MICROCAP COMPANY RESEARCH

U P D A T E R E P O R T

Bulletproof Group Limited

HY17 Results Review

Event

HY17 Results: Bulletproof recently released 1H17 results, with revenue and earnings in line with the guidance provided in late December. While the results weren’t surprising, it was

still a disappointing result, given the kind of margins that we think BPF is capable of delivering.

Refocusing and right-sizing: Management have taken steps to refocus their offerings to better align with market demand and differentiate their services, including launching the Microsoft Azure product, and higher value-added Professional Services offerings. A number of cost saving initiatives were also enacted late in 1H17 in order to recover margin in 2H17.

Sticking to full year guidance: The company has reiterated their guidance for FY17 of revenue of $54m and underlying EBITDA of $6m, implying 2H17 revenue and EBITDA of $29.6m and $6.4m, respectively.

Our view

2H17 turnaround: While 1H17 was underwhelming, we have largely maintained our FY17 forecasts. The guidance implies a significant turnaround in the 2H17, which we believe is achievable as 2H17 will benefit from a catch-up in foregone revenue from 1H17, and cost reduction initiatives undertaken during 1H17 to preserve profitability.

Higher profits, lower growth: The pain endured in 2H16 and 1H17 looks to have imbued management with a greater focus on sustainable profitability, and less emphasis on revenue growth. While we still expect BPF to grow strongly over the coming years, we would like to see this balanced with consistent profitability and free cash flow generation.

Valuation | Recommendation We have moved to a BUY recommendation, but lower our price objective to $0.26 from $0.29. This represents a 28.7% premium to the last traded price of $0.20. While FY17 will be a tough year, we believe that it will put BPF on a more solid footing towards building a more profitable and sustainable business.

RECE NT NE WS

Bulletproof Group [ASX:BPF] has recently released their

1H17 results. The company delivered revenue of $24.5m and

underlying EBITDA of -$0.4m, in line with the guidance

provided in December 2016.

6th March 2017

BPF BUY

Price Objective: $0.26

Last traded A$ 0.20 Nº of Shares m 158.7 Market Cap A$’m 31.7 Enterprise Value A$’m 32.6 2016A EPS ¢ 0.57 2017F EPS ¢ 0.72 2017F P/E x 30.1 2017F EV/EBITDA x 5.4 2017F DPS ¢ 0.0 Div Yield % 0.0 Sales 2016A m 47.2 Sales 2017F m 54.1 EBITDA 2016A m 4.9 EBITDA 2017F m 6.0 NPAT 2016A m 0.8 NPAT 2017F m 1.1

Share Price | 12 month

Analyst Declan M cLenaghan declan@microequities.com.au

Tel: (612) 9009 2906

GICS: Information Technology – Software & Services

IMPORTANT DISCLOSURE INFORMATION AT THE END OF THIS REPORT

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6th March 2017 www.microequities.com.au 2

HY17 RESULTS REVIEW Bulletproof recently provided forecast results for 1H17, delivering revenue of $24.5m and EBITDA of -$0.4m, which is in line with the guidance provided in late December 2016. Despite meeting guidance, we

view this result as disappointing. Management have also reiterated their guidance for the full year, guiding

to revenue of $54m and EBITDA of $6m.

The issues underlying the weak 2H16 results caused further problems in 1H17, driving a sharp fall in

profitability and lower than expected revenue growth. There are several reasons for the underwhelming 1H17 results and FY17 revenue guidance. In 2H16 the company encountered several customer-side

delays, which then continued into the first half of FY17. While some of these delayed projects will be

undertaken in the second half, this sudden deceleration was exacerbated by slower than expected sales bookings due to underperformance in the sales team. This combination of factors drove the weak results

seen in the 1H17 numbers.

