is rolling out with a strong distribution partner has the potential to disrupt the current enterprise telephony market. In addition, the Company has a stable, growing business in Korea with improving margins. Apivio has three product categories: the Monet Series, the Liberty Series, and the legacy Dexter Series. The Monet Series is an Android-based Video Phone sold in North America through a partnership with NEC. The Liberty Series is composed of Mobile Wi-Fi Wireless Phones, which Apivio is trying to gain traction with in North America. The Dexter Series is the legacy Desktop IP Phones sold into South Korea that currently account for a majority of the Company s revenue. We believe that the Company s Monet Series is disruptive technology, the Legacy Dexter Series provides a steady growing revenue base, and the Liberty Series widens the Company s product offerings. Apivio s goal with the Monet Series is to replace old enterprise desktop phones with Android-based smart desktop phones. Apivio secured a key partnership with NEC, initially shipping 10,000 units, which we believe has significant upside potential to increase. Apivio s focus for its Dexter Series will be maintaining status as a leading vendor of Centrex VoIP phones to carriers and improve gross margins, cash flow, and working capital management. The Company s go-to-market strategy in this arena has been to become the supplier of VoIP handsets to all leading South Korean telecommunications companies. The basic premise of the Liberty Series phone is that users will pay ~$20/month (including the phone and free long distance) for a Wi-Fi phone that will replace their home land line, which currently costs ~$30/month (without long distance). We are forecasting FY15 revenue growth of 16%, FY16 revenue growth of 14%, and FY17 revenue growth of 17%. We estimate FY15 revenue growth of 16% on a YoY basis to $53.9M with a majority of this revenue coming from the South Korean market, as the deployment of the Monet Series in North America is only starting in H2FY15. Of our estimated $53.9M in revenue for FY2015, $49.6M is from the South Korean IP Phone business, $2.4M is from the Wi-Fi Phone segment, and $2.0M is from the NEC partnership in North America. We believe there is significant upside to our numbers, should Monet Series product orders begin to accelerate. Improving gross margins from 9.8% in FY12 to 22.3% by FY17E. We believe that Apivio will continue to strengthen gross margins over the coming fiscal years. This will result from improving efficiencies in the North Korean operations, as well as product mix as we anticipate higher gross margin software revenue from the Monet Series product will turn on in the medium term. Adjusted EBITDA expected to improve modestly. Adj. EBITDA improved significantly under new management from an Adj. EBITDA loss of $4.9M in FY12 to an Adj. EBITDA gain of $1.6M in FY14. We expect Adj. EBITDA margins to increase modestly from 3.2% in FY15 to 5.9% in FY17 as the company continues revenue growth, but also reinvests in R&D. We are initiating coverage of Apivio with a BUY recommendation and 12-month target price of $1.00. Our target price represents an EV/Revenue multiple of 0.6, and an EV/EBITDA multiple of 11 applied to our FY17 estimates, which is a 245% share price increase from the recent close. We rate Apivio with a High Risk given that it is a small cap company with low trading volumes and a limited history of profitability. Pardeep Sangha, MBA psangha@haywood.com Page 3

4 Significant Investment Risks The investment to which this report relates carries various risks, which are reflected in our Overall Risk Rating. We consider the following to be the most significant of these investment risks: Competition squeezes margins. Apivio s hardware-dominated revenue stream is very competitive amongst enterprise telephony vendors, ultimately causing a gross margin squeeze. We believe this risk is mitigated by the potential to own the ecosystem with the Monet Series product, eventually rolling out higher margin recurring software revenue by introducing value-added applications. New product adoption. Apivio s new Monet Series product is in the early adopter stage as the Company begins to roll out the product in the North American market through NEC. We believe this risk is mitigated by the legacy Korean business backstopping the Company with steady organic and market size growth. Limited liquidity and small market capitalization. Apivio s stock has limited liquidity and is still in the <$20M market cap range. This could cause increased volatility over the short term. We believe this risk can be mitigated by continuing to establish a strong institutional shareholder base. Our Risk Profile Parameters ratings and Overall Risk Rating are set out on the cover page and are explained in our Rating Structure section under Overall Risk Rating and Risk Profile Parameters. These ratings are an integral part of our Report Potential Upcoming Catalysts Additional purchase orders from NEC. We view Apivio s NEC partnership as an engine for growth as more Android-based video phones are deployed into the North American Enterprise market. We are expecting an additional purchase order from NEC in late Development of applications on the Android-based phone. By building out apps on the Monet Series smart desktop phones, the Company will provide value-added software capabilities that could provide recurring software revenue streams in the medium term. We are expecting NEC to launch an NEC app store for its UT880 smart desktop phone before the end of Launch of L2 Wi-Fi phone in North America. The Wi-Fi phone has had considerable success for Apivio in Korea, but has taken longer to launch in North America. We are expecting that a North America launch could happen in the spring to mid Partnerships with additional telecommunications equipment vendors. Although not looking for another partnership until late 2016, we believe an additional partnership similar to NEC would provide material step-growth in distribution of the Company s smart desktop phone. In turn, additional distribution of the Monet Series will provide a larger potential install base for apps, thereby increasing the potential for recurring software revenue. Pardeep Sangha, MBA psangha@haywood.com Page 4

