02802104 - DUG 1-5-24.pdf

DUG's announcement today attached, from my earlier post's looks like my thesis is intact, demand for High Performance Computing is strong and their cost base shouldn't rise proportionally with revenue. Good growth is 2 of the 3 business lines with revenue up 39% and EBITDA up 24%. US$5.6M FCF for the quarter isn't bad either, so nice to see the EBITDA translating to cash flow. Having said that I was more impressed with the operational leverage last half (profit rose faster than revenue last quarter which is always preferable). This dip in leverage is explainable. They are still being weighed down by having to hire compute power, so hopefully with the new install done by June this will improve, but maybe not full impact till Q1FY25 from what this announcement says. So I'll be looking for that October update to see if the thesis really remains true. Still has net cash on the balance sheet (c. US$5m), which is always a plus...and management maintain a strong holding, another plus.

Hold IRL and SM.

Director disclosed ~90k shares purchased on market yesterday.

That is a significant purchase and I note that previous announcements have disclosed that they expect to finalize the installation of new compute in April.

good signals

Could someone with more time than I have available at the moment have a go at a valuation?

Alot of selling occuring in DUG over the past 3-4 days.

Wilsons (WMI). Who had listed themselves as a significant shareholder since values of ~$1.50-60. They have sold down and are no longer a significant shareholder. They have also listed DUG as a top 20 holding over the same period, which probably equates to about a 5% position for them, at a minimum.

Sheila Lamont, who is the spouse of the founder and MD has sold off 2.5m shares. Together they still hold a significant # of >21m shares. By my calculations they together still own around 20% of the company.

However. This has seen some significant downside to the share price, falling ~20%.

So the question is..... Is now a good time to buy

• New "Multi-Parameter Full Waveform Inversion" (MP-FWI) product had US$11mil of new project awards in the last quarter.
• New project announced. "DUG Nomad" which is a mobile supercomputer installed inside a shipping container. Using the DUG Cool immersion system, the mobile contain can be deployed anywhere for "edge solutions" such as defence, mining and education.
• Generally high tendering activity continues, good outlook.
• Still constrained by computer power and expecting new computers in December.

Trading notes after AGM.

• MD Matt Lamont has sold 2.5mil shares (in wife's name), he still owns around 24 mil shares.
• Wilson asset management has sold down their position to under 5%.

Image from presentation of "DUG Nomad":

General notes:

•  Third of new orders at MP-FWI workflows, showing the product is gaining traction.

Positives:

• $30.9m of new services award. Last 12 months services project wins of over $70 mil.
• Order book continues to increase to $47.2m
• Revenue = $12.9m up 15% on PCP.

Negatives:

• Operating cash flow neutral for the quarter. Would have liked this to be a bit more positive. However, I noted at the end of FY23 the cash flow was stronger than expected, could be some lumpiness here.
• Revenue constrained by compute resources. DUG operates on a just in time basis for expansion so I hope not to continue to see this occur. $7 mil of equipment is due in November and were also upgrading RAM in Houston which created down time.
• HPCaaS and software divisions are not growing. HPCaaS as a major growth driver is definitely not going to occur with the services business being the focus area.

Has the thesis been broken?

• No, revenue still increasing and DUG appears to be winning more and more projects. Need to start seeing the equivalent jumps in revenue as the order book over the next year. Additionally, waiting for the cash flows to come through from the extra revenues.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Compute resources don't continue to constrain revenue longer term. DUG is meant to operate on a just in time basis for compute power.
• Converting increased orders into strong positive operating cash flow over time.
• CFO revolving door doesn't continue.

Note: All figures in USD.

Been watching DUG for a while and started a position IRL this week.

By Bull/Bear case below:

Positives

In an interesting niche, assisting mainly Oil & Gas companies to examine propects, using data analytics on large data sets.

Just coming into profitability in FY23, on the back of really strong revenue growth, particularly in the US.

If (and it's an if) trajectory continues the PE at 23 does not seem particularly high.

Nice operating leverage - employee and operating expenses only up about 10 to 12% in FY23 on 50% higher revenue - obviously hoping they can continue with that ratio!

Minimal debt and starting to get to good ROI, cash flow was strong.

Negatives, things to watch

Stability for CFO, looks like there's been quite a few through there in last 2 years - would be looking for that to not change again anytime soon.

Was this year's revenue recurring or one off - looks to be spread across multiple contracts at least which is encouraging, but hard to tell on my skim of the annual report.

Long term, will there continue to be demand for the core product? - not sure, but they are looking to take their skills into other areas.

Overall, the positives and valuation got me across the line, that and High Performance Computing is an area I've been working with recently and I believe there's some very interesting applications to come (particularly in the Quantum space). The SP is up 100% over the course of this year, but still more to go IMO.

