I jumped on the ASX Small Cap Wrap with Claude Walker earlier this week to chat a few stocks, one of which was XRG.

@Tom73 has covered this one excellently here on Strawman and CEO Wayne Jones presented well a few months ago to the group (though may be worth getting him back post the Texas Department of Safety contract @Strawman).

Given the working capital model they need to keep winning contracts but the recent history on that front has been strong and with the Texas Department of Safety and US Department of Defence kicking in I expect 1H26 should be quite strong.

https://youtu.be/SF_fu_9pFcc?si=StEATk7pGqrfC4TD (XRG conversation starts at 14:30)

With a lot having happened in the last 6 months, time for a review of the big issues.

Recapping XRG’s current investment outlook:

·        Entertainment business unit exit: we await news on this, but the expectation is that FREAK is being shut down and probably a small cost and iFly is on the market with a price tag that should cover the current debt of ~$5m plus give them ~$5m additional cash.

·        Operator XR base line sales to smaller PD’s remain solid and underpins growth and the basic business case, which has me valuing the business at around 8c (was 9c pre dilution from cap raise)

·        Large deals, as we see with the Texas deal offer significant value upside and provide validation to support and potentially grow sale rates to smaller PD’s.

·        Debt is still an issue, but half was capitalised and the remaining ~$5m pushed out to 2027 maturity which moved it from a red to orange flag. As @UlladullaDave notes this is now a green flag with the announced $4.3m Q2 receipt expected from the Texas deal able to cover most of this assuming normal cash flows outside of this deal.

·        Director buying over the past year has provided a lot of support as @Goldfish notes. I would add that the capitalisation of the $4.6m Birkdale Holdings at 5c a share was also a strong insider signal of confidence in the businesses direction at a time the market was very very sceptical and priced accordingly.

FY26 Watch List, what I am looking for:

·        DoD contract outcome: If they don’t have a follow on engagement of a similar size or larger size by the end of this contract then AR (as opposed to the VR in market with Operator XR) may be a dead end. If they do, we are looking at a new product/customer line (Military) that is worth 4x the current Law Enforcement opportunity.

·        Exit Entertainment: as noted above, I expect this complete in FY26.

·        Distributors Ex-USA: There has been a lot of positive talk on the European and Asian interest in Operator XR, with distributors appointed. I would be disappointed if there were no sales in these regions by the end of Q2 and worried if none this year. I expect margins for sales to be lower than US sales, but this is incremental income, so offers high returns on the bottom line for a much higher valuation outlook.

·        Product Development: We had the upgrade to Op XR2 in FY25 which also consolidated the separate police and military applications (improved product and development efficiencies). In FY26 we have the NRF grant kicking in (~$250k cash each quarter), we should hear more about cloud developments and see some enhanced functionalities flowing to customers – plus lots of mention of the word AI… Note also R&D tax rebates should also grow to offset some of this investment.

·        Debt: While debt may still exist by year end, I would expect to see positive net cash. The sale of iFly and the Texas deal underpin this expectation.  I expect capex to increase but not significantly above what the NRF grant provides.

Valuation:

·        I am sitting on my previous 9.1c valuation which is just based on the Enterprise business in isolation, but with dilution is probably around 8c. It doesn’t assume any upside from any of my FY26 expectations or Texas deal and NRF grant just announced. Hence it is very conservative.

·        I am sitting on this value because I don’t have any solid figures to project things like the sales distributors may generate (or margins), what further contracts with the DoD may look like or the likelihood/value of other big Texas type contracts.

·        These all simply provide the asymmetric upside on my 8c valuation. If the price hit’s 8c without any new information I may have to reassess, but it is likely that such a value uplift would be on further information about these.

Risks (beyond already noted):

·        Cash has been a risk but managed well and is now less of a risk, so we will now start to see how the company and management will employ excess cash. They have been judicious in it’s use to build a growing Enterprise business out of the excess cash flows from a stagnant Entertainment business, but where to from here?

·        Competition: they are providing a tech product in an increasingly AI world that is accelerating development cycles. Competition may come quick and hard if they prove a large and high value market exists. However I would note that management love the problem not the solution. They have been focused on developing effective training tools (based on their previous experience of what was needed for special forces) more than a particular product, hence I think they will embrace and adapt to the market needs rapidly rather than continue to invest in a product that fails to deliver or compete.

·        Trump: always a risk that something he does will cause issues for XRG, beyond just tariffs which at worst will drop margins a little. The cancelling of law enforcement grants available to small PD’s to purchase equipment like Operator XR is a big risk, but not terminal for the business. The DoD contract may also be influenced by Trump issues.

Investing in XRG is investing in a business that is only a few years old, being the Enterprise business (Operator XR). They have runs on the board, but it’s very early days. Management have persisted and adapted through previous business iterations (iFly then FREAK) and have good board and investor support. 

I see them as genuine and of good integrity, which I expect is the culture across the company. As their SAS history implies, they are brave but careful and diligent in managing and growing the business. In the face of setbacks, I will be comfortable provided these assumptions hold.