5 Company Overview Background Apivio develops, markets and supports a portfolio of VoIP telephone solutions, including a range of wired and wireless devices and integrated advanced software applications. Apivio, through its subsidiary in South Korea, has been developing and selling IP phones for more than 10 years, and has sold 4.5M VoIP phones to date. The Company s products and services are designed primarily for use by small- and medium-sized enterprises and home offices. Apivio has had historical success selling these products and services to major telephone companies in South Korea where the Company has a leadership position in the Korean Centrex market. The Company is now looking to expand into the North American market with an Android-based smart desktop phone, which replaces archaic enterprise telephony solutions. Apivio was formerly Moimstone, before changing its name in May The Company began as a technology company in South Korea in 2003, founded by Mr. Chang Woo Lee, and focused on VoIP devices and applications. In January 2010, Moimstone Corporation was incorporated in Canada to be the parent company of the wholly owned subsidiary in South Korea, Moimstone Co. Ltd., which continues to operate under the Moimstone name. Moimstone Corporation s shares were listed on the TSX Venture Exchange through an RTO on September 9, 2013, trading under the symbol MSE. As a result of the name change on May 22, 2014, the Company s common shares now trade under the symbol APV on the TSX Venture Exchange. Products & Distribution Apivio has three major product lines: Monet Series Android-based smart desktop phones; Liberty Series Mobile Wi-Fi wireless phones; and Dexter Series Desktop IP phones. Figure 1: Apivio s VoIP Phone Product Offering Monet Series Liberty Series Dexter Series Source: Investor Presentation (October 2015) Apivio s vision is that all enterprise desktop phones will one day be smart desktop phones. As enterprises continue to enhance technological capabilities, an instrumental piece of technology seems to be stuck in the past: the desktop phone. With simple display and minimal functionality, currently available desktop phones do not offer the value-added services provided by Apivio s Monet Series smart desktop phones. Apivio is bringing apps and the Google Android platform to the enterprise desk Pardeep Sangha, MBA psangha@haywood.com Page 5

6 phone market. In the same way that the smartphone has taken over the mobile phone market, we believe there will be a transition to smart desktop phones. Apivio has enabled NEC to become the first multi-national vendor to launch an Android-based VoIP desktop smartphone, which we believe will become the new standard. Apivio s Monet Series is an Android-based VoIP desktop phone designed to enhance collaboration, communication, and productivity. Apivio completed the development of its first Android-based VoIP phone in partnership with NEC Corporation of North America ( NECAM ) at the end of This nextgeneration Android phone, the UT880, enables enterprises to run a range of value-added applications on desk phones. NECAM committed to 20,000 units of the UT880 phone (approx. $4M contract value). Apivio completed the shipment of 10,000 units to NECAM by the end of September 2015 and additional product orders are expected in the near term. Of the 10,000 units shipped, 8,000 have gone to North America, while 2,000 units have been sent to Europe. According to our call with NECAM s management, Apivio delivered the UT880 product on time and with good quality. NECAM s management highlighted that there were initial hiccups in the deployment, but these delays were primarily due to NEC s handling of the global shipments and not Apivio-related issues. NEC s main concern with Apivio is the Company s limited manufacturing capabilities should the NEC require a larger increase in volumes. We believe this concern is mitigated, as NEC has the resources and relationships to eventually take over the manufacturing process, further driving down costs to end users. The Company is working with NEC to develop a range of enterprise applications that will target specific industry segments. The Monet Series phones that Apivio is providing NEC with will have an app store. This provides end users the access to value added applications that has not been optimized in any previous work setting. The launch of the NEC app store with 200 apps is estimated to be before the end of FY2015. This further differentiates Apivio/NEC, because to date, no other competitor in the marketplace has an app store. This will unlock higher margin revenue streams for Apivio and is pivotal as a go-to-market strategy for the software product. Apivio s goal is to replace traditional cordless phone technology with the Liberty Series Wi-Fi phones. Apivio s new Wi-Fi phones enable consumers to receive phone calls using local phone numbers over any Wi-Fi network, thereby enabling a home phone to become virtually portable. The Company s first Wi-Fi product, the MWP1100 series, was launched in early 2014, while the Company s second Wi-Fi Phone product, the MWP2500 series, was launched in late To date, Apivio has sold 150,000 Wi-Fi phones in the South Korean market, and a limited number of Wi-Fi phones in North America. There are some differences in the features enabled in the North American and South Korean versions of these phones due to distinctions in patterns and telecommunications carrier network architecture in each jurisdiction. Hence, the Company is anticipating a commercial launched of the L2 Wi-Fi phone in North America in mid Apivio has developed significant feature enhancements to the phones targeted to the North American market in order to maximize the market potential and acceptance of these innovative phones. Apivio s Dexter Series IP phones have been dominant in the South Korean Centrex market. To date, the Company has sold over 4.5M handsets, mostly in Asia. The Company s go-to-market strategy in this arena has been to become the supplier of VoIP handsets to all leading South Korean telecom companies including Korea Telecom, LGU+, SK Broadband, and CJ Hellovision. The Company has sold into this market for over 10 years. Apivio s top selling IP Phones are the IP225, IP335, and IP370 models. The IP355 and IP370 models were introduced in 2012 and feature high definition voice which enables users to have more clear and natural sounding conversations. A new IP Phone model with several advanced features, the IP700, was introduced in The Dexter Series provides a stable business which by itself, will almost reach $50M in revenue in FY15. This revenue stream provides cash flow to fund the new growth business areas: the Monet Series and Liberty Series. Pardeep Sangha, MBA psangha@haywood.com Page 6

