7digital Group FY17 results

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16 August 2018 7digtal has now reported its FY17 results, which show a strong uplift in revenues, reflecting the 24-7 acquisition, and a greatly reduced EBITDA Price 4.5p loss. The publication of the results was delayed in order to conduct a Market cap £18m thorough review by new auditors, resulting in a significant strengthening in reporting procedures and systems, and a restatement of historical Net cash (£m) at 31 December 2017 7.0 figures. The rapidly shifting streaming market gives the group significant Shares in issue 399.6m B2B opportunities, with music a key element of customer engagement for retailers, connected devices and mobile network operators. Free float 84% Code 7DIG

Revenue EBITDA PBT* EPS* DPS EV/ EBITDA PE Primary exchange AIM Year end (£m) (£m) (£m) (p) (p) (x) (%) 12/16^^ 11.2 (4.3) (5.6) (4.9) 0.0 N/A N/A Secondary exchange N/A

12/17^^ 16.8 (1.6) (3.8) (2.3) 0.0 N/A N/A Share price performance 12/18e 21.8 2.4 0.0 0.0 0.0 4.2 N/A 12/19e 26.5 6.5 3.4 0.8 0.0 1.5 5.7 Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. ^^restated.

FY17 – results reflect MMS acquisition FY17 revenues, up 50%, reflect the May 2017 acquisition of its largest competitor, 24-7, from MMS. Revenues from MediaMarktSaturn (MMS, now 7digital’s largest customer) underlie the 74% increase in high margin licence revenue. This resulting gross margin improvement has enabled the group to narrow its EBITDA loss % 1m 3m 12m significantly, ahead of our previous forecast. Over FY17, 7digital carried out a major Abs 0.0 (7.1) (33.8) project to integrate the three tech platforms (its own, Snowite and 24-7’s Juke), with FY17 capex of £4.7m. This will improve its ability to offer clients ‘Platform-as-a- Rel (local) 2.2 (4.5) (35.0)

Service’. Year-end net cash, bolstered by the December 2017 capital raise, was 52-week high/low 7.0p 3.9p £7.0m. The previous CFO, Matt Honey, has resigned and David Holmwood Business description (previously financial controller at Universal Music) has been serving as CFO on an interim basis. He and other candidates for the permanent role are currently being 7digital Group provides an end-to-end, white-label digital music platform and access to global music considered. rights that enable its clients, which include businesses in the radio, electronics, social media Outlook – ingredients for success and telecoms industries around the world, to offer music streaming and download services to their own FY17 was a transformative year: the 24-7 acquisition added scale, enabling the customers. Its global customer base includes group to move towards EBITDA profitability, and the December 2017 capital raise musical.ly, Onkyo, Panasonic, MediaMarktSaturn, provided ample funds to see the group to cash flow (and operating profit) break- Cdiscount, Electric Jukebox, eMusic and i.am +. even, targeted for H218e. The group has continued to add reference clients across Next event a range of industry verticals, cementing its position as the leading B2B end-to-end music platform provider. With its ‘ducks in a row’, we expect FY18e and FY19e to H118 results September 2018 show good progress. H118 sales are indicated at £9.3m, up 57% and management Analysts points to a strong pipeline and increasing momentum across the business. Fiona Orford-Williams +44 (0)20 3077 5739 Neil Shah +44 (0)20 3077 5715

Valuation: Positioned for growth [email protected]

On a FY19e P/E of 5.7x based on our revised forecasts, 7digital trades at a Edison profile page considerable discount to software peers (UK sector, excluding outliers, on 24x).

With the platform, reference clients and balance sheet structure now more secure, 7digital Group is a research and with a significant amount of operational leverage in the business, we expect client of Edison Investment the group to move to a growth rating. Research Limited

FY17 results reflect acquisition and integration of MMS

Strong investment case intact

 FY17 was a transformative year for the group, which in acquiring its largest European competitor (24-7, bought from MMS), gained both scale and reach across Europe. While the cost of integrating the platforms exceeded our expectations, we understand that the bulk of this work is now complete and the platform is more robustly positioned to support the scaling of the client base.

 The group has been reporting a steady trickle of new reference clients across a range of sectors, which, while fairly small in terms of revenue contribution, support the investment case that there remains an untapped market for streamed music services for the casual listener – beyond the current three dominant global platforms (Spotify, Amazon and Apple Music) that will be served by a range of business models.

 We forecast FY19e to be the first year of operating profitability for the group and, despite capital expenditure remaining elevated, we expect net cash flow break-even in H218.

 While the December 2017 capital raise was significantly dilutive in terms of EPS, the group has a greater degree of balance sheet flexibility.

