AVA Risk Group Limited (AVA) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for standing by. Welcome to the Ava Risk Group First Half FY '22 results webinar. [Operator Instructions] As a reminder, this call is being recorded. I will now turn the conference over to Robert Broomfield, the CEO of Ava Risk Group. Please go ahead.

Good morning, everyone, and thank you for joining us for the presentation of Ava Risk Group's half year FY '22 results. I'm Robert Broomfield, the CEO of Ava Risk Group. And with me on your screen is our CFO, Neville Joyce; and our Chairman, David Cronin. So moving through the slide, the agenda for today's update is I'll cover the first half FY '22 performance with an overview. Neville will cover off the FY '22 financials, then strategy and outlook, and then we'll open up for questions. FFT and BQT that forms Ava Risk Group, provides technologies for the management of risk, both security and operational risk. Both FFT and BQT have an exceptional global footprint of successful installations. FFT generates the vast majority of its revenue from outside of Australia, while BQT has a balance between Australia and global sales. You'll note that we have installations in some 70 countries and thousands of systems. FFT has an exceptionally high-quality blue-chip customer base, both in terms of the end users and in terms of global system integrators. Our blue-chip customer base covers military, government, energy, utilities and transport, and some of the most security risk company -- conscious companies in the globe. BQT also has an exceptional blue-chip customer base. And again, some of the most risk-sensitive companies in the world and applications, particularly in transport, but also they have a global reach with distribution partners. So they have a network of local and global and international distributors and some of the largest distributors in that particular area. So moving on to the operational highlights. I was pleased to say operational improvements continued in the first half, as does continued progress against strategic initiatives previously outlined in our earlier updates. With the Services divestments completed in the first half of FY '22, the Technology division achieved a large growth in new sales orders over the prior comparable period and successfully navigated through significant supply chain and logistics disruptions related to COVID-19 to maintain an exceptional standard of timely order fulfillment. We're very pleased to finalize the dormakaba framework agreement for BQT locking solutions and that we've received the initial stocking order that will be fulfilled over the next 2 months in support of dormakaba's launch plans. FFT also progressed its strategy of licensing programs to leverage legacy technology to access cost-sensitive markets not fit for our normal go-to-market and we signed our first agreement for Brazil. And due to the extended lead times, we don't expect contribution this financial year, but will support the partner this year with initial demonstration units so they can continue to do business development activities. The benefits of assembly in Brazil extend beyond the import duty reductions, with the government providing financing support for projects that use made in Brazil products. Moving on. In terms of operational highlights, we also have done an excellent job of extending into new applications. We've received further orders for Aura through our partner working in the power cable sensing market. We've successfully commissioned our system for a high-profile European power project being France's first offshore wind farm. Our FFT Aura already had world-leading sensing distances of up to 55 kilometers per channel. But with this project, we've extended this out to 64 kilometers, and the customer was delighted with the quality of sensing even at 64 kilometers, and feedback is, we will be selected in the next 4 tenders expected to be issued in the coming months. In the first half, FFT Aura won projects for the world's largest solar farm projects in Latin America and in Europe. And we've deployed 4 sites in Brazil alone. I spoke last year about the recurring revenue potential FFT has from its installed base of over 2,500 systems. And we have an objective to build on some initial success in multiyear maintenance programs, and we have a longer-term target of 250 systems under contract and $5 million per year from recurring revenue, associated with these comprehensive maintenance contracts. When we started the half, we had some 5 systems under contract. But through our existing sales and support team, we contracted another 31 systems. We have plans later in this half to increase the sales effort with a dedicated aftermarket sales resource in the U.S., also as part of our U.S. growth strategy. We're also working to integrate both our advanced Cyber Assurance program and artificial intelligence capabilities to add some significantly new compelling value to the value of our comprehensive maintenance offerings in the first half of FY '23. Although disappointed we didn't receive the expected contract for our innovative conveyor solution Aura IQ, in the first half of FY '22, I will provide a more detailed update shortly on the program status and why we remain confident on significant success in the coming months. Turning to the financial highlights. Although Neville will cover in more detail, but I can say the group achieved revenue and EBITDA results in the first half of FY '22 that were in line with guidance at the group level. And in fact, due to Service contribution being less than was expected when the guidance was provided, the Technology performance was ahead of expectations at that time. The underlying revenue performance of Technology, excluding IMoD, was up some 9.6%, with a strong increase from FFT and the majority of the backlog at the end of the half also coming from our strong order intake within FFT. So looking at the sales orders. This particular chart shows back in the first quarter of FY '21, a large contribution of orders from BQT associated with a large Australian Department of Defense program, but relatively flat order intake in the subsequent quarters as the major markets in New South Wales and ACT were both impacted by the ongoing lockdowns. FFT was experiencing very strong order growth from the second quarter FY '21 with good growth in the Americas in the last quarters, and the Americas continues to be a focus for ongoing sales investment. I'll now hand over to Neville for further financial details.