Figure 1: BPF – Financial Results - 1H17A vs. 1H16A

Figures in A$’million 1H16A 1H17A % chg. $ chg. Operating Revenue 21.6 24.5 13.2% 2.8

Operating Expenses 19.9 24.8 24.8% 4.9

Underlying EBITDA 1.7 (0.4) (120.7%) (2.1) EBITDA Margin 8.0% (1.5%)

Chg. Y.o.Y. 29.4% (167.5%) Source: Company data

At the start of 1H17, Bulletproof found itself overstaffed in the face of the lower than expected available

work, depressing staff utilisation rates such that costs remained high while revenue declined. The impact is evident in the higher employee expenses during 1H17, which increased to $9.5m from $7.3m in 1H16.

We also understand that some employee expenses related to Professional Services work are now being

allocated to the ‘Consumables used’ line, which increased to $13.3m in 1H17, up from $9.2m in 1H16. This sharp increase in expenses drove the precipitous fall in EBITDA from 1H16 to 1H17. In order to

restore profitability, management enacted a number of measures to reduce costs in line with the reduced

revenue forecast. The impact of these initiatives will not come through in full until the start of 2H17.

As foreshadowed in the FY17 guidance from December 2016, the company has incurred restructuring

costs of $0.8m below-the-line. Further, Bulletproof’s accounting policies relating to the capitalisation of

product development costs has also been reviewed, and BPF took an impairment charge of $3.7m against the value of the capitalised product development assets on the balance sheet. Going forward, product

development expenses will be expensed, rather than capitalised. This will negatively impact EBITDA and

NPAT, but has no impact on free cash flow or our discounted cash flow valuation.

Figure 2: BPF – Financial Results - 2H17F vs. 1H17A

Figures in A$’million 1H17A 2H17F % chg. $ chg. Operating Revenue 24.5 29.6 21.2% 5.2

Operating Expenses 24.8 23.6 (4.7%) (1.2)

Underlying EBITDA (0.4) 6.0 NM 6.4

EBITDA Margin (1.5%) 20.2%

Chg. Yoy (167.5%) 92.3% Source: Company data

BPF recently released 1H17 results, which were in line with guidance. While revenue grew by 13.2% over the pcp, EBITDA fell sharply to -$0.4m.

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The second half guidance implies a sizeable increase in margins and profitability, which is one-off in nature.

This increase in margins is attributable to BPF receiving some ‘catch-up’ revenue from 1H17, which will

not require a corresponding increase in expenses. Also, management has moved to take cost out of the

business in 1H17 in response to the lower revenue base and renewed focus on profitability, with the

benefits to flow through in 2H17 and beyond. This has been achieved by reducing headcount from 170 at the end of FY16 to around 140 at the end of 1H17 and some savings in management structure and

corporate costs. Going forward, we understand that management intends to make use of a contractor pool

to fill short-term deficits in personnel needs, rather than hiring more full-time staff and bearing the risk of another slow-down in project work. To better meet customer needs going forward, employees have been

re-skilled to ensure that BPF’s offerings are in line with market demand. Cost savings have also been

achieved through internal reorganisation, and efficiencies on licencing deals with suppliers. The net result is that the cost-out initiatives are expected to remove $4.5m of expenses on an annualised basis, and will

enhance profitability in FY18 and beyond. These savings will largely be responsible for the company

meeting EBITDA guidance for the full year.

BPF generated operating cash flow of -$0.6m in the half, which includes $0.8m of restructuring costs.

Excluding restructuring costs, operating cash flow was $0.2m, a solid performance in light of the

underwhelming level of profitability. Capex (payments for PP&E and payments for intangibles) came in at -$0.3m, which was surprisingly low. We expect capex to be considerably higher in the second half, though

lower than we had originally forecast. The company ended 1H17 with gross debt of $3.6m (up from $3m

at FY16) and cash of $2.8m, for net debt of $0.9m. Given the relatively small amount, we are comfortable with Bulletproof’s current level of debt.