Disc: I own RL+SM

We now have have a clear message that the Entertainment business is being fully exited and doing so will likely clear remaining debt and likely provide some working capital (~$5m), so I am going to focus just on the Enterprise (Operator XR product) value. Also, I am going to base it on ARR and customer growth remaining at current rates being achieved in the US, which I see as a conservative base given upside from ROW distributors and the DoD contract.

I have assumed customer growth of 12 per quarter (run rate for two most recent quarters), ARR generated at $70.8k per customer (current run rate, but this has been dropping so may be aggressive). To allow for non-ARR sales revenue I am multiplying ARR by 1.2 to estimate sales (which seems to fit for the current year).

GM% of 70% is low end on indications provided and the Net Margin % is an educated guess because FY24 segmented reporting is the last we have and the Enterprise segment was still in loss with only $717k in sales but sales for FY25 should be $5m+ ($2.1m in H1 and growing rapidly). Hence I start with a 10% Net margin but think 30% by FY29 is possible on this capital light and high gross margin business, but we will know more when the annual report is out.

Discounting the per share value from FY29 back to now results in a $0.083 value per share, well above the current $0.030 and if we add $5m ($0.007 ps) for the Enterprise business we have a total value of $0.091.

This approach is deliberately different to my initial valuation method in January, but ultimately relies on the same assumption that Operator XR continues to grow at currently strong rates.

Using an ARR sales multiple may be another way, but I am unsure what multiple to use or comparable companies to benchmark against currently.

TCV might also be used as a value metric. At a 10% Net profit assumption the valuation comes up with a market cap of almost exactly the TCV. So if comparatives exist for the TCV we could use that then adjust for NPAT% assumptions.

Conclusion

This valuation is ballpark around my previous valuation of $0.097 per share, which is encouraging. However, until the business gets to a relatively steady state, it’s value is going to be very hard to narrow down. The only thing I am taking from this valuation is that plenty of upside potential exists on the current price. Given it is based on the key assumption that what has been happening over the last year continues to happen, it also doesn’t rely on heroic assumptions about things that might start happening.   

Disc: I own RL+SM

Henslow Defence Conference presentation (19/6/25)

We have a market update via the presentation to the Henslow Defence Conference provided to the market today. Held in Canberra but online from 1pm free to register (Henslow Defence & Security Conference 2025 - ONLINE Tickets | TryBooking Australia), the presentation is very investor focused, rather than product, which is interesting, but good for investors.

Key take aways and points of interest:

Sales Update

Enterprise: As at 15 June 65 customers (up 11 QTD Vs 12 last Qtr), ARR is $4.6m up from $4.2m Q3, TCV $10.7m up from $9.2m Q3. So nice and solid growth similar to last quarter per below for the XR Operator business.

Entertainment: No clear update other than iFLY continues to contribute to cash flow and profit and the FREAK business is being exited based on lease terms, so it looks like a shut down, so we can expect some wind up costs. An exit of iFLY at some later date is with their corporate advisors, but no ETA.

Business Model

Slide 11 shown below provides the clearest view on the revenue and cash flow generation paths they are currently operating on. In general cash is up front as previously advised, but we now have a clearer view on how ARR and TCV is calculated.

International Markets

Not a lot of detail – distributor network is engaged.  I am very interested to start seeing revenue in this space!

DoD Contract

Cash receipts have only been A$1.5m to date, so we can expect around A$4.1m over FY26 as milestone payments are back loaded.

They are now about halfway through, it seems to be going well and may lead to expansion – but we will wait for more conclusive information around this. Currently it’s another lotto ticket.

Conference starts at 1pm, I don’t know the format but hope to catch it but it will depend when they present.

Disc: I own RL+SM

Included in the notice of Extraordinary General Meeting (held 30 April in Sydney) released today is an independent opinion by Titan Partners of the deal which was that it was “not fair but reasonable”. It was not fair due to the controlling interest acquired but reasonable due to the 39% premium offered.

The analysis of the business which starts from page 30 and well worth reading for those interested in the business – I picked up a few new things.

Including about Mr Baxter, I hadn’t realised he was the guy from Shark Tank Australia:

Mr Baxter is an Australian venture capital investor and entrepreneur, with a focus on innovation and technology. He was previously featured on Shark Tank Australia from 2015 to 2019 and has founded and exited a number of companies. He founded TEN13, a tech startup investing platform as well as Beaten Zone Venture Partners, a venture capital fund dedicated to investments in Australian sovereign legal defence technology.

https://en.wikipedia.org/wiki/Steve_Baxter_(entrepreneur)

The valuation is a regulated (RG111) formulaic academic piece of garbage (capitalisation of revenue methodology for Enterprise and Net Asset for Entertainment) you expect from an independent valuation with no consideration to the growth of the Operator XR (Enterprise) business, which holds almost all the value.