Thanks, Rob. Good morning, everybody. I'll provide a brief overview of financial performance through the first half of the year. The results of both revenue and EBITDA level was in line with the guidance, which was provided in October. The income statement shows a very strong profit result of $32.9 million, underpinned by the gain on the disposal of Ava Services. Comparisons with the prior year are muddied by the divestment of services in the current year and the impact to buy [ IMoD ] revenues in the prior year. This is why reported revenue, margin and EBITDA are all lower than for the prior year. We've pulled out the impact of both the Services divestment and the impact of IMoD revenue to both revenue and EBITDA. The chart show that the year-on-year movement for revenue is highly attributable to the investment of services in the current year and the realization of revenue on IMoD in the prior year. These factors are largely -- also largely explained the movement in EBITDA. It's worth noting that the prior year EBITDA also benefited from the receipt of JobKeeper support in Australia, which is obviously nonrecurring. Looking specifically at the performance of the Technology division. This slide shows our current year performance compared to our normalized view of the prior year. To be explicit, the normalization adjustments to the prior year to remove the impact of IMoD and JobKeeper and to smooth the lumpiness in some of the prior year orders, particularly associated with BQT. Against this metric, we see revenue growth of almost 10%, reflecting the improved order intake through the first half of the year. We also see consistency in our gross margin year-on-year and improved EBITDA margins as we leverage our cost base to generate higher revenue. The cash position of the company remains strong. In addition to the proceeds from the divestment of Services, it's pleasing to report that the operations of the business generated positive cash flow of $3.5 million. The CapEx of $700,000 in the half relates primarily to continued development of our technology, in particular, Aura IQ. Looking at the balance sheet. It reflects our very strong cash position at 31 December. It also reflects the divestment of services through the first half year. The specific balance sheet adjustments for the Services divestment are set out in the financial -- note 11 of the financial statements, which we released earlier this morning. Finally, many of you will be aware that an update on the return of funds to shareholders was provided earlier this week. After extensive discussions with the ATO, they indicated that around $7.6 million would be traded as capital. Based on this advice, the distribution to shareholders will be split between a special dividend of $0.13 per share to be paid on March 10 with a record date of February 28. $7.6 million will be distributed as a capital return, subject to shareholder approval at an AGM scheduled for April 22. With that, I'll pass back to Rob, who will now discuss strategy and outlook.

Can you hear me?

Yes.