 The bulk of revenues are now from high-margin licence sales and we see scope for EBITDA margins to increase rapidly from the 11% forecast in FY18 to 25% in FY19.

Thorough audit and restatements 7digital appointed a new auditor, BDO, in January 2018. In the course of its appraisals, BDO discovered some weaknesses in the internal reporting. This triggered an exhaustive review of system and accounting practices within the group. The review also led to a number of corrections in prior year accounts, mostly relating to the accounting relating to acquisitions.

 For FY15, cost of sales accruals at the year-end relating to content revenues has been reduced by £773k.

 For FY16, a number of adjustments have been made to the balance sheet treatment of the Snowite acquisition. £546k, previously apportioned to goodwill, has now been reclassified as a bespoke application intangible asset, increasing amortisation by £137k for the year. A shareholder put option has also been brought on balance sheet (+£114k of liability) and £109k of revenue under accrued has been added back. In addition, £551k of FX gains were incorrectly recognised as revenue and a further £241k of revenue was mis-stated. Other adjustments relate to third-party work being moved from WIP to other debtors, patents being reclassified as intangible assets from current assets, liabilities within Snowite that had been presented as loans being reclassified as trade and other payables, and errors in the calculation of share-based payments.

 The auditors have qualified the accounts on a material uncertainty over the going concern basis on a technical issue regarding a short-term funding to cover restructuring payments. Two of the group’s largest shareholders have committed to cover this eventuality. Only letters of intent had been issued at the time of the audit sign-off, hence the note of caution. Management’s view is that if the timing of the firm commitment had been sooner, the auditors would not have made this qualification.

While the detailed audit process has undoubtedly been painful (and painstaking) for those involved, investor confidence in the published figures should be greatly enhanced. A permanent appointment to the post of CFO will further enhance the group’s financial credibility.

7digital Group | 16 August 2018 2

EBITDA loss much reduced In its final audited results, revenues have been reported of £16.8m, slightly lower than those pre- announced in February (£17.3m), as revenue previously booked to FY17 has been shifted out to FY18 under the IFRS15 definitions. The EBITDA loss of £1.6m compares to a previously announced figure of £1.0m.

We had previously updated our FY17 figures for both the December 2017 £8.5m equity issue and these preliminary figures. However, given that the final results differ from these preliminary numbers, in terms of looking at the operational performance of the group, we believe it more relevant to compare to our previous forecast (published in September).

7digital’s results were a little better than our forecast for an EBITDA loss of £1.7m and a substantial improvement on FY16’s £4.3m loss (restated). This outperformance came despite the small shortfall in revenues indicated above.

Operational progress largely reflects the MMS deal The 50% increase in revenues in FY17 was largely due to the acquisition of 24-7 from MMS effective May 2017. As part of this transaction, 7digital not only acquired 24-7’s roster of clients (the largest of which are Juke and Danish telco TDC), but also agreed additional project work for MMS. Together, this underlies £18m of contracted revenues over the next three years. MMS generated £7.0m of revenue in FY17, but £2.0m of this relates to one-off revenues. Although these were paid in advance, under IFRS 15 they will be recognised in H118.

High-margin licensing revenues increased by 74% to £11.6m, with the monthly recurring element of this licensing revenue increasing by 71% to £8.4m. Total exit monthly recurring revenues (MRR) increased by 23% as at the year-end, largely driven by this transaction and a steady underlying increase in MRR from the other clients where it has a good spread of reference clients across key industry verticals. For instance, during the year (and subsequently) it has announced deals with, for instance, SoundHound (voice-enabled connected devices), Global Eagle Entertainment (in-flight entertainment) and DTS (automotive audio), as well as expanding its relationship with social media app musical.ly.

The Creative division (12% of sales) delivered another year of good revenue growth at 6%. During FY17, it retained key broadcast clients such as the BBC’s Pick of the Pops, The Folk Show and The Golden Hour, and also added new clients including Amazon (news bulletin productions) and BBC iPlayer (video documentary), as well as benefiting from a wider network of clients across the group. Within the Content division (19% of group revenues), direct-to-consumer downloads continue to weaken, but this was more than offset by higher-margin, one-off projects for music labels and the continuing shift to high-res formats. Revenues were up by 21%, a result much better than we had anticipated.

With 69% of FY17 revenues derived from licence sales (FY16: 60%), gross margins increased to 72% from 69%, underpinning a 55% increase in gross profits. This margin increase and delivery of a cost-saving programme meant that with the absorption of the cost base of 24-7 from May 2017, operational expenses increased by only £3.7m for the year, enabling the group to deliver a small EBITDA profit in H217.

