IKE issued its Q4 and FY23 performance update today. In this straw I cover:

• Their key highlights
• Insights from the presentation and the Q&A discussion
• My key takeaways

Overall, Q4 brought home a very strong result for FY23.

Their Key Highlights

• FY24 revenue of ~$30.8m (+93% vs pcp)

o ~$6m ahead of internal budgets set at the beginning of the financial year and above upgraded analyst consensus.

o FY23 gross margin approx. ~$16.4m (+67% vs pcp), with a gross margin percentage of ~53%.

• Total cash and receivables as at 31 March 2023 of $23.2m, comprised of $18m cash and $5.2m receivables, with payables of $2.3m and no debt. 

Figure 1: Revenue Performance

Figure 2: Key Metrics

Insights from the Presentation and Q&A Discussion

1.      Revenue and Margins

Overall, Q4 finished off a very strong year above both internal management “stretch targets” and analyst views. Q4 contributed $7.5m of revenue to take the unaudited total for the year to $30.8m.

While Q4 was slightly softer on revenue than Q3 ($7.9m), a stronger %GM performance meant that Q3 and Q4 each contributed a GM of $4.1m, taking GM for the year to $16.4m, up 66% on FY22.

I’ll write a separate straw providing a detailed analysis quarter by quarter across each of the segments over the last two years. However, the good news is this will show that the concerns raised in this forum about weakening %GM performance over time appear to have stabilised from 1H to 2H of FY23, even if we aren’t yet into margin expansion. That lies ahead, given some of the investments being made and discussed below.

Importantly, 89% of revenue now comes from “recurring and re-occurring revenue” – subscriptions and transactions.

2.      Cash

Although $IKE don’t report a quarterly 4C, the total of cash, cash equivalents and receivables were essentially unchanged from Q3.

Given a slight weakening of the NZD vs. USD over Q3, I estimate they gained a small FX benefit. Because of this, I estimate they were once again mildly OpCF positive and mildly FCF negative for the half, due to ongoing investment in the platform focused on IKE Insight, development of next generation of Pole Foreman, and building out core business systems (See below).  

We’ll get a proper look when the financials are released in a few weeks’ time and we can back out H2 cashflows, however, cash burn for FY23 is very significantly reduced from FY22 (-$10.6m) and by my estimate likely to be in the range –($3.5-5.0)m, given the -$1.8m FCF (or -$2.0m including lease payments) in 1H and the even split of margin between 1H and 2H.

I tried to draw Glenn on how they are thinking about FY24 cash generation, however, as expected he refused to give guidance on cash flow. He said: “we keep a close eye and engagement on analyst consensus, and we’re quite comfortable with where they sit at the moment.” (Note: According to marketscreener.com, based on the one analyst that provides a FCF outlook, they have $IKE at -$4.5m (FY23), -$1.30m (FY24) and +$2.90m (FY25).)

Overall, $IKE maintain a strong balance sheet to continue to build the platform, increase automation, and embed themselves in their customer workflows, without a need for further capital. As subscription and transaction revenues grow, they can if they choose transition to the point where future growth could be supported out of operating cash flowsby managing the rate of investment in platform development.

3.      Market Update (slide 10)

Glenn indicated that while the tailwinds of broadband and 5G buildouts are key in the next 3-5 years and are well understood, the biggest and most rapid change in the market is the required investment in the electricity grid where the energy transition will see the grid grow from providing 20% of US energy to around 50%. Importantly, this is a multi-decadal shift out to 2050. Glenn summarised $IKE’s position as simply being in the right place at the right time, as much of this investment will be focused on the distribution – adding “capacity and stability to the grid”.

4.      New Sales

Glenn reported that they are going to stop reporting new contract wins and renewals. The primary reason for this is that many of their customers who have embedded the product in their workflows are no longer taking out long term contracts and are now being billed on a monthly basis according to licences (seats) and usage (transactions).

Being the suspicious type, I wondered if this was a convenient time to make the transition – being potentially a softer quarter. (I’m still troubled by Ian’s behaviour at $3DP!) Glenn was challenged on this in the Q&A, and he repeated his stance.

Throughout the presentation and discussion some further information relevant to this, and the success $IKE continues to have, was obtained.