7 Controlling the Ecosystem Apivio has historically been a supplier of hardware endpoints and now looks to introduce recurring revenue streams through its Monet and Liberty Series products. Applications and cloud initiative are a large part of this strategy. The Company s hardware business is under constant pressure on gross margins. Apivio s gross margin are currently 18-20%, which management believes can increase to 30% in the longer term as software revenue rolls out from the North American business. The Monet Series Android phone is a platform upon which Apivio can develop and sell premium applications targeted at enterprises. The Company is currently developing applications that increase productivity or serve a specific need to enterprise clients. In some cases, the applications create new revenue streams for the customers themselves. Therefore, the enterprise clients are more likely to pay for these applications. Recurring revenue from these applications will increase as the Monet Series install base grows. Potential applications for the Monet Series include biometric facial recognition for security and concierge services, live diagnostics for hospital administration, hospitality in-room apps that encourage use of guest services, and video-conferencing and live alerts for small- to mediumsized business. Figure 2: Applications for Vertical Markets Source: Investor Presentation (October 2015) Apivio is also developing a cloud-based provisioning system for its Wi-Fi phones. The next generation L2 phone will have a limited launch in mid-2016 in North America and will be registered on the Company s cloud-based auto-registration service ( CLive ). CLive will allow ease of use, upgrades, tracking, and features that make the phone easy for carriers to deploy and end-to-end users to activate out of the box. More on these initiatives will be announced in the months ahead. Operations Apivio s R&D team is primarily located in South Korea, taking advantage of a lower cost base. The Company currently has 80 employees, with 75 in South Korea and 5 in Canada. Apivio s offices in South Korea employ people in functions such as Admin, Logistics, Purchasing, Marketing, Sales, and R&D personnel. In addition, the Company also has a warehouse with a small prototype and repair facility where production staff are located. In Canada, the Company s employees work out of Richmond, British Columbia, and focus mainly on strategy, financing, investor relations, and North American sales. Apivio employs third-party manufacturing facilities in South Korea. The Company outsources production to two manufacturers, with each having three or four facilities. Apivio sources 60% of its Pardeep Sangha, MBA psangha@haywood.com Page 7

8 materials from outside Korea (Taiwan, Israel, Hong Kong, China) and 40% from within Korea. The Company s legacy Dexter Series product has been made by the same manufacturer for nine years. The relationship with the Monet and Liberty Series manufacturers is newer, at two years. These facilities are capable of shipping 100,000 units of IP Phones per month and 10,000 units of Wi-Fi phones per month. The limits are adjustable in the medium term, as each manufacturer has the capability to ramp up capacity given adequate notice. Management indicated that capacity for the Monet Series product has increased from 2,000 units/month to 4,000 units/month, which significant enough to handle shortterm increases in unit volume, should NEC submit another purchase order. Acquisitions By acquiring an application development team or service, Apivio can expedite the process of monetizing the recurring software revenue stream on the Android-based desktop phone. Given adequate build-out of the Company s potential user base with the current NEC deal, the focus in the medium term shifts to building out applications that provide value-added options for the Androidbased desktop phone users. The distribution of hardware phones places the Company into the endusers ecosystem. Although the hardware revenue stream has historically been the Company s strength, we believe higher margin app license fees are a much more lucrative opportunity. Management and Share Ownership Entrepreneurial leadership looks to drive innovation and disrupt the enterprise telephony market. Apivio is led by Mr. Rob Bakshi who was formerly President and CEO of Silent Witness Enterprises before its acquisition by Honeywell in Mr. Bakshi became the Executive Chairman of Apivio in 2010 before taking on the role of President and CEO in We believe that under Mr. Bakshi s guidance, the Company has taken valuable steps towards strategic reformation including becoming incorporated in Canada, listing on the TSX, driving sales increases, improving gross margins, and establishing relationships with distribution partners on a global scale. Mr. David Pais joined the Company as CFO in 2014 before serving as VP finance at Carmanah Design and Manufacturing Inc., and CFO of Eyeball Networks Inc. and Star Solutions International Inc. Mr. Pais has over 20 years of experience as a finance professional, including a Senior VP role at Ernst & Young Corporate Finance, and four years working in a VoIP company. Apivio s subsidiary in Korea, Moimstone Korea, has its own sub-management structure in which Mr. J.Y. Ahn (CEO), Mr. J.S. Kang (CFO), Mr. S.H. Shin (CTO), and Mr. Chang Il An (Executive Director of sales) lead the Moimstone Korea subsidiary. CEO Rob Bakshi s significant ownership position aligns his interests with those of the shareholders. Mr. Bakshi currently owns 6.1M shares directly, which represents 10% of the Company s fully diluted shares. Mr. Chang-woo Lee, who is the founder and previous CEO of Moimstone Korea, owns 4.5M shares, representing 7% of the Company s fully diluted shares. In total, Apivio s management and Board owns approximately 20% of the fully diluted shares in the Company. In addition, we estimate that Mr. Bakshi has arms-length influence over an additional ~5M shares with friends and family (Refer to Appendix II, for details on management and board ownership). Pardeep Sangha, MBA psangha@haywood.com Page 8

