Cybersecurity and customer experience company Prophecy International Holdings Limited (ASX: PRO) reported a 17% revenue increase to $22.9 million in its FY 2024 results.
Contracted Annual Recurring Revenue (CARR – we’ll get to that) grew by 22% to $28.4 million. Disappointingly, the loss for the year increased by 70% to $4.2 million, largely due to a 70% rise in communication expenses, including cloud services. This cost increase was driven by higher hosting expenses on Oracle Cloud Infrastructure and AWS. In response, the company is developing a new Emite application architecture to save $700K annually in Microsoft licensing and reduce overall hosting costs. Prophecy also experienced an unfavourable foreign exchange movement of ~$800k and did not receive an R&D benefit which in the prior year was $618k.
Revenue declined in the second half, which has historically been the stronger period. The loss was also pretty flat half on half.
Despite this, operating cash flow was positive $200k, up from an outflow of $1.2 million in the prior year, though free cash flow was slightly negative once you consider capital expenditure and lease payments. Prophecy reported a cash balance of $11.7 million, relatively unchanged from the prior year.
The business model involves receiving annual payments in advance, allowing early cash inflows for investment before revenue recognition. This is good because the business can fund its own growth, but makes things tough if the business is declining.
Prophecy releases quarterly updates so we have had some insight on performance throughout the year.
Management expects Prophecy to be EBITDA positive in FY25, but when I originally covered the stock last year I wrote:
“The Prophecy International team believes they can be cash flow positive in the first half of 2024 and for the year. The company is currently targeting a small earnings before interest tax and depreciation (EBITDA) profit.”
In the end, Prophecy delivered an EBITDA loss of $3.15 million. Interestingly, this was omitted from the summary sheet at the beginning of the report. This wasn’t the case in 2023.
In Prophecy’s Q3 Update, it had said it would achieve positive cashflow for FY 2024. In the end operating cash flow was about $230k, with free cash flow being slightly negative after taking into account about $300k of capital expenditure and lease expenses.
Prophecy’s (ASX: PRO) Segment Performance
Emite
SaaS-based analytics platform Emite grew revenue by 27% to $13.9 million up from $10.9 million in the prior year with “contracted annualised recurring revenue” (CARR) growing a further 22% to $18.2 million
Emite experienced record revenue in FY24 driven by a number of new contracts signed. In particular, a 6-year, $10.7 million contract signed in H2 FY24 to provide Emite to Optus Networks for Services Australia as part of Services Australia’s migration from its legacy on-premise contact centre to a new cloud-based CXOne platform.
In the June quarter, Prophecy commenced a new approach to Emite to enable greater scale for large customers and to improve efficiency and reduce costs with the hope of improving future gross margins. Historically, Prophecy has expensed this type of activity, but this specific expenditure will be capitalised on the balance sheet. Increasing the amount of expenditure capitalised has the effect of increasing profit metrics in the short term, as the associated amortisation will only impact the profit and loss over an extended period.
And of course, capitalising more software development expenditure will immediately boost EBITDA, hypothetically assisting the company to achieve a positive EBITDA result.
Management continues to be positive around the segment and sees it as a significant growth trend, particularly around hybrid working conditions and the associated cloud migration.
The AI threat to customer experience is yet to play out with a growing dissatisfaction amongst consumers and an inability to quickly reach an empathetic human agent.
Snare
Prophecy’s cybersecurity product Snare revenue grew by 3.84%, while CARR increased by over 34% in FY24.
While revenue growth appears to be underwhelming, it’s important to note that the transition from legacy perpetual licensing is ongoing. During the year, 83% of new Snare sales were made on a subscription basis rather than under a perpetual licence model.
A shout out to Luke Winchester for his assistance with recalling that CEO Brad Thomas has previously said that a recurring sale of Snare is roughly 40% of the original perpetual licence value.
Below, you can see that the revenue generated from Snare “goods or services transferred over time” increased while the “goods or services transferred at a point in time” is decreased.