1.      Glenn said the sales team are working well, closing on average “one new enterprise customer per week”. He showed a slide on the sales team organisation, which has dedicated resources focused both on winning new customers, but then also on customer success and expanding use within accounts. They are following a strictly direct to market strategy (good!) and following a clear priority order based on customer size.

2.      He repeated information stated at the ASX Conference earlier in the year, that they have recently won one of the large ("top 5") East Coast publicly-owned utilities from a competitor. According to Glenn, the competitor product had been used by the utility for around 20 years – showing how sticky utility customers are. So, a good win for $IKE. More on that below.

3.      Engineering Service providers: These have huge significance in supporting the utilities and often have decades long contracts doing the network development and maintenance work. $IKE have just won the “second largest engineering group in the USA in terms of customer footprint across utilities”. They are starting in New Mexico on a big, 10-year project and $IKE hope to be successful there, so that they get rolled out across the entire organisation, which will “take time”.

Overall, even if this might have been a convenient quarter to make the reporting change, the change makes sense. For now, the quarterly operational updates give investors great transparency on revenue by type (transaction, subscription, product/service) and customer numbers. And with transaction volumes becoming a dominant revenue component, it makes no sense for customers to lock in defined volumes when their contract sees them being billed on a monthly basis based on usage. (I think Glenn has been smart to drop the TCV metric to avoid getting into the pickle that Ian is facing at $3DP.)

5.System Investments (slide not in ASX release)

For some reason, the below slide wasn’t in the ASX release, and Glenn spent several minutes speaking to this. 

On System Efficiency, this is all about scalability and operating leverage via investing in core systems (“unglamorous stuff"). This was new information, and he described the system investments $IKE has been making so that they can scale the business efficiently in finance, HR and staff development, marketing/CRM. He also spoke about the substantial SOC2 compliance investments were proving important in customer procurement decisions (“IT departments now just tick that we are SOC2 compliant.”).

The points on Brand and CX have been made previously, albeit not directly linked to driving pricing power.

Glenn went on to say that “when you look at our P&L, you will see that we are investing very substantially in product and technology investment. We are still small and early in penetrating the market, but we’ve got a good view into what our customers require.” I took that as potentially preparing the market for a larger Research and Engineering Expense in H2. This item has been trending up over the last three halves as follows: $3.2m, $3.3m, and $3.9m. (So, if it has moved up again then it will move FCF to the lower end of my estimated range (or beyond?). Even if this cost is increased, given the traction $IKE is getting with its customers, I am happy for this to be the case – now is the time to lock in customers for the next 2-3 decades of growth.

Pole Foreman: A key focus for investment has been the next generation of Pole Foreman, and Glenn spoke about the early positive feedback they are getting from the Customer Council. “We believe it can be quite disruptive versus competition.” Glenn linked this to a key reason for flipping “one of the top 5 investor owned utilities” to $IKE from an incumbent providers, starting with a 100 user licence for 3 years. (See section 6 below.)

AI and Automation: Glenn referred to a small AI acquisition they’d made and said they have been working for two years on using generative AI for poles. He indicated that they are getting some very interesting proof points, and are just coming to market with one of the “world’s largest digital data collection companies” as their pole or distribution asset partner. “This is exciting because it lets us access data at real scale and potentially bring some quite disruptive automation capability into the North American market.” (Note to self: look out for more information flow about this.) (Further note: previously Glenn had spoken about collaborating with $3DP in WA with a utility, but it sounds like they are moving ahead commercially with another partner, as $3DP doesn’t fit the descriptor of “one of the world’s largest digital data collection companies”.)

Glenn concluded the section on product and tech investments by saying that none of these things happen very quickly, but that they are very optimistic about them from a proof point perspective.

6.      Why Customers Switch to $IKE

I asked Glenn if he could explain why the latest large utility customer had switched to $IKE from their legacy provider. Glenn replied that it certainly wasn’t because of price! (chuckled) The deal winner was the user experience and simplicity of using the $IKE platform. He said that when a utility has 500 engineers using a product, then simplicity is important. He said that the competitor product is great, its just complicated to use.

7.      Customer Council (Slide 33)

Glenn spoke again about how important the Customer Council is in guiding the development of the next generation of Pole Foreman. The slide shows some of the huge utility companies on the Council. The new information Glenn gave is that the people involved on the council are the senior people responsible for setting standards in the utilities. Essentially, by doing this $IKE is developing their product to meet customer requirements for the evolving standards in the industry, a huge competitive advantage when procurement decisions arise.

