SUMMARY

Following addresses by Chairman and CEO at today’s AGM, I’ve lost my remaining conviction in $IKE, and this morning gingerly exited my RL position. (I was a little nervous at the open as volumes are very thin, and I consider myself lucky to have gotten a good price,… $0.595 and $0.59, albeit a reasonably hefty loss.)

For those who follow $IKE, I have foreshadowed this decision in previous straws, including my selldown of 50% of my holding following the FY23 results. I’ll not repeat the background in this straw, but rather explain why my thesis is broken.

To summarise, for my thesis to remain intact, I needed to begin to see evidence of a return to growth during FY24. $IKE is a small company, still burning cash, so the level of growth I needed to see coming back was strong growth. I can’t see that growth in prospect and, given that guidance provided in the AGM included new elements of bad news, I am exiting to use the capital elsewhere.

What was Communicated Today

Glenn Milnes provided an update on the FY24 outlook as part of his AGM address today. The key messages are (verbatim from the presentation):

• "Revenue in 1H FY24 is expected to be below analyst expectations due to timing delays of engineering programs across three of IKE’s largest national infrastructure customers. Specifically, this will result in:
• Lower reoccurring transaction revenue in the period vs pcp
• Overall, lower revenue in 1H FY24 vs pcp
• Importantly, the delayed long-term customers referred to are not ‘lost’ and in fact are guiding for very high levels of IKE product usage over the coming future periods
• In addition, the company continues to see ongoing strong growth in recurring subscription revenue vs pcp
• IKE’s additive sales opportunity pipeline supports the potential for substantially increased revenue in the 2H FY24 period, and beyond, from existing customers and new logos"

Covered in previous straws, this is the continuation of less than positive news that began three quarters ago and which the Chairman in his address summarised as follows:

“Looking forward, we expect to see continued overall growth, noting that for Q1 and Q2 FY24 transaction revenue was softer on a run rate level due to the traditional engineering practices of one or two utilities where two larger IKE customers are building their fibre networks.“

That was old news, and the SP and my model have accounted for it. The impact of a reversal of the strong growth from FY22 into early FY23 is clear to see in graph below showing the quarterly numbers. (Note: you can't see this picture when you look at the annual results.) With the sharp reversal of growth over recent quarters it dawned on me that $IKE’s revenues are concentrated in a small number of large customers – something that wasn’t clear to me until these major customers slowed down and it had to be explained.

Figure 1: Trend Analysis from Quarterly Reports

Source: Analysis from $IKE Quarterly Report

So, today’s guidance is more of the same. Now three major customers are experiencing “delays” in their infrastructure programs which, in aggregate, has a material impact on overall forecast company revenue.

What does this likely mean for the numbers?

Glenn makes reference to “analyst forecasts”. What does he mean?

The single analyst covering $IKE currently has FY24 revenue forecast at $38.5m, up 25% over pcp. According to TradingView.com that analyst has a price target of $1.28, and according to marketscreener.com their last revenue revision was an upgrade (!) after the annual results were released – something I cannot get my head around.

I’m not sure who the covering analyst is. Bell Potter had $IKE on their “Picks for 2023” with a price target of $1.21. I also have an old report from Forsyth Barr from September 2022 with a “spot valuation” of $NZ1.07. That old report bears the disclaimer “Forsyth Barr has been engaged and paid by the company covered in this report for ongoing research coverage.”

Whatever the source, the forecast revenue number was perhaps a reasonable estimate given that Glenn had guided investors that growth would resume in FY24. The analyst’s number for 1H FY24 is $17.8m vs $15.4m in the pcp. Following today, that needs to be revised DOWNWARDS, and it will be interesting to see whether it is.

So, Glenn is guiding the market to 1H revenue in the pcp of less than $15.4m, because activity levels at three of $IKE’s largest customers are “delayed”. To soften the blow, Glenn optimistically states that these customers are guiding for “very high levels of IKE product usage over coming future periods.”

So once more, we have bad news on the facts with a promise that things will be better in later periods.

From my perspective, however, what is more concerning is that there isn’t any message that current activity levels have increased from the decline we have already seen over the last three quarters into 1Q24, evident in the graph above.

$IKE claim to have good line of sight into revenues based on the usage of their platform and the deployment plans of their customers.

With $IKE’s 2Q FY24 almost done, I would have thought Glenn would have reassured investors if activity levels were looking more like any of 2Q23, 3Q23 or 4Q23, which they would need to be if the 1HFY24 revenue isn’t going to fall materially below $15m. Now, for full disclosure, I wasnt able to attend the AGM today, and so I don't know what was said in the Q&A. Certainly, transactions and price action indicate that none of the attendees today were spooked. So I may be missing something.

The message of ongoing “strong growth” in recurring subscription revenue is only partial comfort. Here’s why. 1HFY23 subscription revenue was $4.2m. “Ongoing strong growth” would imply to me >30% growth to pcp, meaning that 1HFY24 subscription revenue would be in the region of $5.5m or more, leaving as much as $10m of revenue to find from transaction and hardware revenues to stay flat over the pcp. But that would imply a very strong 2Q24 number for transactions, and there is no message to indicate that this is occurring based on what Glenn is seeing now.

So putting all the pieces together, 1H FY24 revenue might be (and I emphasise MIGHT) significantly below $15m, and I wouldn’t be surprised if it came in anywhere in the range $11-14m.

With closing cash in FY23 of $18 and a cash burn in the year of $7.5m, $IKE isn’t in any immediate need for new capital. However, with costs rising and revenue flat (at best), “Fortress Balance Sheet” has now gone from the lexicon.

On a positive note, $IKE is continuing to add logos, maintaining a rate of about one new enterprise customer per week, and we had the good news of a significant contract of an existing customer moving into a deployment mode and committing to $1.5m of subscription spend over 18 to 24 months. IN addition FY24 will see the launch of the next generation of Poleforeman as well as new versions of AI-powered IKE Insights. Both will drive significant increases in revenue per user.

New customer numbers are good. But more of those 379 enterprise customer on board at the end of FY23, including from many very large utility companies and engineering service companies, need to start using the products, enterprise-wide. Performance cannot continue to rest in the hands of a handful of large customers. Now I know utility network engineers are a conservative bunch in their work practices and I recognise that it may take time for full deployments to be realised. But if that's true, then as an investor it will gradually become apparent over time that the ship is turning, and I will be able to get back onboard.

My Conclusions

I hold small cap, unprofitable companies on SM and RL because their strategy, market position, leadership, and track record indicate they are going to move through the inflection point, on their way to becoming profitable, future industry leaders.

I know it takes many years to build a great company, and that progress is not continuous. Equally, I know most small businesses don’t make it.

$IKE has fallen to the bottom of my merit order, and the loss of conviction has occurred over a 12 month period. I need the capital elsewhere. So, with today’s news I have to exit and I have.

I still believe in the industry opportunity, the product looks like a good one that will drive productivity in its customer organisations, the competition is limited, the management team know their business well.

There is a lot to like about $IKE. It remains a business I would like to own, and I’ll continue to follow it as closely as ever. But I need to see numbers heading in the right direction, and I am happy to sit on the sidelines for a year or some and return if they do.

Disc: Not held in RL; selling on SM

Disclaimer: This is not investment advice. It is a record of a personal investment decision and rationale.