Thank you. So look, moving on to the track record. So we really are in a strong position with the Ava group technology companies. We've maintained high margins along with cost disciplines. We've generated strong cash, and we've been able to provide investors with a return. We're progressing our plans for scalable growth from our existing go-to-market. We're increasing revenues from our existing blue-chip customer base, and we're moving into new applications and markets. We're positioning the group for a leading position in condition monitoring through a number of effective partnerships. We're investing in technology leadership in artificial intelligence, both to enhance our position in security and condition monitoring and to increase the value of multiyear support agreements. And we're expanding locking distribution with a recent agreement with one of the world's largest locking distributors. Moving on. So the growth initiatives. So we've spoken around growth initiatives a number of -- at times. But around those growth initiatives, we have a growing ecosystem of high-quality partnerships that the group is using to expand from IP and innovation partnerships, application and solution sales partnerships through the distribution partnerships. We've already started to see the growth of maintenance agreements in the half and have clear plans to resource and enhance the solution for sizable growth next financial year. We have a clear line of sight on the impact of Aura IQ with a solutions partnership on the conveyor fire detection. Licensing has been a game changer for securing the IMoD contract, which provided high-margin, low investment revenue, but we've started to use the licensing model to establish long-term licensing programs in cost-sensitive markets, which will also contribute and expand in FY '23. Moving on to Aura IQ. We've had a number of questions around Aura IQ. But just to make sure this is a predictive conveyor sensing solution. It has the highest value, the greatest return on investment on critical conveyors, which have exceptionally high cost of downtime. And conversely, we've seen the challenges of installing our system for a small section of these conveyors for our proof-of-value trials, and can understand the global mining industries looking at the downtime, cost to install sensing solutions. The order that was expected and was well advanced in December was, in fact, stopped by the organization's Global Head of Condition Monitoring. And we were asked to work to develop a solution in conjunction with the provider of their fiber optic fire detection to develop an integrated solution that would use a common fiber infrastructure. At the same time, the global tenders for the implementation of their fiber-based fire detection solution was delayed, pending an integrated solutions. FFTs tested and integrated the fiber cable construction into Aura IQ, and the fire system providers redesigned their fiber cable deployment to meet the needs of Aura IQ, and we're completing final field validation next month. When complete, the customer will have a solution that halves the downtime, will simplify implementation of fire and/or Aura IQ, dramatically lower the cost and time, and we see as a huge impact on the ROI, and we already have multiple mine operators waiting to see the same solution. So just moving on to the broader Aura IQ program. And where we are is where with Aura IQ is really much more than a product. It's a platform and it's a longer-term program. And we have future plans for a number of high-value functional additions that we've got for the coming years. And we can see we're about halfway through this long-term program. So we started with IP developed by Mining3 over a number of years, and that patented intellectual property, they partner with FFT to take it to the global mining industry and our Aura Sensing Platform was a platform of choice. We've done the integration testing at proof-of-value trials, and we have a number of successful trials already completed. We're now into the customer-driven enhancement phase and integrating into a fire detection platform, which will accelerate the commercialization program ahead. But beyond that we have additional versions being planned, which will include greater ability to operate on a high variety of conveyors and providing situational awareness around a conveyor, including spillage or vehicles that we can already see today. And then we're moving on to more low-dependent processing, long-term trending and prediction around the lifetime of bearings and rollers. Also, we can already see a number of attributes from the conveyor belts on these conveyors, such as where the splice is where they join. We can actually see it moving around the conveyor. And so we'll have a plan of actually developing that to provide information about the state of ware or condition on those conveyor belts. And then we actually are being asked about what else we can do and where we can deploy these sensing technologies across mining infrastructure, including down in mines, where you can provide a lot of situational awareness in terms of people and activity through to all the rotating equipment around mines and also the other infrastructure where we can provide valuable information. So as we move on, a lot of this does start to segue into where we can see great opportunities in the cities of the future. So there's a number of activities that we're showing on this particular slide. And we have demonstrated all of the things that you can see on this slide, including seismic and earthquakes. And for those that experienced the Victoria earthquake late last year, you may not have been aware of the number of after shocks because they're way too small to be felt. We could see the aftershocks with our buried fiber. Not only that, we can extract information from the earthquake waves that we detect, and we can actually calculate how far away the source of the earthquake was, and we were extremely accurate in the determination of the position of those very small aftershocks that occurred last year in Victoria. So we've also got significant interest from IT companies that have massive deployment of fiber optic cable, where you can gather information, where you don't have any other sensors where the fiber might run in terms of road condition, traffic density, accidents. All that situational awareness we're able to provide, which feeds into the strategy around smart cities. So we're pretty positive and excited about the outlook from what we've been doing and the activity is underway. And we're very positive about the contribution growth from core sales, future contribution from the global agreement with dormakaba, from Aura IQ and from licensing in the coming year. So solution expenses will continue. We're going to drive growth into the adjacent applications in the power area as well. Our investment in the U.S. presence will also continue. So for the second half of FY '22, we are giving guidance in the range of $11.2 million to $13.2 million, excluding any contribution from the IMoD contract. So thanks very much for the opportunity to present. I'll now hand back for questions.