Total Value: $21.9 - $27.1m (3.84 to 4.74 cents per share) sum of parts approach.

Enterprise based on revenue between $3.6m (the ARR) and annualised reported revenue of $4.3m times a multiple of between 4.2 and 4.8 times based on the average of spurious comparable transactions of a wide range to get a value of $15.1m to $20.3m

Entertainment net assets of $15.3m attributable to the Entertainment business alone.

Adjusted for net cash/debt of -$8.5m

The only interesting part of the valuation is the net asset value of the Entertainment business. If they could realise that into cash that would be a game changer. The FREAK business is almost none of that, it’s all iFly, which isn’t up for sale as yet – sooner the better in my books.

Disc: I own RL+SM

Announcement from XRG that it’s $4.6m debt with Causway Asset Management (due to mature Sep25) has been renegotiated to a $5m facility maturing in Mar27 with a possible $1m addition subject to conditions. Interest payable quarterly (same as prior arrangement) but also 5m XRG warrants issued at a 20% premium to the 30 day VWAP at initial drawdown, 3 year expiry.

This concludes the debt restructuring for XRG near term, assuming the 30 April EGM to approve the capitalisation of the Birkdale Holding $4.6m debt at $0.05 per share (which I would bet on).

Having moved the Debt issue from a red flag to orange on the Birkdale announcement my view is it is now no longer an issue (white flag?) at least for another 2 years. The business is generating positive cash and they now have a bit more capital to accelerate Operator XR development and sales growth.

The next major announcement in the works is what they are doing with the FREAK business, hopefully some extra cash on disposal, but we will have to wait and see.

Disc: I own RL+SM

Results for the half just released – things look in order.

Key points:

·        Loss of -$992k, improvement on -$1,501k PcP due to GM up $1,096k, grant income up $437k offset by higher Op cost of $995k.

·        Sales up 30% v PcP, Entertainment -10% (to $3.8m) and Operator XR +565% (to $2.1m), fall in Entertainment put down to professional user sale in November, bringing forward cash but delaying revenue (don’t see that as valid, but thesis is not about Entertainment business).

·        Revenue includes $1,183k in Grants Vs $1,068 PcP for R&D rebates and also includes $313k for revaluation of inventory (Hmmm, would like more info on this).

·        Operator XR customers now at 51, was 29 at the end of FY24. Includes 30 US federal agencies, state and city police and sheriff departments.

·        Operator XR launched OP-2 in November which added “Scenario Creator Suite” and combines OP-1 (Military) and OP-1LE (Law Enforcement) systems to streamline development.

·        Formal engagement of Distributors in Europe and Asia occurred in the half.

·        $1.7m cash at the end of the half, FCF at break even now -$23k Vs -$1.2m PcP.

·        Deferred revenue now at $5.8m, of which $3.6m is current. I am looking for $8m in Deferred revenue by year end, it’s up $2.0m in the half so tracking ok and they now report a break out between businesses which is good.

·        Plan to exit FREAK in FY25 and the first indication that iFly is also under review as they turn their total focus on Operator XR.

·        Debt Refinance: engaged with debt provider, watch this space.

·        Ash Crick, globally recognised AI expert has joined CRG as Chief AI Advisor.

Operator XR revenue is running of a very low base, so % change is not relevant. Nominal increase in customers is what I am tracking and had assumed 60 by the end of FY25 for my initial modelling. The are at 51 in February, having added 22 since 30Jun24 with 9 of those since 31Dec24, so look like they could pass this, but low numbers and sales cycle time lines could through the number around, but they are tracking well ahead of 60.

P&L results were better than I anticipated but only due to the Grant income (was ultra conservative), GM was very close but Sales and Marketing expenses much higher by $496k and Dep & Amt by $311k. I expect a lot of variance at this point – a lot of moving parts and I am still firming up my model. However cash flow and customers are heading in the right direction and these are the key indicators for me at this stage. The P&L is going to jump around a lot, but cash flows will show the directional trend with sales following. Operating expense growth is going to be a wild card for a while.

So, it looks like we may get some info on debt sometime soon, the Causeway $4.25m matures in September, so they are getting in early which is good to see.

Other than that mostly old information, good to get a financial update, but that looks backwards and forwards is where the value lies so I am looking forward to progress reports on customer growth and sales wins of Operator XR.

Disc: I own RL+SM

I asked chatGPT to summarise today's interview with Wayne Jones.

Overall, my initial impression is that they are doing interesting things and are right to focus on the OTS segment which is clearly the growth engine. They have ~1% of the target market in terms of law enforcement alone, and seem to be getting a bit of traction there. And really good to see them focused on sustainable, self-funded growth. I was surprised to see them generating free cash flow.

It strikes me as a tough market which will be hard to sustain an edge, but if we see ongoing sales momentum the company is likely very cheap. Not a buyer for now (i haven't done nearly enough research) but interested to keep an eye on it.