Rich

Again, another CFO gone. This time they held the role for just under two years. While this is a yellow flag given DUG's history of being unable to maintain someone long term in the role, this appears to be an orderly transition with the new CFO starting on 6th November and current CFO leaving at the end of the year. This announcement was made on 2nd October for reference to the dates above. 

Overview Comment:

Very positive results for DUG. Order book is looking very strong already for FY24 so hopefully results can continue to improve from here. Seems like a step change has occurred driven by oil and gas exploration. 

General notes:

• NPAT = $4.9m. Slightly below what I hoped but inline with my valuation. However, cash flow was stronger than NPAT.
• Order book at $27.9m. About the same as what it was at during Dec 22. However, in July 23 $18.6m of work was signed. 
• Op cash flow seemed very strong but not sure if this was a result of timing?
• Outlook for oil and gas remains strong according to the company. 
• Making a $7m investment in the install of new hardware in Houston to support new services projects (this will be asset financed). 

Positives:

• Revenue = $50.9m up 51% and 70% in services division.
• My "FCF" = $7.6m.
• Strong operating leverage. Employee and other expenses only rose by $5.6m while revenue grew by about $17.2m. 
• July order of work worth $18.6m is a strong start to FY24.
• Turnaround in services is due to expansion into new markets and commercialisations of DUG's "multi-parameter FWI imaging".
• Net cash of $5.2m. Very positive that the company is no longer in debt. Additionally $7.1m cash was received i August due to repayment of a loan funded share plan. 
• Market liked the results up 10%. 
• Given some numbers in the presentation the FWI product appears to be a leap in magnitude type better product. It can replace traditional processing of imaging of seismic data. The improvement for customers shown below in presentation:
• Multiple examples provided by the company in their presentation of the significant value proposition they provide to their customers. See bottom of post for copied quotes.

Negatives:

•  HPCaaS only up 2% to $4.0m of revenue. Clearly not a focus anymore for growth. No sign of the graph of monthly sales again.

Has the thesis been broken?

• No, opposite, all seems to be going well. Starting to see DUG make some real progress and becoming a valuable resource for its customers. Examples of order of magnitude improvements such as FWI will help adoption. Lots of investment in increasing computer side indicators expected growth in compute time which directly relates to revenue, especially given the just in time format of their computer setups.
• Worried about valuation here but all depends on what happens with profitability. The order book as been a very rough guide as to the revenue over the next 6-month period over the previous year. As of end of July this figure is indicting a large improvement in revenue potentially. Given the operating leverage that has appeared in this year's results if things go well DUG will probably look cheap, if not expensive. Adding to position very cautiously.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• It is clear oil and gas through FWI imaging is a key driver for revenue growth for the business. If oil and gas explorations slows DUG will be impacted.
• If DUG continues to grow revenues rapidly it will be through the continued expansion of FWI. 
• Revenues to be above FY23. Order book at the end of FY23 $27.9m with $18.6m added to that in July. Order book as of June 30 22 was only $22.2m. 
• Watch the order book numbers. Does it continue to grow?
• Share price has been on a run. All news has been generally positive in recent times. Watch out if some bad news hits, I would expect a pull back. 

NOTE: All values in USD unless otherwise specified.

Value proposition quotes in company presentation:

Expectations:

• Revenues to be the highest ever. Multiple announcements throughout the FY of high numbers of new services revenues awarded.
• Order book was $28.8m at end of Dec 22. Has this increased further? I would have expected it to given the $18m new services in 3Q.
• Debt is continued to be paid down.
• Continued movement to a company that grows from operating cash flows.
• Improvement in HPCaaS segment or is this dead?
• Unknown date of results release.
• Financials:
• Revenues = $50m+. Hopefully $55m+. Expecting to at least match 1H of $25.2m
• NPAT/FCF of $6-6.5m+. Remember there is the bolstered NPAT from Searcher announcement in January.
• Growing margins.

Questions to be Answered:

• Any further details on the grant funding recently announced?
• What is happening in the HPCaaS space? 3Q results didn't have the normal table. Is this part of the business failing to take off? Is DUG actually based on oil and gas exploration as its revenue source rather than the need for HPC.
• Are the tailwinds of FWI still there?
• How is the debt situation looking?
• What is the valuation like now? DUG has gone on a run while owning it. I am looking to add but is it too expensive?
• What are the plans for any spare cash?

Note all values in USD unless specified otherwise.