[Operator Instructions] Rob, Neville and David will initially address questions that have been submitted in advance. The first submitted question is, why did you choose a special dividend to return capital when a share buyback is more tax efficient to shareholders and support the share price?

Okay. Thanks, Alex. I'll answer this question. Firstly, I'd just like to acknowledge that Ava has a very diverse shareholder base. We've got local shareholders, institutional shareholders, overseas shareholders. We also have shareholders who have been on the register a long time, and we have some more recent shareholders as well. So the Board is well aware of our diverse shareholder base. When we announced the return of the surplus funds last year, as you'd all be aware, we sought to establish an appropriate timetable and method of returning the surplus funds to shareholders. Unfortunately, our class application didn't proceed in the manner in which our advisers and ourselves had hoped. But you'll be well aware of the ATO's position on the treatment of the proposed sort of capital and profit as to those funds. It's also important to note that Ava has substantial carryforward losses. And at the moment, whilst we have very healthy profits, we are not in a tax paying position. So what that means for shareholders is obviously, Ava is not paying tax out of our profits to the ATO first. And then if it distributes a dividend normally for the Australian shareholders, they would receive the franking credit. So essentially, the gross amount is being distributed to shareholders rather than tax being withheld at the company level. But unfortunately, because the tax hasn't been paid on it, you don't get a franking credit and I know that was raised as an issue by certain shareholders, and we do appreciate that. Undertaking a buyback was raised by a couple of shareholders as well. And as everyone would be aware, the company was already taking an on-market buyback. And we had made our intentions very clear there. I'd like to point out that either is not a very liquid stock at this point in time, and it's something that the company is working on. But it was certainly not the intention of the company to return surplus funds by way of an on-market buyback. And in fact, we wouldn't have been able to do it with the quantum in which we're proposing to return to shareholders. If we did an off-market buyback, we would have had to consider all shareholders an equal access to the off-market buyback, also timing considerations as well. So off-market buybacks also have their own tax considerations as well. I'm not here to provide tax advice to individual shareholders, but there are plenty of guidance notes on the ATO website as to the ATO's ability to deem certain buybacks part capital, part profits in the hands of shareholders. So obviously, with advice from our advisers, the Board considered various options and we ultimately decided on the special dividend and the capital return as the most efficient and appropriate methods to provide shareholders a timely and somewhat certain outcome. Obviously, the dividend is certain. If you are on the register at 28th February, you will receive that dividend. The timing of the capital return is subject to a shareholder approval process, which will be forthcoming and an AGM notice will be sent to shareholders with further particulars. So I'm sorry, it's a bit of a long-winded answer. It's certainly a complex decision for the company to make. But hopefully, I've addressed all the relevant points.

Thank you, David. The second question is, did Ava bid for the BHP conveyor belt condition and fitness monitoring challenge for its Port Hedland iron ore operations as this seems to be a problem Aura IQ solves.

No. Thank you. So the answer is no, but you would have seen on that road map that particular function is part of the future road map. It's not available yet. There's work to be done. We've obviously got to develop the algorithms. We'll be using a lot of the field experience that we get from proof-of-value trials, from commercial installations and working with our partners, including Mining3 to develop that particular capability and add that to the sensor capability. There is already existing belt thickness and condition monitoring technologies that are available commercially. And so therefore, we need to develop it such that it is a very efficient, cost-effective addition to our Aura IQ platform.

The next submitted question is, is Aura IQ a viable product in the current market? And if so, when do you expect to announce a contract?

Yes, it is viable. And as a result of the work that we've just got underway about the integration is becoming much more viable in terms of barriers, in terms of installation. And so therefore, yes, it is definitely viable and even more so now. And we expect contracts to be announced this half.

Does the Q2 guidance include any revenues from Aura IQ?

It has some very small expectations on Aura IQ.

The next questions are from Mark Yarwood at Petra Capital, which I will read now. When you look at the geographic revenue profile of the business, the U.S. is underpenetrated relative to its opportunity size. Can you maybe help us understand what the appointment of Jim Viscardi can bring to the table? And what he has goal on achieving in the first 12 months?