Summary of the Interview with Wayne Jones, CEO of xReality Group

Wayne Jones, CEO of xReality Group (ASX: XRG), provided an in-depth discussion on the company's operations, strategic direction, and financial performance. xReality Group operates in two core divisions: Operator Tactical Solutions (OTS), which delivers simulation-based training solutions for military and law enforcement, and Virtual Reality (VR) Entertainment, which includes brands like iFLY indoor skydiving and FREAK VR. However, the company has shifted its primary focus toward Operator XR, its enterprise-level training and mission rehearsal software, which has seen rapid adoption, particularly in the U.S. law enforcement market.

Company Focus and Strategy

Jones emphasized that xReality is a software company, not a hardware manufacturer. The team develops proprietary training software that integrates with commercially available VR and AR hardware. This allows flexibility as new headsets and hardware solutions enter the market. While the company initially started with physical simulators like wind tunnels for military free-fall training, it quickly recognized the broader potential of VR-based training and pivoted towards simulation training for military and law enforcement.

Operator XR has evolved beyond just training and now includes real-time mission planning and execution, making it highly valuable for defense and law enforcement agencies. The company has also begun integrating AI-driven scenario creation and real-time environmental customization, enabling agencies to build their own training simulations rather than relying on xReality to develop them.

Breaking into the U.S. Law Enforcement and Defense Market

While xReality initially pursued contracts with the Australian Defense Force (ADF), Jones explained that Australian military procurement cycles are slow and bureaucratic, making it challenging for small companies to rely solely on domestic defense contracts. Instead, xReality identified U.S. law enforcement as a faster, more scalable entry point.

The U.S. law enforcement sector is highly fragmented, with 18,000 separate agencies at various levels—federal, state, and local. xReality originally targeted Tier 3 agencies (departments with 40-200 officers), but quickly realized that smaller agencies (Tier 4) also had access to federal and county budgets for training solutions. This expanded the company’s total addressable market (TAM) to 17,500 agencies.

Jones described xReality’s breakthrough moment in May 2024, when after six months of groundwork and marketing efforts, the company secured 22 U.S. agency contracts in a single month. This came after hiring a team of five experienced U.S. sales representatives, some of whom came from competitors, giving xReality an edge in navigating the U.S. law enforcement sales process. Since then, adoption has accelerated, with xReality reaching its 50th U.S. customer in early 2025.

Competitive Advantage and Differentiation

Jones highlighted several key differentiators that set xReality apart from competitors in the simulation training space:

1. Hardware Agnostic Software – xReality does not manufacture its own hardware, ensuring that its software is compatible with any VR/AR headset or commercial off-the-shelf device.
2. Offline Capabilities – Unlike many competitors that require cloud connectivity, Operator XR runs fully offline, making it suitable for field use in remote or sensitive operations.
3. Real Weapons Integration – xReality’s system allows users to train with their actual firearms, retrofitted with a tetherless gas system that simulates real recoil, rather than using toy guns or simulated weapons.
4. Custom Scenario Creation – Agencies can build their own training environments, tailoring scenarios to specific geographic locations, operational needs, and real-world threats.
5. Rapid Deployment & Portability – The entire system fits in a rifle case, allowing quick transport and deployment, unlike legacy systems that require fixed installations.

These features have allowed xReality to quickly disrupt an industry dominated by legacy screen-based training solutions, which are less immersive and require dedicated training facilities.

Financial Performance and Revenue Model

xReality reported record cash receipts of $5.2 million in the last quarter, up 87% year-on-year. Its Annual Recurring Revenue (ARR) for Operator XR has grown significantly, with a total contract value (TCV) of $7.4 million, an 80% increase on FY24.

The company’s revenue model is based on a mix of:

• Three-year upfront contracts (the preferred model for most customers)
• Annual subscription renewals after the initial three-year term
• Potential cloud-based SaaS offerings in the future, allowing agencies to store training data and access new scenarios on demand

Jones emphasized that xReality is cash-flow positive, covering both operational expenses and capital expenditures (CapEx) from existing revenue, which reduces reliance on capital raises. The company is now focused on scaling sustainably without overextending itself.

Challenges and Growth Constraints

Jones acknowledged the challenge of balancing growth with financial discipline. Many small-cap ASX companies pursue aggressive expansion, only to burn cash too quickly. xReality has taken a measured approach, scaling sales and support teams only once key revenue milestones are hit.

The company does not carry large hardware inventories, instead sourcing HTC Vive headsets and other equipment on demand through major suppliers. This helps avoid supply chain issues while ensuring fast fulfillment for new orders.

One of the biggest risks, according to Jones, is ensuring high-quality customer service and support, as word-of-mouth referrals are critical in the law enforcement and defense sectors. Poor customer experiences could damage xReality’s reputation and slow adoption.

Future Plans and Expansion

xReality is working on several initiatives to expand its software offering and revenue streams, including:

• Cloud-based subscription services to support remote training and scenario sharing.
• Live-streaming capabilities, allowing larger groups to train simultaneously.
• New training scenarios being developed as part of its U.S. Department of Defense contract, which is progressing well and does not require additional capital.