7digital Group | 16 August 2018 3

Exhibit 1: Summary results Revenues FY16 FY17 change FY17 Variance to forecast FY18e FY19e (Nov 2017 (£000s) (new) (new) Edison forecast) License sales 6,679 11,616 74% 14,721 (3,105) 16,838 21,635 Content 2,625 3,167 21% 1,845 1,322 2,692 2,423 Creative 1,912 2,018 6% 2,294 (276) 2,220 2,442 Other 0 0 250 (250) 0 0 Total revenues 11,216 16,801 50% 19,110 (2,309) 21,750 26,500 Revenue growth 7.9% 49.8% 29.5% 21.8% Gross profit: Licensing 6,167 9,436 53% 13,249 (3,813) 15,491 20,121 Content 798 1,939 143% 203 1,736 135 242 Creative 805 660 -18% 1,147 (487) 799 928 Total gross profit 7,770 12,035 55% 14,849 (2,814) 16,425 21,291 Gross margin 69.3% 71.6% 77.7% 75.5% 80.3% Operating expenses (12,080) (13,643) 13% (16,596) 2,953 (14,025) (14,760) EBITDA (4,310) (1,608) -63% (1,747) 139 2,400 6,530 EBITDA margin N/A N/A 11.0% 24.6% Normalised EBITA (5,603) (3,761) -33% (2,875) (886) (25) 3,345 Normalised PBT (5,616) (3,816) -32% (2,875) (941) 0 3,358 Reported PBT (5,475) (5,026) -8% (4,267) (759) (1,100) 3,358 Source: 7digital – historics, Edison - forecasts

Outlook – on track for profits and positive cash flow in H218 FY17 was largely about the acquisition and integration of 24-7, and the on-boarding of reference clients across strategic verticals. In FY18, management will focus on the relaunch of the Juke services on the 7digital platform across 15 territories (as these services come online, we would expect to see a commensurate pick up in MRR, as well as converting larger clients in its target verticals . Negotiations with companies in the retail and telecoms sector in North America looking promising for H218.

Management has reiterated its guidance that, given a strong pipeline and the increased momentum it is seeing, it is on track to reach operational profitability in H218, and to become net cash-flow positive in the same accounting period.

Forecast changes; lower FY18 EBITDA, higher FY19 We update forecasts for the FY17 reported results, changes in accounting, higher level of capital expenditure and associated amortisation in future periods.

At the operating level, this results in a decrease in our forecast EBITDA in FY18e from £3.0m to £2.4m (11% EBITDA margin), although a higher amortisation charge means that we reduce our normalised EBITA forecast from £2.1m to breakeven. With the bulk of the integration work now done, we forecast the level of capital expenditure to decrease from the £4.7m reported in FY17 (28% revenues) to £3.5m in FY18 and £2.5m in FY19. For FY19e, we are now expecting EBITDA of £6.5m, reflecting the improving gross margin from the change in mix and the limited rise in operating expenses as the cost of merging the platforms falls away and the synergistic benefits start to come through. We currently model a 25% EBITDA margin for FY19e. Overall, these changes mean that, provided working capital continues to be managed tightly, the group should be cash-generative from H218. We forecast a year-end net cash position of £3.3m.

7digital Group | 16 August 2018 4

Exhibit 2: Summary forecast changes £000s FY18e FY18e Change FY19e FY19e Change Old New Old New Revenues 24,856 21,750 -12.5% 27,587 26,500 -3.9% EBITDA 2,965 2,400 -19.0% 4,646 6,530 40.6% Normalised operating profit 2,145 (25) N/A 3,762 3,345 -11.1% Reported operating profit 493 (1,125) N/A 3,762 3,345 -11.1% Normalised PBT 2,130 0 N/A 3,762 3,358 -10.8% Reported PBT 478 (1,100) N/A 3,762 3,358 -10.8% Normalised net income 2,130 0 N/A 3,386 3,022 -10.8% Source: Edison

Valuation and investment case The revised expectations mean that FY19 should be the first forecast year of profitability since the strategy shift in 2015. The shares are trading at a PE multiple of 5.7x for that year, with reverse DCF implying that negligible revenue or margin growth is being factored in.

We believe the investment case for 7digital remains compelling and that it should be on a growth rating; 10% annual revenue growth FY10–25 with EBITDA margins reaching 25% (11% WACC, 2% perpetuity), for instance, would point to a DCF valuation of 12.6p/share – implying a PE of 16x FY19 earnings – more in line with UK software peers.