Yes, certainly. Look, when we were doing our budgets, which incorporates a 3-year plan, the U.S. market was one of particular focus, and hence, the investment that we've made in terms of appointing Jim Viscardi. And Jim's got strong background in security technologies and also a very strong background in one of the vertical that's very attractive to us, which is transport. And really, his role is to obviously focus and develop the sales infrastructure and capabilities, obviously, use his C-level connections, his industry connections to make sure that we're accessing much more of the market. We have an extremely dense number of installations in that Washington, Virginia area that are exceptional and we really need to build on that across the entire U.S. and further into the U.S. defense and security industries. So it's a huge growth potential and opportunity. And already, Jim has been opening up doors to a number of organizations of significant size, introducing technologies to them and starting to grow as we speak. I guess the other area that he's very much focused on is employment and recruiting and investing in the right skills. And so he's already starting to add to his team in terms of the technical and sales skills that he needs to grow on top of his connections and relationships in the industry.

The next question from Mark Yarwood at Petra Capital is, Aura IQ, wider tangent into fire protection integration, how much additional product development, OpEx and investment is needed?

I hopefully have covered it in the presentation. But just to recap, the -- one of the hurdles is the time it takes to install all the fiber, although I wouldn't have thought it was very long that in terms of the operation of a critical conveyor that downtime can be hundreds of thousands, if not millions of dollars per hour. So therefore, downtime is quite serious. And we've seen that in terms of our experience in the proof-of-value trials. So we understand clearly that to install the fiber infrastructure once and to have it used for the fire system and condition monitoring obviously has significant benefit. And the effort to do that has been quite relatively modest. We were able to do the evaluation of the cable structure in our factory that's been done. The next investment is the actual side-by-side comparison on the live mine, where the system was to be ordered and has been tested and proven already to show we get similar results. So it's really modest OpEx needed in terms of finalizing that development. There may be some software that's -- that we need to develop to improve the performance, but it's looking like there isn't at this particular stage. And as I said, this actually is significant in terms of the adoption and the rate of adoption of the technology in the market. Many of the global mining companies already have a strong plan for deployment of their fiber-based fire systems based on an insurance reduction ROI. And so that's well advanced now to be able to tail on to that, the ability to upsell the Aura IQ solution and have no installed time if the infrastructure is already there is very attractive. Going forward, we see an opportunity where the CapEx is that they're putting out might be for a combined solution. And so therefore, we've got a strong partnership with players in that industry in terms of our ability to provide these integrated solutions.

On the licensing side, what targets without naming names, do you have in the pipeline and perhaps some color on the use cases and regions?

Sure. So as I mentioned, it's really those markets that are probably very cost sensitive and where we've not really been as successful as we might otherwise with the go-to-market of our premium Aura platform. So Latin America is one. Now we have had some success in major large projects, solar farms,, in major subway investment with our Aura AI platform through our normal go-to-market, which is selling to system integrators at our normal high margins. For the larger market, though, we needed a lower cost solution entry point. So therefore, anything that can use the Secure Fence, our older technology, that we've already successfully integrated into the IMoD program, we know we can do it easily. And so that's the product. LatAm is the target. We've now obviously signed 1 in Brazil, but there are obviously other countries in Brazil that we're working to find a suitable partner. The benefit, of course, is we then get sales that we don't have to invest in the sales resource. The partner does all that. We don't have any working capital for the material. We don't worry about the logistics. We simply get paid a licensing fee per system. The other market actually is interesting is India again. Outside of the IMoD program, there are a number of large volume opportunities that could well be triggered by a licensing arrangement. But also remember, we're doing very strong business in India in terms of military air-based programs, which are continuing on through the second half of this year. And there's a number of pipeline projects that we're doing in India. But to get some very significant volume, the licensing would be the way to go. So they are 2 first ones. But interestingly enough, there's opportunities that are coming in the United States as well. And here, the licensing arrangement is a little bit of a difference in that the BQT readers have array of encryption technologies and they have a partner in that particular market that sells readers, and they have some of their own technologies. And they're wanting access to BQTs, encryption capability for one of its platforms. And there is a potential where that we could do a licensing arrangement on BQT as well. We've still got some work to do on that one, but that's certainly also another target, how to bring BQT into some other markets, whereby you really want a strong partner that has the footprint and the capability, local approvals to accelerate that at low investment and low cost for BQT as well.

