Sales declined by 3% y/y, somewhat below our forecast of -1%. Organic growth was -8%. The volatile System revenue fell 14% y/y, about 7% below our expectations. All three Service revenue types beat our estimates slightly – just as in Q2. The recurring revenue (Cloud and Support) grew by 9% organically y/y, and all Business Units had organic growth in ARR. We believe that is a relatively strong level, and the trend since 2021 has been strong. The ARR (annual recurring revenue) was SEK1 747m (1 479). While System revenue, as mentioned, tends to be volatile, making quarterly swings hard to interpret, the solid trend in recurring revenue is just what we like to see in Proact. However, as the System revenue growth and the intake of new cloud contracts have declined somewhat in recent quarters, we expected a slight decline in organic growth in recurring revenue going forward.

The net intake of new cloud contracts was SEK119m (158). Management believes the somewhat lower pace is due to timing effects rather than softer demand – which, however, was mentioned in Q2 as well. Also, management states that the number is hurt by some customers wanting more flexibility, resulting in potential volumes Proact cannot add to the intake number. Thus, the implications of the cloud contracts intake number are more unclear from now on, as a softer number does not necessarily imply weaker cloud revenue growth.

Gross profit was in line with our expectations, following a somewhat higher gross margin, while sales, as mentioned, was slightly lower than estimated. The gross margin also improved y/y by one percentage point, which is quite substantial in a business like Proact with ~6% in EBITA margins. The improvement suggests that the service delivery’s cost-efficiency and general efficiency measures had a positive effect. It is encouraging to see Proact now being able to compensate for cost inflation by efficiency measures, as that has been its main issue lately, in our view.

SG&A was about 2% higher than expected, which, combined with a gross profit largely as expected, resulted in an EBITA of SEK73m (73) compared to our forecast of SEK76m. Note that last year’s Q3 – as was the case in Q2 as well –  was a strong quarter regarding of System revenue, boosting EBITA. The EBITA margin was 6.8%, while we forecasted 6.9%. Despite EBITA being flat y/y, considering the rather sharp fall in System revenue, we believe the result is solid, highlighting the successful cost cuts.

Alos, cash flow was strong and net debt (ex. leasing) to EBITDA was 0.4x 2023e. Thus, leaving a lot of financial room for acquistions.

As we often see in Proact, the largest Business Unit, Nordics and Baltics, performed better than the others, reaching an EBITA margin of impressive 10.1% this quarter. None of the other three Business Units had an EBITA margin above 2.5%. While the difference is larger than usual in this quarter, the trend is clear, with Nordics & Baltics having an average EBITA margin of 6.9% since the start of 2020 – where the current segment reporting started. Central is closest with an average of 6.1%, UK next with 5.1% and West last with 3.6%.

The difference has recently increased, where the market has been softer outside the Nordics and Baltics. That probably explains some of the difference. However, it also put some question marks on Proact’s partly M&A-fueled international expansion, as the track record so far is soft. At the same time, BU Nordics & Baltics has an R12m EBITA margin above Proact’s target of 8%. Thus, on the other hand, one could argue that mimicking the BU Nordics & Baltics in the other business units should take the group to its 8% margin target over time.

As the gross margin and organic growth in recurring revenue have improved, which is encouraging, we believe Proact needs to show it can have solid profitability over time outside of the Nordics/Baltics. Such signs could trigger increases in our Base Case.

We leave our total sales forecasts unchanged while slightly decreasing System and Consulting and increasing the recurring revenue – Support and Cloud. This holds for 2023 and 2024. Regarding EBITA, we lower 2023 somewhat, partly due to the lower-than-expected outcome in this quarter. For 2024, we leave our EBITA forecasts unchanged.

We lowered our Base Case to SEK110 (115) largely because we increased our risk-free rate from 2.5% to 3%, resulting in a higher WACC.

Proact is trading at a discount of 30% 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 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, which this quarter highlights. We believe Proact could be on track to becoming a more stable business, which we believe would motivate a higher multiple.