9 Industry Overview Market Opportunity IP telephony technologies enable the use of data networks for carrying voice communications. According to Nemertes research, trends in the IP telephony space include increased cloud offerings, enhanced mobile support, and increased ability to interface with external applications. In a pure VoIP telephone system, the handset is no longer directly wired to the phone system; instead these phones are connected to a data network and use the same cable, jacks and switches used by a PC. This telephony trend is replacing TDM (time division multiplexing) phones, which work on the premise of a dedicated wire from the telephone jack directly to the phone system s key service unit. The enterprise telephony market is moving from TDM solutions to IP solutions; according to Gartner Inc., from 2012 to 2013, worldwide IP Seat licenses increased 6.6% to 30.4M while worldwide TDM Seat licenses decreased 6.5% to 24.3M. This resulted in an increase of IP Seat licenses market share from 52.3% in 2012 to 55.6% in While Gartner s Magic Quadrant for Corporate Telephony highlights NEC as a challenger in the space, we believe Apivio can help NEC become a leader. NEC is a top three player in the global corporate telephony market, with a large installed base of customers, especially in the Asia/Pacific region. NEC positions different solutions in different regional markets with the SV9000 family as a software-based telephony platform that runs on virtualized servers. This software-based approach appeals to enterprises of all sizes, particularly in North America. We believe NEC has the potential to shift from a challenger in the marketplace to a leader as it leverages its software based approach using Apivio s Monet Series product to ultimately provide a unique smart desktop phone with value added applications. Figure 3: Gartner s Magic Quadrant for Corporate Telephony Source: Gartner (October 2014) The telecommunication equipment vendor market is made up of numerous fragmented players. As of 2013, of the top players in the market, no individual vendor represented an over 15% market share. Pardeep Sangha, MBA psangha@haywood.com Page 9

10 Due to various acquisitions by other vendors over the last few years, NEC is currently in the top 3 vendors for enterprise telephony equipment worldwide. Figure 4: Enterprise Telephony Seat License Shipments Worldwide in 2013 Others 31% Cisco 15% Avaya 12% Digium 3% NEC 10% Huawei 4% Aastra Technologies 4% Mitel 4% Microsoft 5% *Nokia is undergoing an acquisition of Alcatel-Lucent *Mitel Acquired Aastra in November, 2013 Alcatel-Lucent 6% Unify 6% Source: Gartner (March 2014) Of NEC s midmarket customers, about 47% of the employees use its IP telephony platform. This midrange of penetration within NEC provides upside for Apivio to sell its solution into the distributor as IP telephony proliferates both across the industry and within NEC. According to Nemertes, customer loyalty among NEC s customers is top among all providers, with the lowest percentage planning to leave NEC in the next two years. Competition Apivio has taken the approach to not sell directly to the end customer, which would have them compete against Cisco, Mitel, NEC, etc., but rather sell to the OEM. In the North American Enterprise market, competition between telecommunications equipment providers is tense. As shown in Figure 4 above, the fragmented market composition of enterprise telephony vendors leads to high levels of competition. We believe Apivio has a unique value proposition to these companies, as there are only two competitors that have launched an Android-based phone (Unify and Grandstream), neither of which have an app store. We believe there is very limited direct competition in the marketplace that provides a high quality solution as well as Apivio. In the Korean hardware market, Apivio competes against Korean IP phone vendors. In this space, vendors mainly compete on price. Competitors in this market include Dasan Networks and Jungwo C&F Co. Other Korean enterprise market vendors Apivio competes with include Samsung, Aprotech, and LG Electronics. We believe that Apivio s key differentiation in this market is a strong relationship with telcos for distribution as the Company will enjoy steady industry and organic growth over the coming quarters. Pardeep Sangha, MBA psangha@haywood.com Page 10

