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Date : 11/11/2021

Family Zone Cyber Safety

ASX :

FZO

Market Cap : $421.75 Million

Buy

52 Week Range : $0.395 - $0.850

Share Price : $0.605

A high growth firm with a fantastic operational and financial metrics. A Buy from us

Company Analysis

We all know how important cybersecurity is, especially when it comes to protecting children on the internet. This is the problem Family Zone is solving with their products. FZO is an emerging leader in the fast growing global cyber safety industry. We recommended Family Zone Cyber Safety (ASX: FZO) at a price of $0.605 back in June 2021. Since then, the company has performed exceptionally well operationally, and the share price moved in a very positive direction – setting an all-time high of $0.85 in September. Since then, despite FZO not putting a foot wrong, the share price has come under pressure. We are of the opinion that FZO has bottomed, and the only forward is up. Currently, FZO trades at the same price level as our earlier recommendation.

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Source: Tradingview.com

Family Zone’s unique innovation is its patented cyber safety ecosystem, a platform enabling a world-first collaboration between schools, parents, and cyber safety educators. Family Zone’s unique approach is delivering rapid growth in the education sector, as well as through direct sales and scalable reseller arrangements with telco providers.

It’s a very unique product. Family Zone’s platform is a cloud-based parental control platform, which incorporates networking and application technologies, which allow parental controls to be embedded within Home, enterprise, public, and telecommunications carrier networks and installed on mobile devices. This platform allows users to block porn and adult content; restrict access to social networks; set access and sleep times; limit application downloads and in-application purchases; restrict access to mobile games, applications and restrict YouTube content.

FZO has a terrific and very interesting business model. We like the fact that their ecosystem is completely integrated, and that it generates circular and recurring revenue. The business model consists of two key channels, the (1) direct consumer business (B2C) and the education business which comprises B2B and B2B2C (Fig.1). The education business segment is the most promising one. It provides to Family Zone multiple revenue streams including (1) School compliance, (2) school community, and (3) premium parental controls. These services are unique and there is no alternative at the moment that can provide such a level of service and integration as Family Zone.

FY2021 was Very Positive

One of the most recognisable flow-on consequences of the COVID-19 pandemic has been the great acceleration in how much of all our work, education and social lives are carried out online. There is no doubt that the role technology played in allowing large sections of the economy to continue, and society to remain connected, through the public health measures offers a case study on the value of digitisation and the internet. However, the resultant accelerated adoption brought to light for regulators, schools, and parents the challenges of online safety.

In the year ended 30 June 2021 the Group passed several milestones as part of its growth and operational objectives, including:

  • Revenue from ordinary activities grew 76.1% to $8.96 million.
  • Revenue from the important US education market grew 266% delivering $4.94 million.
  • Innovative classroom management technology provider NetRef was acquired.
  • Completing migration of the Company’s education platforms to Google Cloud materially improving platform performance and operating leverage.

Family Zone experienced a period of rapid growth in FY21, underlined by the Group’s success in the strategically significant US market. Early in the financial year the Group surpassed the 1 million student license milestone. By December this had reached 1.5 million students and by year-end it had doubled in licensed students again, reaching 3 million on the platform and servicing in excess of 5% of US school districts. By the end of the year 5,600 schools across the US, Australia and New Zealand had engaged Family Zone to access their cyber safety products and services.

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Revenue has grown in line with sales successes reaching $8.96 million for the financial year, an increase of 76%. The growth in revenue was driven by the US education business with sales being approximately $4.94 million, representing an increase of 266% from the prior year. The Company continued to invest in expanding the scale of its Platform to support the increasing number of users and scale of opportunities presented in the US education market as well as the development of new products and features.

US sales revenue surpassed the Australian business in the period for the first time. Growth in the US education market delivered sales of approximately $4.94 million, which marked a rapid increase of 2.6 times on FY20.

Family Zone’s continued investment in R&D activities during the year, resulted in the Group accruing government R&D grant income of approximately $3.45 million at year end. During the year the Group undertook a project to move its data and hosting from Amazon Web Services to Google Cloud Platform (GCP) which resulted in increased significant direct costs whilst these platforms were being run in parallel.

Since the migration to GCP was completed in March 2021 however there has been a significant decrease in these data and hosting costs on a per student basis. Employee benefits was a key expenditure item for the financial year being approximately $18.1 million. As a technology business, employee wages and salary are a key business cost. During the year the Group significantly expanded its team increasing to have approximately 180 employees on 30 June 2021, with key growth in the engineering, product development and sales teams.