The company is also evaluating the future of its VR entertainment businesses, iFLY and FREAK, which have provided valuable R&D insights but are not expected to deliver the same long-term returns as Operator XR. xReality is considering a strategic exit from these businesses to focus entirely on the defense and law enforcement sector.

Competitive Risks and Long-Term Moat

When asked about competition, Jones stated that many existing players suffer from “legacy technology” constraints—they built their systems on outdated hardware and software, making it difficult to pivot quickly. xReality, being a late entrant, benefited from launching with modern, flexible, and mobile-first technology.

Jones also emphasized that xReality’s team composition provides a significant competitive edge. With a strong background in military and law enforcement, the company deeply understands its customers’ needs. Unlike larger defense contractors that require external consultants to guide product development, xReality can iterate quickly based on direct user feedback.

Final Thoughts

xReality Group is executing well on its strategy, gaining rapid traction in the U.S., while maintaining financial discipline and positive cash flow. Its hardware-agnostic, customizable, and portable training platform gives it an edge over legacy competitors, and its recurring revenue model provides strong visibility on future cash flows.

While the company is still in the early stages of its global expansion, Jones remains confident in scaling sustainably, ensuring customer satisfaction, and continuously improving Operator XR to remain ahead of the competition.

With a growing U.S. footprint, a strong sales pipeline, and a clear focus on the high-margin enterprise market, xReality Group is well-positioned for continued growth.

Strong positive Operating Cash Flow (+1.5m Vs +0.5m Q1) and for the first time since Q2FY22 positive Free Cash Flow (+416k Vs -423k Q1) as I expected. Receipts from Entertainment were $2.5m at the top end of where I was thinking given it’s normally a strong quarter, but Enterprise (Operator XR) was $2.7m, up from $2.1m in Q1 but I thought it would be at least $3m.

Product Manufacturing and Op Costs were $734k, down from $1,004k in Q1 which is a bit unexpected. I am yet to get an understanding of their supply chain, but would expect that these costs are a lead indicator for sales growth, so I would like to see them go up. However, it is early days and they may just be lumpy and nothing of concern, or Q1 spike was associated with inventory build for the new Op-2 system released mid Q2.

Intellectual Property spend of $1,105k up from $958k is generally a good thing if they can afford it (which it looks like they can), but they have now spent just under what was indicated for the full year. Again, it may drop off in later quarters given they have just released OP-2 the new version or indicate new promising opportunities – a question for Wayne.

ARR and TCV both growing well as per below and 7 new customers added in the quarter for Operator XR which is around the run rate I am looking for and they have been tracking at.

The sales pipeline remains very health at 216 leads or $27.3m (190 & $27.2m in Q1)

The only other point of interest is that they expect the OP-2 system which consolidates the previously separate OP-1 (Military) and OP- LE (Law Enforcement) also adding a new “Scenario Creator Suite”. This may make the product more attractive to customers and streamline development and maintenance costs, we will see.

So nothing to change my view at this point and I will be looking forward to H1 results and hopefully a SM interview to flesh out some details and see how things went at Shot Show.

Disc: I own RL+SM

A notice today for the issue of 1m options to an NED is interesting for the fact that the exercise price is $0.065 and the expire is 23/1/26. I am not sure which director this is for but given today’s close of $0.043 and a 52-week high of $0.067, this shows some confidence or bravado on the price over the next 12 months. 

I don’t think I have ever seen options issues where the share price needs to go up more than 50% in 12 months for them to be in the money at the time of issue…

That said, I wouldn’t be at all surprised if there well in the money by then!

Disc: I own RL+SM

This valuation is totally focused on the Operator XR product and Enterprise part of the business.

XRG is breaking new ground when it comes to training for PD’s and Special Forces, so the market potential is staggering compared to the current small but still impressive sell in. So I am starting a BASIC valuation on the grounds the sell in continues at a modestly increased pace, but way short of the opportunity just in the US (note Europe being approached via distributors).

Due to the cash up front sales model, cash flows are very favourable compared to profit in the current growth phase, which has only just started. Hence, I have used a mix of value methods based on price multiples, a DCF is a bit wild given the high growth rate, up front and pulsing cash flow pattern and picking suitable terminal value assumptions is a wild guess.

The multiples used are based on high growth (20%+) and high margin factors, but are totally up for debate and challenge. The result is a ballpark market cap of a bit over $100m in 3 years which at a 15% discount rate is about $61m now (taking an average of 2-4 year results) or about $0.097 per share on a fully diluted basis (628.9m shares+options).

I do not accept this valuation as in any way accurate and neither should anyone else – I just wanted to get a feel for if it may be worth well above the current value based what I consider low ball assumptions, as well as see how the P&L and FCF’s may play out based on unit economics.