Notes below are reference this announcement

Summary

DUG announced on 18/7/23 that they will receive $5mil AUD worth of grant funding from the WA state government. The funding from the "Investment Attraction Fund" will be used by DUG to build its first data hall at DUG's Geraldton High Performance Computing Campus. The funds will be dispersed as milestones are achieved. A lease has been signed for the 44.5-hectare site which will include space for onsite sustainable energy solutions.

Data Centre Size

The first data hall will have a capacity of 400 petaflops of compute, enabling 13x growth in DUGs compute power once fully established. This will make it one of the largest super computers in the world. The campus could accommodate ten data halls with a potential 4 exaflop capacity. The latency from Geraldton to Perth is only 3ms so the location isn't an issue.

Other Funding

The company will fund the remain cost of the build through operating cash flows.

My Comments

• Net cash figure of US$5.2m is a significant improvement from net debt of around US$2m at end of first half. Total cash on hand = US $8m. Given we don't have the payables vs receivables change it is hard to interpret the result. If the assumption is there is no change in the difference than the second half result will be very positive.
• The fact the company will be able to fund the rest of the project through operating cash flows is a very positive sign the company is cash flow positive and expects to continue to be.
• This investment will enable the future growth pathway of the company by creating capacity to significantly increase revenues (potentially by multiples?) using their just in time build method within the data halls. However, it should be remembered while the growth pathway is enabled by this project, we will need to see how DUG will actually bring in the extra revenues as a result of having the extra compute power available.
• Well done to management for being able to secure this significant amount of grant funding. It de-risks the investment and accelerates the growth of the company.
• Thesis on track and DUG is performing very well, somewhat better than expected (assuming no surprises at FY end results). 

Announcement below... Another recently highly charged tech stock with pretty significant exposure to SVB. I will expect this craters pretty hard on opening.

Buying back into DUG with a small starting position as a result of recent turnaround in the momentum.

Main Thesis:

A HPCaaS provider that has carved out a niche. The PUE of its computers if very low which allows them to be competitive on cost. On top of the efficiency of their HPCs they run, they provide services on top to allow companies to gain the insights they require from raw data without requiring the know-how of the ins and outs of HPC.

Recent years have been poor for DUG, however, fortunes seem to be turning with increases in revenue that I believe will provide a point of operating leverage for the company to become sustainably profitable, especially after the cost cutting in recent years. There have been multiple recent announcements stating new/improving revenues and increased profitability. The balance sheet is in a much better position. Tailwinds of the oil and gas industry exploration and new FWI imaging will help improve revenues further.

Risks:

• Revenues stop growing or go backwards again.
• The CFO revolving door issues come to light as to why this occurred. IE there was something actually wrong.
• The business doesn't have the margins you think it might.
• Oil and gas industry stops exploring again.
• This isn't a good business that has sustainable margins that increase with revenue growth.
• The HPCaaS is unable to make significant revenue outside of the revenue made from services and software part of the business.

Definitely a company to watch closely while holding to make sure recent momentum continues. Will also have a personal stop loss level as a soft check point as to whether the momentum I think the company and/or share price has will be maintained.

DUG announced today the extension of CBA term loan facility until 1 July 2024. The facility will be reduced to US$4.5 mil and US$7 mil will be repaid. The working capital facilities of a A$1 mil overdraft and US$1 mil bank guarantee facility will continue. DUG will be able to obtain funding from alternative lenders for purchase of new equipment.

DUG provided some guidance, stating the company expects to be operating cash flow positive over the second half.

Still very much watching from the side lines but this is a positive development in reducing the likelihood of a capital raising being required. While operating cash flow positive I doubt the company will be FCF positive over the half reading between the lines.

DUG has some favourable tailwinds caused by current environment with regards to oil and resource companies. If DUG cannot significantly increase revenues over the next 1-2 years this will be a telling sign of the long-term prospects in my opinion.

Another new CFO for DUG since listing. This is now a big yellow/red flag!

CFOs since listing (around 12/8/20):

1. Louise Bower - was CFO for 11 years pre-IPO and executive director. On resigning became non-executive director.
2. Bhavesh Morar - from 2/11/20 till 7/12/20.
3. Louise Bower - steps back in an a role to "assist with comprehensive transition to a new CFO and oversee half year audit and results". Some company reports note she is CFO, some just executive director. No CFO listed in FY21 annual report. Timeline from 7/12/20 till 1/10/21.
4. Greg Haskis - from 1/10/21 till 8/3/22.
5. Sam Cruickshank - from 9/3/22. Appointed "interim CFO".

Not a great look. No outsider CFO has lasted more than six months. Now it makes sense why the financials of the company haven't looked great since IPO, no one has been steering the ship consistently. Is there a cultural issue at the top that CFO's want to leave or is there something dodgy going on? With that much turnover it is surely one of those?