Non-cash share-based payments to advisors, employees and consultants during the period were approximately $1.90 million. These equity incentives are designed to ensure employee interests were closely aligned with the achievement of the Group’s operational and financial targets and also to reduce cash payments as part of the Group’s commitment to reduce cash overheads. Another significant non-cash expenditure item was the depreciation and amortisation charge for the financial year of approximately $2.61 million.

The Group reported a net loss attributable to members for the period of approximately $21.98 million.

Company Updates

Cloud services migration

During the period Family Zone migrated its cloud services from Amazon Web Services (AWS) to Google Cloud
Platform (GCP). This was a major project because of the nature of our business and the extent to which it is conducted digitally. We rely on our cloud services partner to ensure the continuity and integrity of the products and services that we provide to customers in the public sector, as well as to parents as consumers. The investment will deliver a long-term reduction in our direct costs and a sustainable competitive advantage.

M&A and Funding Activities

The Group raised approximately $48.7 million through the sale of new shares in the period. The equity funding was to support organic and acquisitive growth opportunities. Technology and operations growth funding. During the year the Group raised $20 million from sophisticated and institutional investors through a share placement of 45.45 million new fully paid, ordinary shares at an issue price of $0.44 per share.

An accompanying share purchase plan was opened to all shareholders, raising a further $2 million. Funds raised were allocated to support the acceleration of growth in existing and new markets, focusing on the development of technology as well as our sales organisation. The uses of funds included expanding the Group’s engineering teams and investing in operational systems.

NetRef Acquisition

In June, Family Zone announced that it had agreed to purchase US classroom management technology provider NetRef from Verite Educational Services, LLC (Verite), a US-based boutique provider of custom software solutions operating across the education, government, and private sectors. The acquisition formed part of the Group’s strategic focus on the significant US market. Verite was a relatively new entrant into the US K-12 online safety market with its innovative NetRef cloud managed classroom tool. In less than 12 months Verite had grown impressively to support in excess of 250,000 students.

The acquisition of NetRef provided Family Zone with access to a premium classroom management tool; access to engineering expertise in technology domains key to the Company’s success; and additional experienced sales and support personnel. Total consideration paid and payable for the acquisition was approximately $5.97 million (US$4.48 million).

The NetRef business contributed to $nil profit or loss to the Group for the year ended 30 June 2021. To assist with acquisition funding and to support the continued growth of the Group, especially in the US, $23 million in equity was raised from institutional, professional, and sophisticated investors. The 42.99 million new fully-paid ordinary shares were issued on 1 July 2021 at a price of $0.535 per share.

Smoothwall acquisition and capital raise

Subsequent to year end, Family Zone announced that it had entered a transformative agreement to acquire
Smoothwall, UK’s leading K-12 digital safety solutions provider. Smoothwall’s market-leading “Monitor” product is a key driver of growth and services the rapidly growing market for educational data, analytics, and monitoring. The UK market opportunity for the product is significant following regulatory mandates in the jurisdiction, with the offering also significant to the Group’s growth potential in the US.

To support the funding requirement, Family Zone completed a capital raising of $146.64 million, consisting of an entitlement offer and placements to sophisticated and institutional investors, as well as a retail entitlement offer. A shortfall of approximately 14.1 million new Shares ($7.8 million) in the retail entitlement offer was allocated to the joint lead managers and underwriters in accordance with the terms of the Underwriting Agreement.

Shaw and Partners Limited and Euroz Hartleys Limited acted as joint lead managers and underwriters to the Equity Raising. Argonaut Limited acted as Co-Manager. Transaction costs paid in connection with the Equity Raising were approximately $7.1 million.

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Source: FZO

The acquisition of Smoothwall creates the world’s most compelling K-12 digital safety solution incorporating Family Zone’s fast growing Linewize K-12 solutions, Family Zone’s parental controls and Smoothwall’s scale and world leading solutions.

Executive Appointment

Todd Morcombe was appointed chief financial officer (CFO) and commenced in the role on 17 May 2021. Morcombe brings valuable experience to the executive team, including previous roles as CFO of private investment companies Wyllie Group and Cape Bouvard Investments and CFO of ASX-listed Little World Beverages. He is a member of the Australian Society of Certified Practicing Accountants and has a Graduate Diploma in Applied Finance and Investment Securities from FINSIA.

Industry Analysis

According to the Australian Cyber Security Centre (ACSC), an average of 164 cybercrime reports are made by Australians every day. Between 1 July 2019 and 30 June 2020, the ACSC responded to 2,266 cybersecurity incidents and received 59,806 cybercrime reports. It’s not too far-fetched to think that the reports in FY21 will surpass the numbers from last year.