There were a number of operational developments during 1H17. In Cloud Services, the company launched Microsoft Azure capabilities in October 2016, including consulting, delivery and ongoing support, and we

understand that early results are encouraging, with the company seeing high quality leads coming in from

Microsoft. However, BPF has seen some pricing pressure on lower value-added Cloud Services offerings, and for this reason, management is seeking to move away from the more commoditised, holistic managed

services offerings. Instead, the company is reorienting towards newer, higher value-added products and

services, such as Agile and Devops, where there is less competition and margins are better. In Professional Services, management are pleased with the pipeline, and Bulletproof is getting an increasing

volume of work from newer customers. During the half, management have also sought to integrate the

New Zealand business’ sales and engineering functions more closely with the Australian business, following the issues in the NZ business in 2H16, which were impacted by the aforementioned customer

slowdowns. This integration is expected to enhance the future growth prospects of the NZ business. These

changes should assist in Bulletproof’s shift to becoming a more sustainable and profit-oriented business,

while still offering compelling growth prospects.

Regarding the status of the Chief Financial Officer, Kylie Turner resigned in December 2016, and was

expected to remain with the company until the end of February 2017. On the release of the 1H17 results, BPF announced that Kylie would continue to act as Chief Financial Officer until a new CFO is appointed.

We understand that the company’s search for a candidate is well-advanced, and that a new CFO is

expected to be announced within the coming weeks.

The second half will benefit from a one-off increase in margins as BPF regains some of the revenue lost in the first half of FY17.

6 Excluding restructuring costs, BPD delivered operating cash flow of $0.2m in 1H17. Operational changes in 1H17 included launching Microsoft Azure capabilities, increasing integration between the Australia and NZ businesses, and moving further into higher value-added Cloud Services offerings.

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CHANGES TO OUR FORECASTS Figure 3: BPF – Financial forecast summary

Figures in A$’million FY16A

FY17F FY17F FY18F

OLD NEW % Revision NEW Revenue 47.2 53.8 54.1 0.6% 61.4

Expenses (42.4) (47.9) (48.1) (54.3)

Underlying EBITDA 4.9 5.9 6.0 2.3% 7.1

% Chg YoY 13.8% 21.1% 23.9% 17.6%

EBITDA Margin 10.3% 10.9% 11.1% 11.5%

- Depr & Amortisation (3.8) (4.5) (4.5) (1.9)

EBIT 1.0 1.4 1.6 9.6% 5.2

EBIT Margin 2.1% 2.6% 2.9% 8.4%

Other (0.4) (0.1) (0.1) (0.1)

Net Interest (Expense) (0.1) (0.2) (0.2) (0.1)

Profit Before Tax 0.5 1.2 1.3 11.7% 4.9

Tax Benefit (Expense) 0.4 (0.3) (0.3) (1.4)

Underlying NPAT 0.8 0.9 1.1 14.9% 3.5

Underlying NPAT Margin 1.8% 1.7% 1.9% 5.7% Source: Company data, Microequities estimates

R e v e n u e Our revised forecasts are largely consistent with management’s guidance for FY17 revenue of $54m, and

only slightly higher than our previous estimates, with 1H17 revenue coming in just above guidance for the

first half. As noted earlier, Bulletproof encountered several customer-side project delays which carried through from 2H16 into 1H17, and will drive lower revenue growth in FY17 than previously expected. Some

of this lost revenue will be received in 2H17, implying that the mix between Professional Services Revenue

and Recurring Revenue will shift towards Professional Services during the second half. Following the guidance update in December 2016, we adjusted our short and medium term growth estimates

downwards, which is reflected in our FY18 estimates.