Key Assumptions:

·        Entertainment business is static (ie ignore benefit of sale of FREAK or iFly growth)

·        The DoD & Aus Gov contracts don’t expand and stays at $3m/$270k per year

·        New customers generate A$250k revenue on average (low end of US$150-200k)

·        Net New customers in FY25 of 30, 40 in FY26 then 50 each year after.

·        Entertainment margins 80% and Enterprise 70%

Enterprise Sales, Cash Receipts & Unearned Income

XRG is adding customers rapidly at an average deal value of US$150-200k for a 3-year upfront payment, so mapping the cash flows and revenue requires also forecasting the Unearned Income balance sheet movements. So, I have used customer additions to calculate receipts and recognised this revenue over 3 years. Noting that the customer number are net of any discontinuations, so you also have renewals of customers first added 3 years earlier.

Below are my workings, customer numbers in green drive the cash receipts in orange which are then split between immediately recognised 0.5yr (1/6), current assets 1yr (1/3) and non-current assets (1/2). With current assets being released to the P&L as revenue in the following year and a potion of non-current assets moving to current each year.

I have included the DoD contract as an addition, which has cash receipts and revenue recognition aligned as they pay by the month for the 20-month contract (Sep24 start). I then assume this continues at the same rate per year going forward. However, it should be noted this is a development project, which will if successful open effectively a whole new business opportunity in Augmented Reality (current is VR).

The Australian Government contract was added separately just due to it’s size. I have just assumed this roles at the end of 3 years as a year by year contract.

The yellow line shows the cash receipts total, which as you will see is well ahead of revenue recognised in the P&L. Due to the 3-year renewal or re-contract approach, you will notice receipts have big increase in FY27 then only a small increase in FY28 as the renewal cycle pulses cash receipts. This is clearer if graphed out a few more years as below.

Gross Margin (total company)

Based on flat sales for Entertainment and 80%/70% margins for Entertainment/Enterprise we get the below gross margin break out into Immediately recognised sales and those from deferred release of Unearned Income. Note that Entertainment has prepaid gift cards but the balance on these is relatively stable, so Unearned Income movements are Enterprise driven.

Note also that I am basing the 70% Enterprise margin on a comment by Wayne that it was 70-75% margins. I suspect that they are moving around a lot as the product/customer mix is evolving, so I have taken the low end as a starting point but would expect scale and maturity to provide improvements on this figure.

P&L Forecast (total company)

Given a relatively steady state growth rate that is assumed I am running with a 10% S&M growth and 5% for Admin. Noting the freeze on Entertainment, these changes are all Enterprise business related. Add a few tweaks for Grant income and Finance cost dropping off and for the period cumulative tax losses of $23.7m from FY24 should mean no tax is payable in the forecast period (acknowledging this doesn’t mean no tax expense on the P&L, but a benefit exists).

Under the assumptions the company is profitable by H2 of FY26. High gross margins enable operating leverage, but depend on controlled Operating Expenses of which Sales and Marketing is the bulk but shouldn’t need to grow at anywhere near the rate sales do. If additional sales teams are added and associated costs, we would also expect much higher sales.

FCF: Receipts Vs Revenue

The Enterprise business is capital light, with negative working capital requirements, hence cashflows run ahead of profits when they grow. This is unlike most businesses which can run out of cash in a growth spurt due to increased working capital needs.

I have assumed growing PPE (capitalised development costs), which goes beyond just maintaining the VR product, it is also to keep them ahead of the competition and continue to innovative.

A DCF on these figures gives a $57m value with a 15% discount and 5% terminal growth (above system because growth is still high in termal year). This is close to the other values but I don’t think this calculation is appropriate based on forward assumptions, just interesting its close.

The current debt should be paid off by the end of FY27, but acquisitions or expanding the business with Augmented Reality products and new markets will radically change this (noting they have the ability to raise 25% of their listed capital ready to fire if needed). Hence, I would only expect a capital raise to fund an acquisition or significant investment to fund a new product line.

The fact they have acquired a company and built from the ground up a world leading VR and weapons integration system from what I can gather is well under A$10m tells me they can do a lot with a little. So, I am not expecting the company to burn shareholder value on empire building, but it is always a risk and particularly if they move heavily into Defence contracts or if they move into capital intensive areas (like iFly where they started).

Conclusion

The Operator XR product is the investment thesis and the companies opportunity to generate very high cash flows. XRG is a highly agile and innovative company that embodies it’s special forces heritage in how it plans, operates and executes. 

Part of the problem with forecasting and valuing is the fact that Operator XR is a new product in a new market so standard operating procedures are still being defined and the business model is evolving. None the less, it is clear there is a value opportunity, it is significant, the market is going to struggle to see and price it, but the cash flows will start speaking for themselves very soon to show value.

As always constructive feedback sought, please poke holes in the valuation and calc’s so I can continue to improve them.

Disc: I own RL+SM and looking to buy more for both.