7digital Group | 16 August 2018 5

Exhibit 3: Financial summary £'k 2015 2016 2017 2018e 2019e 31-December IFRS IFRS IFRS IFRS IFRS INCOME STATEMENT Revenue 10,392 11,216 16,801 21,750 26,500 Cost of Sales (3,308) (3,446) (4,766) (5,325) (5,209) Gross Profit 7,084 7,770 12,035 16,425 21,291 EBITDA (2,102) (4,310) (1,608) 2,400 6,530 Normalised operating profit (2,862) (5,603) (3,761) (25) 3,345 Amortisation of acquired intangibles 0 0 0 0 0 Exceptionals / FX (128) 313 (1,124) (1,100) 0 Share-based payments (137) (172) (86) 0 0 Reported operating profit (3,127) (5,462) (4,971) (1,125) 3,345 Net Interest 11 (13) (55) 25 12 Joint ventures & associates (post tax) 0 0 0 0 0 Exceptionals (4,767) 0 0 (0) 0 Profit Before Tax (norm) (7,618) (5,616) (3,816) 0 3,358 Profit Before Tax (reported) (7,883) (5,475) (5,026) (1,100) 3,358 Reported tax (3) (12) 380 0 (336) Profit After Tax (norm) (7,621) (5,628) (3,816) 0 3,022 Profit After Tax (reported) (7,886) (5,487) (4,646) (1,100) 3,022 Minority interests 0 0 0 0 0 Discontinued operations 0 0 0 0 0 Net income (normalised) (7,621) (5,628) (3,816) 0 3,022 Net income (reported) (7,886) (5,487) (4,646) (1,100) 3,022 Basic average number of shares outstanding (m) 108 114 170 399 399 EPS - basic normalised (p) (7.1) (4.9) (2.3) 0.0 0.8 EPS - diluted normalised (p) (7.1) (4.9) (2.3) 0.0 0.8 EPS - basic reported (p) (7.3) (4.8) (2.7) (0.3) 0.8 Revenue growth (%) 1.8 7.9 49.8 29.5 21.8 Gross Margin (%) 68.2 69.3 71.6 75.5 80.3 EBITDA Margin (%) N/A N/A N/A 11.0 24.6 Normalised Operating Margin N/A N/A N/A -0.1 12.6 BALANCE SHEET Fixed Assets 1,127 2,676 6,481 7,112 7,427 Intangible Assets 423 2,201 6,157 6,913 7,363 Tangible Assets 704 475 324 199 64 Investments & other 0 0 0 0 0 Current Assets 6,212 4,664 13,980 10,491 11,896 Stocks 0 0 0 0 0 Debtors 4,556 3,826 7,002 7,151 8,712 Cash & cash equivalents 1,656 838 6,978 3,341 3,184 Other 0 0 0 0 0 Current Liabilities (3,201) (6,223) (11,951) (10,637) (9,335) Creditors (3,031) (6,080) (11,917) (10,603) (9,301) Tax and social security 0 0 0 0 0 Short term borrowings 0 0 0 0 0 Other (170) (143) (34) (34) (34) Long Term Liabilities 0 (2,057) (2,078) (2,078) (878) Long term borrowings 0 0 0 0 0 Other long term liabilities 0 (2,057) (2,078) (2,078) (878) Net Assets 4,138 (940) 6,432 4,889 9,110 Minority interests 0 0 0 0 0 Shareholders' equity 4,138 (940) 6,432 4,889 9,110 CASH FLOW Op Cash Flow before WC and tax (2,102) (4,310) (1,608) 2,400 6,530 Working capital (2,439) 3,400 2,188 (1,463) (2,863) Exceptional & other (150) (465) (676) (1,100) 0 Tax (3) (12) 294 0 (336) Net operating cash flow (4,694) (1,387) 198 (163) 3,331 Capex (848) (447) (4,881) (3,500) (3,500) Acquisitions/disposals 1,828 109 297 0 0 Net interest 11 (7) 55 25 12 Equity financing 0 0 10,694 0 0 Dividends 0 (1) 0 0 0 Other 0 (4) 135 0 0 Net Cash Flow (3,703) (1,737) 6,498 (3,637) (157) Opening net debt/(cash) (5,312) (1,656) (838) (6,978) (3,341) FX 48 919 (358) 0 0 Other non-cash movements 0 0 0 0 0 Closing net debt/(cash) (1,656) (838) (6,978) (3,341) (3,184) Source: 7digital accounts, Edison Investment Research. Note: FY15 and FY16 restated.

7digital Group | 16 August 2018 6

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Frankfurt +49 (0)69 78 8076 960 London +44 (0)20 3077 5700 New York +1 646 653 7026 Sydney +61 (0)2 8249 8342 7digitalSchumannstrasse Grou 34b p | 16 August 2018280 High Holborn 295 Madison Avenue, 18th Floor Level 12, Office 1205 7 60325 Frankfurt London, WC1V 7EE 10017, New York 95 Pitt Street, Sydney Germany United Kingdom US NSW 2000, Australia