O p e r a t i n g E x p e n s e s Given that our revenue estimates have changed only modestly, our forecasts for operating expenses are

also virtually unchanged, with the slight increases due to the slight increase in our revenue forecasts. As

discussed in detail above, management have taken headcount in the engineering and administration teams, and employees are being re-skilled to better meet customer demand. This has caused a fall in

headcount of around 30 heads in 1H17, down to about 140 heads. Costs have also been reduced through

consolidation of the private cloud platform and some minor savings in corporate costs and management

structure. There will also be $0.8m in restructuring expenses in 1H17 associated with the right-sizing, though this will be below the line. We now expect employee expenses of $17.8m for FY17, and $17.3m

for FY18 due to a full year effect of the lower headcount. Headcount growth is expected to moderate in

future years, with management now increasing their focus on profitability, and building a more solid foundation for future growth.

Our forecasts for D&A are unchanged in FY17, with the increase relative to FY16 attributable to investments made in FY16 in intangibles and PP&E, some of which is related to the fit out of the new

6 Our revised forecasts remain consistent with management guidance and largely similar to our previous forecasts. Our forecasts for operating expenses are also broadly unchanged.

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Sydney office. D&A is expected to decline in FY18 as the last of the AWS RI intangible assets is amortised.

During 1H17, the company took an impairment charge against product development intangibles of $3.7m. Consequently, we are forecasting lower amortisation expenses in FY18 and beyond, as product

development expenditure will no longer be capitalised, but expensed. This is a more conservative

accounting policy, which does not affect free cash flow, but will depress EBITDA and NPAT.

We are forecasting EBITDA of $6m for FY17 (11.1% margin), and $7.1m in FY18 (11.5% margin), with our

FY17 forecasts in line with guidance, having increased by 2.3% relative to our previous forecasts. The higher EBITDA forecast is solely driven by the small increase in forecast revenue. This increase then flows

through the income statement, with the small dollar change driving larger percentage changes, as the

dollar profit figures are relatively small. Our estimates for FY18 revenue and EBITDA are also unchanged. We expect an increase in EBITDA margins in FY18 of 0.4%; this includes product development expenses,

which have been capitalised in prior years.

Overall, FY17 is expected to be a transition year, as the difficulties encountered in 1H17 have prompted a sharp reduction in the cost base in order to preserve profitability, and galvanised management into

emphasising profitable growth going forward. While we view management’s increased focus on profitability

as positive, our long-term margin assumptions will remain conservative until we gain comfort that Bulletproof can scale profitably and consistently generate free cash flow.

C a p e x a n d C a s h F l o w Our estimates for capex in FY17 have decreased following the first half, in which capex was surprisingly light. Payments for PP&E are expected to fall in FY17 compared to FY16 following the completion of the

fit-out of the Sydney office. We expect capex to begin trailing off in FY18 and beyond, as BPF leverages

the investments from prior years. We understand that the private cloud infrastructure will require some refresh, but this should largely be complete by the end of FY18. Overall, we are forecasting total capex of

$2.4m for FY17, and $1.7m for FY18.

Our estimates for FY17 operating cash flow of $5.3m include restructuring expenses of $0.8m, which were

incurred in 1H17. This implies a material turnaround in cash generation in 2H17, consistent with our

expectations for a considerable increase in EBITDA in the second half. We are then forecasting operating cash flow of $5.7m in FY18. As with our EBITDA forecasts, the updated forecasts for operating cash flow

are only marginally higher than our previous estimates. Our forecasts imply free cash flow of $2.9m for

FY17 and $4m for FY18. BPF ended 1H17 with gross debt of $3.6m and net debt of 0.9m, and we are

comfortable with this level of debt given that the business is expected to be cash flow positive in the second half.

FY17 has not been smooth sailing for Bulletproof as a company or for investors. We continue to believe that BPF has a long runway for growth, but that the drive for growth must be tempered by discipline in

spending and demonstrating consistent profits and free cash flow. We expect that BPF will emerge from

FY17 as a more disciplined company with a more sustainable business. There will be some short-term pain, but we view this as necessary to better position Bulletproof for the next stage of its growth as a

business.