Management Buying Summary Last 12 Month

Note: I haven't include exercise of Options etc, just the purchase of shares on market

Management Buying

Danny Hogan

·      5 December 2024

Buy 291,699 Ordinary Share at average price of $0.0324 ($9,474.07)

·      19-20^th March 2024

 Buying 750,000 Ordinary Shares at average price at $0.028 ($21,000)

Wayne Jones

·      25-27^th November 2024

Buy 805,000  Ordinary Share on Market  at average price ~$0.039 (~$31,395)

Acquired 3,661,878  Shares in lieu of cash bonuses (together $176,092)

https://announcements.asx.com.au/asxpdf/20241128/pdf/06bzcfyh9wbr0c.pdf

·      15 March 2024

Buying 2,200,000 Ordinary Shares (on-market, Off market trade) at average price at $0.028 ($61,664)

John Diddams

·      15 March 2024

Buying 1,000,000 Ordinary Shares at average price at $0.028 ($28,005)

Philip Copeland

·      20 September 2024

Buying 1,000,000 Ordinary Shares at average price of $0.03864 ($38,647.89)

·      21 March 2024

 Buying 1,000,000 Ordinary Shares at average price at $0.029 ($29,014.26)

Market Cap of $24.766m

Management Bio's

John Diddams 

Chairman – Non-Executive 

Appointed 24 January 2022 

John is a professional, highly experienced and strategic public company director with over forty years of financial and management experience in Australia and overseas. 

He has extensive knowledge and experience in the practical application of ASX Listing Rules, Australian corporations’ law, international accounting standards and corporate governance principles, and a strong track record in driving business performance, mergers & acquisition, due diligence and corporate governance. 

John is also a Non-executive Director for Aroa Biosurgery Limited (ASX:ARX). 

He holds a Bachelor of Commerce from University of NSW, is a Fellow of the Australian Society of CPAs and a Fellow of the Australian Institute of Company Directors. 

Wayne Jones 

Director & Chief Executive Officer 

Appointed 4 November 2011 

Wayne Jones is the CEO of XRG and was appointed to the role on the foundation of the company in November 2011. As Chief Executive, Wayne has developed and managed multiple business ventures and projects within Australia, APAC, China and the US. 

Prior to establishing the company, Wayne was a commander in the Special Air Service Regiment (SASR) and responsible for the development and performance of teams in complex and challenging environments. His goal focused approach and strategic vision resulted in Wayne being highly decorated throughout his military career. 

Wayne holds formal qualifications in Project Management, Business, Security and Risk Management and Management (Financial Management) and is a Member of the Australian Institute of Company Directors. He has over 25 years’ experience in leading teams and delivering results. 

Wayne maintains his involvement with the Australian Military and the Special Forces community as Chairman of the Special Air Service Association (NSW Branch) 

Danny Hogan MG 

Director – Non-Executive 

Appointed 4 November 2011 

Danny enlisted in the Australian Regular Army in 1991, and in 1997 was selected for further service within the Special Air Service Regiment. He has been recognised and awarded for his actions and leadership during his 21-year military career including receiving the Medal for Gallantry. He was selected and completed a two-year military exchange in the USA with two of the USA’s elite Special Forces Commands. While in the USA he gained his freefall parachuting qualifications and developed a very strong background in the use of vertical wind tunnel simulation training. Danny was a highly qualified senior dive instructor within the Special Air Service Regiment. Danny served as an executive director and the Chief Operations Officer from the foundation of the company until November 2019 at which time he became a non- executive director. Danny is a member of the Australian Institute of Company Directors. 

Kim Hopwood 

Chief Product & Technology Officer 

Appointed 26 May 2021 

Kim Hopwood brings over 20 years of experience across technology, media, management and operations. Kim started his career as a network engineer at Cisco Systems where he achieved his CCIE. Kim then co- founded digital agency Pusher in 2004 as Managing Director, which he sold to global communications group Publicis in 2014. Kim remained as Publicis Australia’s Managing Director of Digital until late 2017. 

Kim started working with XRG in 2012 as a supplier, then freelance consultant before joining full time in 2019. Kim holds the position of Chief Product and Technology Officer, overseeing XRG’s corporate strategy, technology, current and future products. 

Mark Smethurst 

Director – Non-Executive 

Appointed 15 November 2021 

Mark’s significant Defence experience spans over 35 years in the Australian Army, with 27 years as a Senior Special Forces Officer commanding at all levels including the Deputy Commander of the Australian Special Forces. Mark Commanded the NATO Special Forces in Afghanistan during 2011/12 and was the Deputy Chief of Operations for the US Special Operations Command in 2013/14. 

He currently holds a variety of board and advisory roles with several private and public companies and is an Advisor to the Global Special Operations Foundation and the Chairman of the Commando Welfare Trust. Through his experience and other business interests, Mark is well positioned to support XRG in Australia and International markets. 

Mark is a Non-executive Director for Highcom Limited (ASX:HCL). 