11 Financial Overview Historical Performance Strong historical revenue growth from the Korean market. Apivio s Korean IP phone business has grown at an 18% CAGR from FY09 to FY14. Figure 5 below removes Apivio s revenue from one-time sales during FY11, in which the Company had recorded $46.2M in revenue from tablet sales to NTT in Japan. This unprofitable business of developing Android based tablets was discontinued in We note that Apivio s remaining IP phone business was down in FY11 on a YoY basis, which was mainly due to the distractions of the one-time tablet business. The IP phone business returned to growth in the subsequent year in FY12. Apivio is yet to experience significant revenue streams outside of its Korean operations. Therefore, a snapshot of historical revenue draws an accurate picture of the success of the Dexter series products in the Korean market. Figure 5: Historical Revenue Growth, FY09 to FY14 Revenue ($M) $50.0 $45.0 $40.0 $35.0 $30.0 $25.0 $20.0 $15.0 $10.0 $5.0 $0 FY09 FY10 FY11 FY12 FY13 FY14 Revenue Source: Company reports, Haywood Securities Under new management, revenue has nearly doubled while Adj. EBITDA has significantly strengthened. In 2013, the present management team was put in place, achieving significant growth over their tenure. From 2012 to 2014, revenue grew from $29.5M to $46.5M while Adj. EBITDA improved from a loss of $4.9M to a gain of $1.6M. Recent Financial Results Apivio Reported results for Q2FY15 (ended June 30, 2015) on August 21, Figure 6: Summary Results for Q2FY15 Q2FY15 Q2FY14 Q1FY15 (millions, unless noted) Actual Prior Year YoY Prior Quarter QoQ Revenue % % Gross profit % % Gross margin 17.7% 18.2% -0.5% 19.0% -1.3% Adjusted EBITDA % % Adjusted EBITDA margin 3.9% 6.6% -2.7% 0.8% 3.2% Source: Haywood Securities, Company reports Pardeep Sangha, MBA psangha@haywood.com Page 11

12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Gross Profit ($M) Gross Margin (%) Apivio Systems Inc. (APV-V) 11/17/15 In Q2FY15, Apivio s revenue increased 3% YoY from Q2FY14 and 31% QoQ from Q1FY15. The Company s YoY growth was only 3% because Apivio experienced a one-time revenue boost from a large customer order in Korea in Q2FY14, which was not repeated in Q2FY15. Apivio realized strong QoQ growth in Q2FY15 due to $1.5M of sales in North America and a positive currency effect. North American sales in the quarter were driven by the shipment of 5,500 units of the new Android-based Monet Series phone to NEC. Figure 7: Quarterly Revenue Revenue ($M) $16.0 $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Revenue Source: Haywood Securities, Company reports Gross margins have generally been trending higher, with the exception of the most recent quarter when gross margins declined slightly due to product mix. Gross margins declined slightly to 17.7% in Q2FY15 versus 18.2% in the same quarter the year. Previously, gross margins strengthened over Q4FY13 to Q1FY15 as Apivio s manufacturing process experienced economies of scale and moved along the cost curve to lower cost products as efficiencies increased in Korean operations. Gross margin on a YoY basis has also dramatically improved from 9.8% in FY12 to 15.5% in FY13 and 18.3% in FY14. Figure 8: Quarterly Gross Profit and Gross Margin Percentage $16.0 $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0 25% 20% 15% 10% 5% 0% Gross Profit Gross Margin Source: Haywood Securities, Company reports Operating expenses increased as SG&A expenses climbed 17% and R&D spend ramped from new product development. Apivio increased outlay in R&D from 2012 to 2014 in order to develop products for the North American market. Over the last 10 quarters, the Company has spent $7.3M in R&D. Pardeep Sangha, MBA psangha@haywood.com Page 12

13 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 $Adj. EBITDA ($M) Adj. EBITDA Margin (%) Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Operating Expenses ($M) Apivio Systems Inc. (APV-V) 11/17/15 However, Apivio managed to remain cash flow positive in 2014 and H1FY15 despite investing in the development of a new product line. Figure 9: Quarterly Operating Expenses $1.6 $1.4 $1.2 $1.0 $0.8 $0.6 $0.4 $0.2 $0 R&D SG&A Source: Haywood Securities, Company reports Apivio achieved its fifth consecutive quarter of positive Adj. EBITDA, with an Adj. EBITDA margin of 3.9% in Q2FY15. Adj. EBITDA has varied QoQ over the last two years as OPEX and revenues have varied. OPEX has varied from new product development while Apivio s revenue can fluctuate with purchase orders, causing further variability QoQ. Figure 10: Quarterly Adj. EBITDA and Adj. EBITDA margin $1.2 $1.0 $0.8 $0.6 $0.4 $0.2 $0 $(0.2) $(0.4) $(0.6) 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% Adj. EBITDA Adj. EBITDA Margin Source: Haywood Securities, Company reports Balance Sheet Apivio exited Q2FY15 with $3.5M in cash and $7.7M in debt, resulting in a net debt balance of $4.3M. This is compared to a net debt balance of $5.7M ending FY15. Apivio has currently drawn $6.6M in short-term credit facilities and $1.1M in long-term debt from several Korean banks including Woori Bank, Industrial Bank of Korea, Shinhan Bank, Suhyup Bank, and Nonghyup Bank. In total, Apivio has $13.2M available to it in short-term credit and long-term debt facilities. The Company has been able to make all interest payments from cash flow from operations, paying $45K in Q3FY15. Pardeep Sangha, MBA psangha@haywood.com Page 13