What profit margin do you expect from the deal with dormakaba?

They will get a gross margin that's consistent with what the business is achieving. So it tends to be around the 50% to 60% mark. What's more important with that one will be volumes. That's what we're wanting to see is higher volumes. As the volumes go up, we can further improve that cost base because we can obviously get leverage by much higher volumes to drive down our COGS, and that will give us margin improvement and growth as well. So we should be able to get back to the 60% plus.

Have you experienced any supply chain disruptions?

Daily. And as I mentioned, the procurement, production, logistics team have done an outstanding job in terms of managing, anticipating and negotiating and finding supply as and when needed. We certainly have increased our forward order book for components much further out than we would have normally. We're now going 12-plus months out in terms of critical component ordering. And we also are trying to make sure that we've got an appropriate buffer of key technologies in the factory as and when needed. But it has been a challenge, and it will continue to be a challenge for another year or 2 for all manufacturing organizations globally.

Next question is what do you consider is the sustainable EBITDA margin for your business? And when do you see that achieved?

Sustainable. We're always targeting towards 20% plus. And that's where things like licensing can actually tip that to be much, much higher because obviously it's 100% gross margin and slows down very quickly. We'll maintain our cost discipline, and therefore, we'll see acceleration of that EBITDA as we go forward from its current base to one that will be significantly higher as we scale because our investments will be primarily in the sales area because we've got the technology side and I think very well programmed. And obviously, we'll leverage a cost-effective way the partnerships, where we've got the partner doing a lot of the sales work and development work for us.

The second half guidance on revenue is 26% higher than the previous corresponding period. Is there any noticeable licensing deals included there? Why wasn't an EBITDA guidance given as well?

Well, no, there isn't significant expectation on licensing at this stage. And we will get some small contribution, but not significant. Regarding the EBITDA question, it's still a fair way to go through the second half and a bit early, I think, for EBITDA guidance.

Just adding to that, Rob. Certainly, it's our expectation that we'll provide a third quarter update. At the end of the third quarter, and we'll provide an update of both revenue and EBITDA guidance at that point.

It's good that the company kept a stable gross margin percentage on Tech segment, excluding IMoD. Was the company able to pass some cost increase on some of its customers?

It's kind of difficult if it's something that has been quoted some time in the past. We've tended to not have to worry too much about cost increases at this stage. We do have high-value componentry. We do have programs of cost down, cost reductions anyway that we've built into our future plans. So we'll be able to maintain our gross margins. And in fact, the focus is growing them through licensing in the longer term. So I don't see any degradation in gross margins. There may be a deal that comes up that's of significant nature and size. It's a game changer, we may give away some gross margin just because of the sheer size of it, but not for any of the business that we're forecasting or planning at the moment.

Can you give more color around your expectations for the $2.5 million outstanding on the IMoD contract?

Yes. The reason that we're not forecasting in this half is really related to logistics to begin with. We know that they will not get material within 6 months from when they actually trigger that last part. So we know that it's certainly not going to contribute now to this financial year. It's too late. We still have the orders on it. The program is still rolling out, but we don't actually have absolute clarity at the moment at what point they'll be ready and trigger that last component of that particular program. So we would see it not unreasonably being in next financial year. But obviously, we need to get some clear indication based upon the rollout of that large program, which we haven't been giving at this stage.

I believe this is the last question. For FFTs Aura IQ, you mentioned that you've signed maintenance agreements for 31 systems, generating approximately $3 million in revenues. What sort of margins does the company earn on these maintenance contracts?

So exceptionally high margins because the actual cost to support will be some modest travel if it's an on-site one. If it's a remote one, it's actually just the time of the technical support engineer to log in, and we're talking about exceptionally high margins on these. Where we do have a maintenance contract that might actually have more on-site work, then it may not be near 100%, but it is much higher than our core product gross margin.

Thank you, Rob. There are no further questions at this time. If you have any further questions, please e-mail [email protected]. I'll now hand back to Rob for closing remarks.

Look, thank you, everyone, for your time today, and we are excited about the second half of FY '22 and moving into FY '23. And we'll look forward to continuing to update you on our progress through the half. Thanks very much.

That concludes our webinar for today. Thank you for participating. You may now disconnect.