Philip Copeland 

Director – Non-Executive 

Appointed 23 January 2023 

Philip Copeland is an experienced senior leader in the enterprise software-as-a-service (SaaS) sector with a successful track record scaling enterprise SaaS businesses into global markets across highly regulated industries including government and financial services. Philip’s extensive experience includes being former CEO and co-founder of Avoka Technologies, a digital business enablement platform. Founded in Australia, Avoka rapidly expanded to the global markets with a core focus on the US. Avoka was acquired by Temenos in 2018 for $US245M. Phil currently resides in Colorado, USA and will be assisting XRG to break into the US Government markets and guiding the company as it executes it’s international growth strategy through Enterprise Software. 

Hope this works for everyone:

xReality Group_Alan Kohler 17Jan25.pdf

XRG has exactly what I am looking for in an investment, an imminent and evident unrecognised pivot in performance (well until today maybe). The type of thing that stopped quality SAAS business being recognised in the early days is in play, namely a delayed and hidden profitability from growth investment, high margins and sticky revenue commitments.

Interview of CEO Wayne Jones by Alan Kohler provides a lot of insight (I will try and get a print copy for those who don’t have access): xReality Group: All Geared Up - Intelligent Investor (released Friday so weekend listeners were buying today it seems)

Forbes article for a bit of history: xReality Group going from SAS to SaaS

The business has been investing the profits and cash flows of it’s core business into a new business that is now achieving strong commercial success to the point that it should generate more income than the core business by the end of FY25. The core Entertainment business has performed reasonably well over the last 2 years but the costs to develop the new Enterprise business (6m+) have made XRG unprofitable and unattractive to investors.

In addition, debt has been built up and dilution from capital raises has been needed to fund the development of the Enterprise business. This I expect to see change in the next 4C due to the working capital positive nature of the Enterprise business and quite frankly astonishing growth rate from market acceptance in the US.

Operator XR is the Enterprise product and investment case for XRG. The equipment, licence and systems are sold on a 3 year agreement with payment up front in most cases. So in the first year 1/6^th of revenue is recognised, 1/3^rd in the next two and 1/6^th in the final year on average, but the current high growth rate will sku this as the weight of new contracts in a year occur later. 

To measure success we can look at Revenue Vs Revenue + change in Deferred Revenue as graphed below, which shows a leading indicator for how revenue will move. Looking at FY25 based on YTD information (DoD contract + customer additions), the lead indicator is streaking ahead of revenue as the Enterprise business scales and goes from a rounding error Vs the Entertainment business to the dominant business by the end of FY25.

The DoD contract: US$5.6m over 20 months Development of augmented reality (Vs VR), which is not the final product but XRG will own all the IP at the end of the project.

The upside opportunity is exceptional given it is currently only a $20m cap (EV $28m) company and my expectations that operating cash flows likely to be well over $4m for FY25 (FCF of $2m+) however NPAT is unlikely to be positive due to delayed revenue recognition and cost build to support growth. Profitability I would expect H1 FY26.

LA SWAT is using their equipment + 40 other PD’s

70-75% GM for Enterprise

US$150-200k current deal size average for customers

Expectations for 4C Q2 FY25: I expect positive Operating CF to exceed IP costs to provide positive FCF due to Q2 usually being a strong quarter for Entertainment (Est 2-2.5m up from under 2m) but increasing Enterprise contributions (Est 3-4m up from 2.3m) driving total receipts in the range of 5-6.5m. 

As such I believe Wayne Jones statement in the interview with Alan Kohler that additional capital raise is not likely due to expecting positive CF in Q2 and the additional 500k debt facility to allow for inventory build to provide any required buffer on the $1.5m closing balance from Q1.

I have a lot more analysis to finalise and add, so will publish as complete, but my general conclusion that this is an asymmetric investment with massive upside and clear evidence of likely success is basically locked in!

Disc: I own as of today and looking to buy more.

11/09/2024

XRG is currently up 29.7% (at time of writing) after this announcement:

“$5.6M contract awarded for US Department of Defense project

• The contract scope is to deliver a new immersive training capability and includes supplying Operator XR system licenses along with R&D services.

• The R&D project duration is 20 months commencing 11th September 2024.

• The contract presents opportunities for follow on work.

xReality Group Limited (XRG) is pleased to announce it has been awarded a $5.6M AUD contract to deliver a new immersive training capability to the United States Department of Defence. The contract has been awarded to XRG by Acrolect Solutions LLC, DBA Endurance Group, who is serving as prime contractor to the US Department of Defence for the R&D effort.

This project represents the first sale of Operator XR’s immersive training systems to a US Federal Government customer, and will be delivered across a period of 20 months starting 11th September 2024. The contract includes pathways for follow on work within the DoD and broader US Government agencies.

CEO of XRG, Wayne Jones said “the strategic importance of this project cannot be understated, representing Operator XR’s first major engagement with the US Department of Defence. Operator XR will be jointly developing a cutting edge capability that has the potential to expand into further global agencies as well as the many operational units within the US Defence Force.”

This ASX Release is authorised by the Board of xReality Group Limited. END”

Do not hold, however have added to watchlist.