14 Apivio closed a $3.3M private placement in March 2015 to provide capital for growth initiatives. On March 24, 2015, the Company closed a brokered private placement, issuing 9.4M units at a price of $0.35 per unit. Each unit consisted of one common share and one non-transferable common share purchase warrant with each warrant exercisable at a price of $0.55 per share for two years. Figure 11: Net Cash Position at Quarter End $Debt, Cash, Net Cash ($M) $6.0 $4.0 $2.0 $0 $(2.0) $(4.0) $(6.0) $(8.0) $(10.0) Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Cash Debt Net Cash Source: Haywood Securities, Company Filings Pardeep Sangha, MBA psangha@haywood.com Page 14

15 Forecast and Outlook Since each product targets a different market segment, we break down Apivio s market opportunity by three product types: Monet Series (Android-based video phones), Liberty Series (mobile Wi-Fi wireless phones), and Dexter Series (desktop IP phones). Monet Series Apivio s short-term focus is to increase purchase orders from NEC s international business segments. Apivio s ability to white-label and provide a value-added service to enterprises in North America is in the early adopter stage with NEC. The immediate focus is to generate internal purchase orders from NEC s different international business segments, specifically Europe, Australia, Japan, and South America. We believe that as the Android-based desktop phone gains traction in North America, other geographies will be further inclined to adopt the Company s solution. We estimate that through NEC alone, Apivio has shipped 10,000 units in FY15 representing $2.0M in revenue, ramping up to ~17,000 units in FY16 representing $3.4M, and ~40,000 units In FY17 representing $7.6M in revenue. For near-term growth we are first looking for additional product orders from NEC in North America and Europe followed by product orders in NEC s other geographies. To date, Apivio has shipped 10,000 of the 20,000 committed phones to NEC. From now until the end of the year, we are expecting one more purchase order, resulting in the shipment of the order by March or April With NEC headquartered in Japan, we highlight Europe, Asia and Australia as imminent growth opportunities, followed by the Middle East and Africa in the medium term. An additional partnership with a large telecommunications equipment vendor in the medium term would result in step-stage growth. Although not looking for another partnership until FY16, we believe an additional partnership similar to NEC would provide material step-growth in distribution of the smart desktop phone. In turn, additional distribution of the Monet Series will provide a larger potential install base for the apps the Company is developing, thereby increasing the potential for recurring software revenue. Over the longer term, hardware sales can be used as a go-to-market strategy for a software recurring revenue stream. When Apivio s desktop IP phones reach a critical mass, the hardware device becomes an access point to the Company s end users. From this point, Apivio can then charge license fees for value-added applications from its platform, unlocking higher margin revenues, increasing free cash flow to bolster other business operations, or further reinvest in R&D in order to snowball app revenue. NEC s app store is expected to launch before the end of the year, which we will continue to monitor the health of as a key indicator of potential software revenue in the future. Liberty Series Apivio s vision with the Liberty Series product is that Wi-Fi telephony technology will replace traditional cordless phone technology. The basic premise of the Liberty Series phone is that users will pay ~$20/month (including the phone and free long distance) to replace their home phone, which currently costs~$30/month (without long distance). In 2014, the Company launched the Liberty L1, which authenticates on any Wi-Fi network and enables home phones to be portable. As Wi-Fi continues to proliferate across metropolitan cities, users are able make calls from anywhere on their original home phone plan without additional roaming or long distance charges. As of October 2015, Apivio had deployed ~4,500 units of the L1 model into a test market. In H215, the next generation product, the L2, will launch in North America registered on a cloud-based auto-registration service under development (CLive). This service will allow users to activate the phone out of the box and will ease deployment for carriers. Apivio s goal is to partner with both a retail distribution network and a service provider in order to leverage this product. Pardeep Sangha, MBA psangha@haywood.com Page 15