Concerns Prior to the Prophecy (ASX: PRO) Report
Between Q2 & Q3 the company changed its reporting metric.
Prophecy switched from reporting Annual Recurring Revenue (ARR) to Contracted Annual Recurring Revenue (CARR), a change that, while subtle in acronym, carries distinct differences
While ARR represents the normalised amount of recurring revenue typically calculated by taking the monthly recurring revenue (MRR) and multiplying it by 12. CARR includes not only the current ARR but also future committed revenue from signed contracts, even if the service or product hasn’t started being delivered yet. CARR carries some risk as it includes future revenue that could potentially be cancelled or not realised due to various factors.
Another way of thinking about it is that ARR requires sales plus implementation, and (usually) at least some cash flow, whereas CARR requires only sales. Whereas cashflow should track ARR with a lag, CARR omits key information about whether the product sold has actually been implemented, and implementation times can vary significantly from company to company.
These differences complicate comparisons to prior years, and if you confused CARR for ARR, the result would seem better than it really is. The change appears to have been made at around the time the Devo deal was signed.
Q4 FY24 Business Growth Update
Prophecy’s (ASX: PRO) Devo Contract
The Devo partnership offers Prophecy a significant growth opportunity with minimal selling effort.
By integrating Snare into Devo’s existing software agreements, Prophecy bypasses traditional sales cycles, accelerating customer adoption and revenue generation. Access to Snare is now bundled with all new and existing Devo subscriptions, streamlining the process for customers.
Prophecy expects to add $1 million in ARR by mid-2024 through this partnership, with the potential for over $5 million in ARR once all of Devo’s customers are migrated to Snare by the end of FY25 with most of this revenue anticipated to materialise in FY25.
Prophecy’s (ASX: PRO) Market and Share Price Performance
After Prophecy’s share price temporarily breached $1 it has seen a slippery slope back towards the $0.60 range.
At a $0.65 price the market cap is around $48 million. With a CARR of $28.4 million this puts the stock on about 1.7 times its CARR. It’s not the greatest valuation metric, especially while the company continues to lose money.
If, and it’s a big if, Prophecy can show that the larger expense increases in FY 2024 are not going to be repeated, and the business becomes profitable, it could appear cheap when compared to other profitable tech stocks on the ASX. For example, 10% profit margins, with 5% revenue growth would put the company on a P/E ratio of around 20.
However, Prophecy International has made losses every single year since FY 2018, the first full year under the leadership of the current CEO, Brad Thomas. So you have to believe “this time is different” to believe Prophecy will be profitable in FY 2025.
One of the initial points in my Prophecy thesis was that the company was approaching an inflection point.
As we’ve seen, costs continue to grow, and revenue slowed in the second half. It’s beginning to really test this. At this stage I believe there should be more signs of scale, rather than going the other way. While we should begin to see revenue pick up in FY25 from the Devo contract I’m concerned that this won’t translate into profit and scale.
Ultimately when I published my original article on Prophecy in October 2023, the share price was around 60c, the company reported the higher quality ARR metric, not the lower quality CARR metric, and I believed the company was likely at a free cash flow and EBITDA inflection point.
Unfortunately, the Prophecy International (ASX: PRO) FY 2024 results disproved this thesis and broke it. Fortunately, the share price at the time of writing is 70c. A gain of almost 17% is not a bad result for being wrong. Therefore, I would rate Prophecy shares a Sell.
However, I will continue holding my shares for at least a little longer after the publication of this article, in order to consider my position, and because the company may provide more information, around its ability to scale. I am not promising to sell my shares, but currently that is my inclination.
If an investor call is announced (nothing scheduled, at the time of writing), we might get some positive information around the increased expenditure and whether this may just be temporary. Alternately, I could look to exit and move into more appealing opportunities.
Only time will tell as to whether Prophecy can truly scale or is another ‘gonna’ company, but my original thesis is wrong.
Disclosure: The author of this article Nick Maxwell does own shares in PRO. The editor Claude Walker does not own shares in PRO. Neither will trade PRO shares for at least 2 days following the publication
on of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
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