8.      Non-Exec Director Resignation

In Q&A there was a request for more information about the resignation of Eileen Healy US Telco Non-Exec Director after only two years. I'll paraphrase Ian's response:

“She’s been a very valuable board member but a mutual view just looking at the skills we’ve acquired to get to where we are … and where we’re going … and some other personal components as well … our intention is to keep building capability from a Board perspective … there is a really interesting pipeline of potential candidates but nothing imminent.”

Take from that what you will, but one interpretation would be that with things such as a powerful customer council of current decision-makers in the big utilities, perhaps the Non-Exec found they weren't adding that much value or perhaps are not current with the huge trends sweeping through utility USA. Who knows. In any event, I don't see any evidence of flags to raise of any colour.

9. Guidance

While there was no overall guidance today, Glenn flagged in the release and in the presentation that:

"We expect growth to continue in FY24, noting the potential for Q1 FY24 transaction revenue to be below the Q4 FY23 run rate because of the engineering practices of utilities in certain territories where one or two larger IKE customers are building fiber networks."

Because transaction revenues exploded from $6.4m in FY22 to $18.7m in FY23, any step back in Q1 FY24 will now have a significant impact on overall revenues. So, I wanted to dig into this in the Q&A asking what drove seasonality of revenue.

Glenn's response was as follows: "Seasonality - yes there are two parts."

"First we support people that are building and maintaining outside power and communication networks that are above ground, so that when there are big storm events, folk cannot get outside and do engineering so that slows down activity which impacts us."

"Second part of that question, ... in our update today we talked about some transaction revenue potentially slowing down through Q1 FY24. That context is different. We support a range of national communications companies that are building fibre in different markets. They're all in a race to build a fibre network in a city and then switch on the network and win customers. A couple of these customers that we support are in territories where the utility that has to support their network build-out have relatively old-fashioned engineering standards in terms of how they will approve data. And we as a digital standard don't fit those particular requirements in Kansas and in [some] other states. These groups will go to many, many other markets through the year so we may just see things slow down from a recognised revenue standpoint."

I thought this was a very insightful answer. It means that if $IKE's customer is a utility that relies on an electrical utility for access to poles, then that party needs to accept the use of the $IKE platform (presumably from an engineering standards perspective). This will definitely be the case for the broadband and 5G customers, as the poles are usually owned by electrical utilities.

Secondly, for the situtation at two customers to potentially materially impact quarterly revenue, this must mean that a significant proportion of transaction revenues is likely currently still concentrated in a relatively small number of "super-user" customers (my words). This doesn't worry me, because over time, this effect should become less of a problem as $IKE is adopted by more and more customers. But when your total annual revenue is still only $30m, a small number of "super-users" can impact revenue volatilty, so it is important to understand that and to be prepared for future volatility.

My Key Take Aways

Overall, this was another good result.

It I wanted to focus on any negatives, it would be that growth has flattened in H2 compared with H1. But given that 1H was such a massive step up from FY22, then it is good that it has at least been repeated for a second half. Quarters and halves will be variable, hence my next straw to quantify this more explicitly.

I got a lot more out of the presentation and Q&A, and I continue to appreciate Ian's candour in answering questions, even if his organisation and presentation of material would benefit from improvement to ensure consistent messages are communicated to all investors!

$IKE is tracking well and today's presentation was a good setup for the FY Financials in a few weeks time.

My current holding in $IKE (RL 3%, 10% SM) is supersized for such a small, high-risk and unprofitable company (double what I normally hold due to my strong conviction). I didn't see anything in today's presentation that makes me want to change that position either way. My criteria to increase position size are 1) for $IKE to be sustainably profitable, and 2) growing strong year-on-year revenues and operating cash flows. For now, I am content to hold.

With a valuation of c. 4.4x revenue, today's SP seems justified given the 93% revenue growth of the last last year. However, $IKE needs to sustain strong revenue growth into FY24 and demonstrate margin expansion and operating leverage. Any valuation beyond what we have today is pure guesswork.

For now, none of my other small cap holdings are showing the promise that $IKE has demonstrated in FY23, so I am a happy HOLD.

Disc: Held