16 Dexter Series Apivio s market presence in South Korea with the Dexter Series product is established with reliable renewal cycles and steady organic growth. Apivio has been selling into the South Korean market through telcos for over 10 years. Apivio has two facets of growth in South Korea. First, the Company grows organically by capturing an expanding customer base as adoption rates of VoIP in Korea increase. Second, the Company captures renewal revenue because telcos are selling Apivio s phones to small- to medium-sized businesses on two-year contracts, with a new phone every cycle. Apivio s strength in South Korea comes from capitalizing on the move that carriers are making from traditional and transformational services to pure VoIP (Centrex) service. This provides a value add because Centrex is a service where the call platform and PBX (private branch exchange) features are hosted at the service provider s location. The business end users connect via IP to the provider for voice service and the enterprise does not have to pay for control units, software or hardware updates, or maintenance. Apivio s focus in the South Korean market will be maintaining status as a leading vendor of Centrex VoIP phones to carriers and improve gross margins, cash flow, and working capital management. Apivio s experience in the South Korean market provides the Company with leverage should additional markets open up. However, the sales cycle into telcos (especially in North America) is long and bureaucratic, causing Apivio to pursue go-to-market strategies through other avenues. Forecast We are expecting revenue to increase 29% in Q3FY15 (ending September 30, 2015) to $14.3M compared to $11.1M in Q3FY14. However, we are expecting Q3FY15 revenue to decline 6% QoQ from Q2 as a result of normal seasonality. Apivio will be reporting results for Q3FY15 in late November. We are expecting Adj. EBITDA in Q3FY15 to be relatively flat at $0.6M, compared to Q2FY15. We estimate 16% revenue growth in FY15 to $54.0M with a majority of this revenue from the Korean market. We are expecting $49.6M in revenue from the Korean IP phone business and $2.0M from the sale of Wi-Fi phones in Korea. The Monet Series represents $2.0M revenue in FY15 as the product s deployment in North America only started in FY15. We forecast only 4,000 units of Wi-Fi phones in North America representing $400K in sales in FY15. Figure 12: Unit, Growth Rate, and Revenue Assumptions Segment FY14 FY15 FY16 FY17 Driver Revenue Driver Revenue Driver Revenue Korea IP Phones % Growth Rate % Growth Rate % Growth Rate 60.0 Korea WiFi phones ,000 Units ,000 Units ,000 Units 3.5 NEC Android Phones ,000 Units ,000 Units ,000 Units 7.6 North America WiFi 0.5 4,000 Units ,000 Units ,000 Units 1.6 Other software revenue Total Revenue Source: Company reports, Haywood Securities We are forecasting 14% revenue growth in FY16 followed by 17% in FY17. We expect gross margin to expand from 18% in FY14 to 22% in FY17, as Apivio s Korean operations become more efficient and the Company ramps up sales of the Monet Series product into the market. We expect operating expenses to increase 12% from FY15 to $10.4M in FY16, increase another 15% to $11.9M in FY17 due to both increased R&D and sales and marketing expenses, as the Company promotes its new Monet Series product. We also anticipate that Adj. EBITDA margins will continue to modestly improve from 3% in FY15 to 6% in FY17. Pardeep Sangha, MBA psangha@haywood.com Page 16

17 Figure 13: Summary Forecast Apivio Systems Inc. ESTIMATES Income Statement (000s) F'14 Q1 Q2 Q3e Q4e F'15e F'16e F'17e Revenue Gross Profit Gross Margin 18% 19% 18% 19% 19% 19% 20% 22% Total Operating Expenses Adjusted EBITDA Adj. EBITDA Margin 4% 1% 4% 4% 3% 3% 5% 6% Source: Company reports, Haywood Securities Pardeep Sangha, MBA Page 17

18 Valuation, Target Price & Recommendation Valuation In our valuation analysis we compared Apivio with a group of VoIP Companies as well as select Canadian comparables. In Apivio s Canadian comparable peer group we include Sierra Wireless Inc. (SW-T), Counterpath Corporation (CCV-T), Sandvine (SVC-T), and Redline Communications Group Inc. (RDL-T). We also include VoIP companies Cisco Systems Inc. (CSCO-N), Mitel Networks Corporation (MITL-N), ShoreTel Inc. (SHOR-N), and Polycom Inc. (PLCM-N). Please refer to Appendix III for more detailed comparable valuation data. Figure 14: Apivio s Peer Group vs. Haywood Multiples FY2015 FY2016 EV/Revenue EV/EBITDA EV/Revenue EV/EBITDA VoIP Companies 1.1x 7.2x 1.1x 6.8x Canadian Comparables 1.0x 10.0x 0.9x 5.6x Apivio Systems Inc. - Haywood 0.4x 11.1x 0.3x 7.0x Source: Capital IQ, Haywood Securities Estimates We believe Apivio is undervalued despite its NEC partnership and potential revenue growth opportunities. Apivio is currently trading at 0.3 EV/Revenue of our CY16 estimates, compared against its Canadian comparable peer group average of 0.9 EV/Revenue and VoIP Companies at 1.1 EV/Revenue. We believe Apivio should be trading at much higher multiples given its growth profile, upside to the NEC partnership, and the potential for recurring software to be introduced on top of the Monet Series platform. Apivio s EV/EBITDA multiples are currently higher than its comparable peer group because the Company is currently reinvesting for future growth, so the Company s EBITDA margins are not representative of the long term potential profitability in the business. We believe the Company could have 10-15% Adj. EBITDA margins in the long-term. Recommendation We are initiating coverage of Apivio with a BUY recommendation and 12-month target price of $1.00. Our target price represents an EV/Revenue multiple of 0.6, and an EV/EBITDA multiple of 11 applied to our FY17 estimates. We note that using an EV/Revenue multiple of 1.0x, which is in line with the peer group, would yield a target price of almost $1.50. We believe that Apivio will be trading more in line with its peer group multiples in the longer term; however, given the Company s limited operating history as a Canadian company, small market cap and lack of investor relations activity we apply a lower EV/Revenue multiple than the peer group. Nonetheless, our target price still represents a 245% share price increase from the recent close. We rate Apivio with a High Risk given that it is a small cap company with low trading volumes and a limited history of profitability. We believe Apivio has significant upside in the hardware opportunity with the possibility of converting to a more lucrative recurring software revenue model by owning the ecosystem. With a key distribution partnership in place with NEC, numerous positive indicators on a recent call with NEC s management provides validation of Apivio s new product as it comes to market. With numerous other technological advancements in the enterprise space, we believe the desktop phone has to naturally progress to a smartphone, and we believe Apivio, acting as the middleware glue, is positioned very well to capitalize on this movement. Pardeep Sangha, MBA psangha@haywood.com Page 18

