Milestone Unannounced Funding and Profitability

Last year, Milestone boldly proclaimed plans to dominate the global VMS market. To better understand how well they are executing this plan, we obtained a copy of their original Danish Financial report, analyzed it and spoke with Milestone management. In this note, we dig into Milestone's Danish financials, examining details of never announced new funding, the company's profitability and the future challenges the company faces as it is executes on the VMS market's most aggressive expansion plan.

Revenue

While Milestone reported a 22% increase in overall revenue in 2011, the company says that in local currency terms, revenue was up 29%. Local currency terms are typically a better way to judge a company's market growth, as they factor out short term currency impacts (e.g., in 2011, they were negative for Milestone).

Milestone says that their growth rate places them above their market average, citing nonpublic market research numbers. While this is heavily dependent on how one segments the market, a growth rate of 22-29% is likely in line with the overall market, assuming that IP cameras are growing in a similar range.

Profitability

Profitability across the board declined:

• Gross Margins down from 79.1% to 75.8%
• EBITDA Margins down from 24.8% to 16.9%
• EBIT (or Net) Margins down from 9.8% to 3.8%

Milestone says a few factors depressed profitability: negative currency impact, expansion into new markets and parts of Europe underperforming relative to plan.

However, just like last year, measured in more traditional terms, Milestone was not profitable in 2011. Their reported profitability is based on capitalizing a significant amount of their software development expenses. Milestone capitalized ~$3 Million USD in such expenses in 2011, more than their reported total net income ~$1.8 Million USD net income. More commonly in the Americas as well as for most surveillance companies, development costs are expensed in the same year, not capitalized. Doing so, Milestone would have suffered a loss. Moreover, relative to other top companies in the market, Milestone's profitability is significantly lower. [For more see details in our 2011 Milestone profitability review.]

Why is lower profitability / losses an important factor?

• Positive side: It could mean that Milestone is investing more for future growth, allowing it to outperform the market in future years.
• Negative side: If could mean that Milestone is inefficient and is effectively 'buying' revenue, which may result in a fall if it stops spending as heavily.

Ultimately though, mature companies, like Milestone, need to eventually generate real profits (i.e., positive operational cash flow). Otherwise, eventually you see cost cuts and price increases as the company seeks profitability. Nonetheless, today, Milestone remains bullish about the future.

Funding

During 2011, Milestone received an ~$8 Million USD investment. While this was not announced, it is evident from reviewing their financial records. Milestone clarified that the investment came from Index Ventures, the same VC firm that led their $27 Million investment in 2008 [link no longer available]. According to Milestone, the $8 Million is new and is equity.

Having an existing investor make a follow-up investment is a good sign as it typically indicates the investor is happy with the progress the company makes. On the other hand, it increases the expectations and the targets a company must reach to justify the investment.

Cash Position

Milestone's operational cash position was essentially flat to slightly negative. Prior to the investment, Milestone had ~$6 Million USD cash on hand. Now, they have ~$15 Million USD.

Milestone's challenge is that they have essentially never generated operational free cash flow as they have aggressively invested in scaling the business. This certainly has a potential to be a very good thing, especially if Milestone can come close to their world dominating plans. However, it is abnormal for the market, with most peers being cash flow positive.

Future

Milestone says it is aiming for an IPO and a long-term EBITDA average of 35-40%. However, in 2011, EBITDA was less than half of that (16.9%). Reaching their profit and going public goals depends on what growth rate they can achieve and what spending levels they can maintain.

Revenue growth dropped dramatically from 2010 to 2011 (from 55% down to 22%). However, last year, Milestone claimed that they could average 41% growth and reach at least $130 Million USD revenue in a few years. This seems infeasible given that they are not even at $50 Million USD revenue. However, the overall VMS market growth appears to be decelerating, with weakening economies, approaching market saturation and improving substitutes (e.g., decentralized recording). Given all this, Milestone will likely be fighting against the wind to pursue such rapid growth.

While Milestone is growing revenue, a significant driver is the company's aggressive sales and marketing expenditure. In other words, the growth may not be sustainable without an unjustifiable level of continued spending. On the other hand, Milestone could quickly become much more profitable by cutting back spending but it would most likely hurt revenue growth or cause revenue to actually decline.

We see no risk of Milestone failing nor even receding from being a major player. The company has solid cash position, a broad, competitive product lineup and the best known brand of any player in its segment.

However, we do see a major risk of Milestone failing far short of its goals and expectations. When such events, the fallout can be painful. The closest comparable is Dedicated Micros, a leader a decade ago who fell apart as the market moved past the company. Events like the hardware NVR introduction, rolling out paid support and restricting device pack access may be initial signs of a company struggling to meet its unrealistic goals, making errors that cause problems for partners and customers.

UPDATE

Milestone was acquired by Canon in 2014. They continue to have weak profitability as shown in Milestone's 2014 financials.