We are forecasting EBITDA of $6m for FY17 and $7.1m for FY18. Our estimates for capex have declined given the lower than expected spending in 1H17. After what will be a challenging FY17, we expect BPF to emerge as a more mature and disciplined company.

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VALUATION | RECOMMENDATION

DCF Valuation Our DCF model provides us with a $0.29 valuation for Bulletproof Group, down from $0.33 previously. This represents a 42.9% premium to the current market price of $0.20. The decrease in the valuation is primarily related to the increase in in the WACC, and the increase in net debt. We have used a fundamental beta of 1.4 and a WACC of 12.6%. We have used a long-term growth rate of 3% in our DCF model.

DCF Valuation Breakup

Relative EV/EBITDA Valuation

We have undertaken a relative valuation using the most appropriate peers in the IT services sector. Using an FY17 EBITDA forecast of $6m and an EV/EBITDA multiple of 6.2x, we have derived a relative valuation of $0.23 per share, a 14.5% premium to the current market price of $0.20. Readers should note that we have removed SMS Management from the peer group, as the company has received a takeover offer since our last report, distorting the current trading multiple.

Peer group financial summary (as at 03/03/2017)

Investment Opinion

We have moved to a BUY recommendation despite the lower price objective, due to the fall in the share price since our last report. Our updated price objective of $0.26 ($0.29 previously) represents a 28.7% premium to the last traded price. The price objective is an average of the DCF valuation of $0.29 and our relative peer valuation of $0.23. Our lower price objective is due to decreases in both the peer group multiples since our last report and our lower DCF valuation. FY17 has become a transitional year for BPF, as the company seeks to address the issues that adversely impacted the 2H16 and 1H17 results, and move towards a more profit-oriented and disciplined organisation. While we still view the 1H17 and expected FY17 results as disappointing, we expect BPF to emerge from this period as a more mature and sustainable business. The managed cloud services sector continues to offer compelling growth opportunities, which we expect BPF to capitalise on over the coming years.

Key assumptions Equity Beta: 1.4 Debt: $3.6m Risk free rate: 3.1% Kd: 8.0% Cost of Equity: 13.5% WACC: 12.6% LT Growth Rate: 3.0%

7.0x6.4x 6.4x

5.0x 5.4x

Average = 6.2x

MLB CSV MAQ EPD BPF

EV / EBITDA Average

PV SUM60.0%

PV TV40.0%

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PRICE OBJECTIVE & RECOMMENDATION HISTORY

