Sales declined by 2% y/y, 6% below our forecast of 4%. Organic growth was -3%. The volatile system revenue fell 11% y/y, while we expected an increase of 2%. The recurring revenue (Cloud and Support) grew by 11% organically y/y, roughly in line with our expectations. We believe that is a relatively strong level, and the trend since 2021 has been solid. The ARR (annual recurring revenue) was SEK1 766m (1 596). While System revenue, as mentioned, tends to be volatile, making quarterly swings hard to interpret, as mentioned in earlier Updates, the solid trend in recurring revenue is just what we like to see in Proact. Consulting declined by 10% y/y, slightly worse than expected. However, the Consulting was roughly flat q/q, indicating that the Consulting likely has bottomed out.

Management generally sees improving markets in most geographies as the macroeconomic environment has stabilized somewhat. While the presence of new technology is constant in Proact’s market and what typically drives sales, we note that many related areas have seen an uptick in demand thanks to AI. Although most potential customers have run their AI in large public clouds so far – which is typically the case when testing new technologies – Proact sees an increasing interest in moving AI applications to hybrid/private/on-prem from some customers. Also, Proact has some dialogues regarding Nvidia-based solutions.

During the quarter, Proact strengthened several key partnerships, which is important for a value-added reseller business like Proact's. For example, Proact will be the first NetApp partner to deliver the NetApp Data Protection and Security Assessment. While other partners will be able to deliver that as well, it strengthens Proact's position as a front-runner within cybersecurity. In addition, Proact is one of Broadcom’s partners, meaning that Proact can deliver solutions based on VMware products suit also after Broadcom acquired VMware. Following the acquisition of VMware by Broadcom, the number of partners has decreased, which, all else equal, should somewhat strengthen Proact’s position.

The intake of new cloud contracts was a record high SEK183m (117) for a Q1, mainly driven by BU UK followed by Nordic & Baltics and West. That is a strong number, supporting solid Cloud revenue growth some quarters ahead (there is typically a 6-month lag from signing to revenue, and the contracts usually span three years). While it is too early to talk about a stronger trend in new cloud contracts, we note that both Q4 and Q1 have seen strong quarters, which we have not seen before.

The gross profit was 8% better than we expected, following slightly lower sales but a much stronger gross margin than we anticipated. While the slightly more service-heavy sales mix than we expected motivates a slightly higher gross margin, the outcome of 25.8% (21.7), beating our forecast of 22.5%, was mostly due to strong gross margins within System sales and a result of the efficiency measures taken in 2023. As the gross margin in System sales tends to be volatile, we do not extrapolate the quarter’s strong margin too much. However, the improvement from efficiency measures should continue, resulting in an increasing underlying gross margin.

Thanks to the strong gross profit and OPEX only exceeding our forecasts marginally, the EBITA of SEK95m (56) beat our forecast of SEK82m. The EBITA margin was 7.9% (4.6%), above our forecast of 6.4%. 7.9% is a strong level in Proact and the first time the company is close to its 8% EBITA margin target. While the report has several encouraging points, like the 11% organic growth and efficiency measures boosting the gross margins, considering the positive effect of the strong System sales mix, we believe investors should expect lower margins during the rest of 2024. Nevertheless, the quarter highlights that 8% is a reasonable target, especially as the recurring revenue share increases.

As discussed in our recent update, the largest business units, Nordics and Baltics, have historically continuously outperformed the other smaller BUs. In this quarter, we note that BU West did well (7.0% EBITA margin), while BU UK and BU Central are far from the 8% margin target. Many of Proact’s recent acquisitions have been made outside of the Nordics and Baltics, and seeing a strong performance in those markets is, in our view, important for the long-term case, which partly depends on further European M&A in Proact.

We leave our sales forecasts roughly flat for 2024 and 2025 as we increase Cloud and Support somewhat while slightly lowering Systems. We increased our EBITA forecasts by 2-7% due to raised assumptions regarding gross margins, as the efficiency measures seem to have a greater impact than we initially expected. Somewhat higher OPEX expectations partly offset the increase in gross margin assumptions.

The larger increase in EBITA for 2024 is mainly due to this quarter's stronger-than-expected outcome.

We expect modest organic growth of ~4% for 2024-25 and EBITA margins of just above 7%, slightly below the company target of 8%.

Based on increased forecasts, we raised our Base Case to SEK124 (115).

Proact is trading at a discount of ~20% to the median IT consultant on EV/EBITDA 2024 – Note that EBITDA somewhat overestimates the earnings in Proact relative to the peers considering its hardware-heavy business model. However, the discount is nevertheless significant. We believe a lower discount is reasonable. Also, on the other hand, EBIT (where Proact is trading in line with the median) underestimates its earnings due to its relatively high M&A-related D&A. Proact has the advantage of a high share of recurring revenue supporting a premium. However, the company’s earnings have historically been volatile. We believe Proact could be on track to becoming a more stable business, which we believe would motivate a higher multiple.

We would argue that EV/EBITA is the most suitable multiple for Proact. However, the availability of forecasts on EBITA is limited. Proact is trading at 8.3x and 7.5x EBITA for 2024-25, respectively, implying a discount of about 5-15% to the median of companies with forecasts on EBITA.