19 APPENDIX I Corporate Governance and Management Rob Bakshi David Pais Richard Krupka J.Y. Ahn S.H. Shin J.S. Kang David Shaw Timothy Howley Rob McJunkin Chang-woo Lee Chairman, Chief Executive Officer, and President Chief Financial Officer Director of Sales Chief Executive Officer, Moimstone Korea Chief Technology Officer, Moimstone Korea Chief Financial Officer, Moimstone Korea Director, Director of Silent Witness Enterprises Ltd. Director, CFO of the Mark Anthony Group Inc. Director, SVP of Anthem Properties Director, Founder of Moimstone Korea Rob Bakshi Chairman, Chief Executive Officer, and President Mr. Bakshi is a seasoned entrepreneur with a proven track record for successfully developing market success. As the co-founder of Silent Witness Enterprises, a technology company that was listed on the TSX and NASDAQ, he lead the company s growth strategy until it was acquired by Honeywell for approximately $90M in Since then, he has been involved with industrial land development, including building a Convention Centre in Calgary and other strategic investments. In 2009, Mr. Bakshi began working with a South Korean company to establish Apivio Systems Inc. Mr. Bakshi led the transformation of the business into a Canadian technology company, putting together an independent board of directors, financing, and corporate governance in his capacity of Executive Chairman. In 2013, he was appointed CEO to execute the global business strategy and was responsible for taking the company public. Mr. Bakshi has a Bachelor s degree from Simon Fraser University with a major in Business and minor in Computer Science. David Pais Chief Financial Officer Mr. Pais has been the CFO of three successful companies over the last 11 years. Most recently, he was the CFO of a BC-based manufacturing company that was sold to a Boston-based NYSE listed public company. Prior to that, he was CFO at a developer and manufacturer of base stations and switching gear that he helped spin-off from UT Starcom, a NASDAQ listed company. He was also the CFO at a developer of VoIP server and endpoint software with offices in North America, Asia and Europe. Prior to that, Mr. Pais was a Senior Vice President at Ernst & Young Corporate Finance, specializing in M&A and financing. His investment banking experience spans a number of industries. Richard Krupka Director of Sales Director of Sales, Mr. Rick Krupka, heads up Apivio s U.S. sales strategy to carrier and enterprise markets. He is also focused on Apivio s sales and marketing channels for its new Wi-Fi product (Liberty L2) scheduled to launch later this year. Initially hired in 2013 to develop the market for Apivio s visionary Android-based desk phone and Liberty L1 Wi-Fi phone, Mr. Krupka was instrumental in developing distribution and partnership relationships with NEC America and Teledynamics, which resulted in the successful launch of Apivio s technology in North America. An industry veteran with more than 30 years of experience, Mr. Krupka has held a series of senior executive positions in Sales, Marketing and Business Development for leading communications companies such as ITT, Siemens, Ameritech (AT&T), and Uniden. He helped shepherd in a new industry in the cordless communication arena, which developed into a billion dollar market in Pardeep Sangha, MBA psangha@haywood.com Page 19

20 North America. Mr. Krupka holds a Bachelor of Science degree from the State University of NY and is a graduate of the Kellogg Business School of Management at Northwestern University KMI program J.Y. Ahn Chief Executive Officer, Moimstone Korea Mr. Ahn has worked at Moimstone Korea since He has worked in a number of positions over the course of his career, including logistics, sales and management. Previously, Mr. Ahn has worked in various technology companies in Korea, including Bobu International, YangJae Information Technology Co., and Telexy Co. He joined Moimstone as the Director of Sales, eventually rising to the position of COO. He received a degree in Electrical Engineering from the Hanyang University and completed the KOTRA International Business Professional Course. S.H Shin Chief Technology Officer, Moimstone Korea Mr. Shin joined Moimstone Korea five years ago. Over the last 19 years, he has held several senior engineering roles in several leading electronics companies in Korea including Dain Telecom, Dasan Networks, nsystech, and Hanwha Telecom. He has extensive experience in the areas of, but not limited to, POTS switching systems, Data communications (Network switches & xdsl), Semiconductors, VoIP and Wi-Fi solutions. Mr. Shin has a Bachelor s degree in electronics and computer engineering from Korea University. J.S. Kang Chief Financial Officer, Moimstone Korea Mr. Kang has headed the finance department of Moimstone Korea for the last seven years. He has 20 years of experience in strategic planning, finance and accounting in various Korean companies including Kolon International, Dansung Electron, and Vodus TM Co. He has passed the USA CPA exam and has a degree in business administration from the Konkuk University in Korea. Source: Apivio.com/about-us/management/ Pardeep Sangha, MBA psangha@haywood.com Page 20