Changes to recommendations and/or price objectives

Date Recommendation Price at time of Rec Price Objective

06/03/2017 BUY $0.20 $0.26

10/01/2017 HOLD $0.26 $0.29

02/09/2016 BUY $0.29 $0.36

27/07/2016 HOLD $0.35 $0.40

29/02/2016 HOLD $0.405 $0.45

12/02/2016 HOLD $0.45 $0.46

16/09/2015 BUY $0.32 $0.40

13/03/2015 HOLD $0.265 $0.31

15/12/2014 STRONG BUY $0.22 $0.33

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FINANCIAL SUMMARY PROFIT & LOSS SUMMARY ($m) PROFITABILITY RATIOS

Year Ending June FY16A FY17F FY18F FY16A FY17F FY18F

Revenue 47.2 54.1 61.4 Sales 47.2 54.1 61.4

Expenses (42.4) (48.1) (54.3) EV/Sales 0.7x 0.6x 0.5x

Underlying EBITDA 4.9 6.0 7.1 Underlying EPS, cents 0.57c 0.72c 2.39c

% Chg YoY 13.8% 23.9% 17.6% Underlying EPS Growth YoY 8.3% 27.4% 232.1%

EBITDA Margin 10.3% 11.1% 11.5% Enterprise Value (EV) 32.6 32.6 32.6

- Depr & Amortisation (3.8) (4.5) (1.9) P/E 38.4x 30.1x 9.1x

EBIT 1.0 1.6 5.2 EV/EBIT 32.5x 21.0x 6.3x

EBIT Margin 2.1% 2.9% 8.4% EV/EBITDA 6.7x 5.4x 4.6x

Other (0.4) (0.1) (0.1) DPS Net, cent 0.0 0.0 0.0

Net Interest (Expense) (0.1) (0.2) (0.1) ROE 6.0% 5.5% 18.0%

Profit Before Tax 0.5 1.3 4.9 ROA 2.7% 2.9% 9.5%

Tax Benefit (Expense) 0.4 (0.3) (1.4) D/E 9.4% 6.3% 5.0%

Underlying NPAT 0.8 1.1 3.5

Underlying NPAT Margin 1.8% 1.9% 5.7%

Significant Items 0.9 (4.5) 0.0 Statutory NPAT 1.8 (3.4) 3.5 Statutory NPAT Margin 3.8% (6.3%) 5.7%

BALANCE SHEET ($m) CASH FLOW STATEMENT ($m)

FY16A FY17F FY18F FY16A FY17F FY18F

Cash and Equivalents 4.7 6.4 10.0 Cash from Customers 48.4 53.4 60.0

Trade Receivables 7.4 7.7 8.8 Cash to Supp.s & Emp.s (43.4) (48.1) (53.7)

Other Cur. Assets 2.2 1.7 1.9 Cash Paid for Taxes 0.2 (0.0) (0.6)

Total Cur. Assets 14.3 15.8 20.7 CF from operations 5.1 5.3 5.7

PPE 8.6 7.8 7.3 Payments for acquisitions (4.9) (0.1) 0

Intangibles 13.9 9.0 9.3 Payments for PP&E (0.9) (1.1) (1.1)

Other Non-Cur. Assets 2.4 2.1 1.3 Payments for Intangibles (3.9) (1.3) (0.6)

Total N.C. Assets 24.9 18.9 17.9 Other 0.0 0.1 0.2

Total Assets 39.2 34.7 38.7 CF from investing (9.7) (2.4) (1.5)

Trade Payables 8.1 8.4 9.1 Net Borrowings (1.5) (1.2) (0.5)

Borrowings 1.4 1.1 0.9 Equity issuance 7.4 0 0

Provisions 1.0 1.1 1.1 CF from financing 5.9 (1.2) (0.5)

Other Cur. Liabilities 4.3 3.8 3.7 Net Inc/(Decr) Cash 1.3 1.7 3.7

Total Cur. Liabilities 14.8 14.3 14.8 Opening Cash 3.4 4.7 6.4

Borrowings 1.6 0.8 0.6 Ending Cash 4.7 6.4 10.0

Provisions 0.3 0.3 0.3 Other Non-Cur. Liabilities 1.7 1.7 1.7 Total N.C. Liabilities 3.6 2.8 2.6 Total Liabilities 18.3 17.1 17.4 Net Assets 20.8 17.6 21.2

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6th March 2017 microequities.com.au 9

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RECOMMENDATION GUIDE Recommendation Market Price undervalued/overvalued to Microequities price objective

Strong Buy Above 40% Buy 20 to 40% Hold 0 to 20% Sell 0 to -20% Strong Sell Greater than 20%

ADDITIONAL VOLUNTARY D ISCLOSURE BY M ICROEQUITIES*

Investment Banking Staff Interest Analyst personal Interest

Equity Stake By Microequities

Disclosure to Company

Business Relationship

NO NO * To promote transparency, Microequities voluntarily discloses potential conflict of interests covered by this research document. Additional disclosure: - Microequities has a research distribution agreement with Bulletproof Group Limited - Microequities Asset Management Pty Ltd is a substantial shareholder in Bulletproof Group Limited - We and our affiliates, officers and directors, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives, if any, referred to in this research. -Microequities participated in an institutional placement in September 2015 and received fees for that participation.