The dire need for cybersecurity keeps increasing as we move towards a complete digital economy. It’s not just the good guys moving their businesses online, it’s the bad guys as well. In a digitising economy, cyber security is an essential economic enabler that mitigates threats and builds trust. The scale of the cybersecurity problem is immense, costing as much as US$5 trillion every year, globally. In Australia, the government says cybersecurity incidents cost Australian businesses up to $29 billion per year. While most cyber attacks still do not make the news, there have been plenty of ransomware attacks on Australian businesses in the recent past.

While much of Australia’s digital infrastructure is owned by the private sector, cyber security is a shared responsibility between governments, the private sector and individuals.

Our government has been implementing their cybersecurity strategy and building domestic capability to not just react to attacks, but to prevent them as well. Cybersecurity was even part of the Federal Budget for FY 20-21, wherein the Government provided an additional budget of $201.5 million to deliver the 2020 Cyber Security Strategy (in addition to the already sanctioned $230 million).

The Government also committed $300 million to the Australian Federal Police to strengthen their capacity to keep Australians safe in an increasingly complex threat environment. Finally, to wrap up the strategy, $37.7 million is being invested in expanding Australia’s cybersecurity skills for an industry that adds ~ 20,000 jobs to the economy.

This has been a full blown plan that entails cybersecurity infrastructure that is capable of responding to and preventing attacks. The odds of further policy that positively impacts the industry is extremely high given the increase in attacks and the need for cybersecurity.

Policy is one thing, however, what is the real state of the industry from a business and investment point-of-view? The cybersecurity sector is flourishing in Australia: growth is strong, a vibrant cohort of young cyber security technology and service providers has emerged, and the workforce is expanding.

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Demand is growing, with Australians spending approximately $5.6 billion on cybersecurity in 2020 – from both local and international providers – a figure that is expected to increase to $7.6 billion by 2024. The local sector’s revenue has grown by $800 million since 2017, to reach an estimated $3.6 billion this year.

These gains have been made very quickly. Sector revenue grew by an average of 8% each year between 2017 and 2020. As the cyber threat landscape continues to evolve, sector revenue is forecasted to continue growing at about 9% each year over the next four years.

GVA (gross value added) is a measure of economic activity and can be used to estimate the contribution of the cyber security sector. Research shows that the GVA of cybersecurity is about $2.3 billion as of 2020, already comparable to other digital sectors such as computer software ($4.2 billion) and retail e-commerce ($3.2 billion).

Family Zone’s expansion into the U.S. market is well-timed as well with the recently imposed U.S. regulatory requirements to safety and cyber education. In March this year, the U.S. Congress passed a US$ 3.25 trillion coronavirus stimulus package which included US$ 21.96 billion directed for school technology to support online learning. The funding will be allocated to school districts to provide internet connectivity and internet-connected devices for students from kindergarten to year twelve. The announcement is great news for Family Zone which saw a massive injection of capital into areas key to the growth of its business.

Investment Thesis

FZO has started FY22 very positively. In fact, it has picked up right where it left off in FY2021. The highlights of the quarter were as follows:

  • Completed the acquisition of Smoothwall on 16 August 2021
  • Integration ahead of schedule with realignment and cross sells underway
  • Grew Annual Recurring Revenue by ~$2.5 million toAUD$46 million
  • Collected$10.7 million from customers
  • Ended the quarter servicing9.78 million students across the Group
  • Ended the quarter servicing 19,278 schools across the Group
  • Now service in excess of 9.5% of US school districtsand38% of the UK schools
  • Signed a record of$5.9 million annual value of contracts

The Company’s sales growth in North America continued to exceed internal forecasts with net additions of 340,000 students and 331,000 contracted students in the quarter. The Company successfully completed the acquisition of Smoothwall in the quarter which similarly had a stronger than forecast period, particularly in the UK. Smoothwall ended the quarter with 6.5million students resulting in the Group supporting 9.78 million students and 19,278 schools. The Company now supports more than 9.5% of USA school districts and 38% of UK schools.

The Company has a target of the end of the calendar year to have the following integration efforts completed:

  • OneCompany: A series of initiatives to develop a singular mission, corporate strategy, product vision, brand, and employment values.
  • Collaboration: A series of initiatives focussed on ensuring the global organisation, of approximately 365 team members, are able to effectively collaborate and communicate.
  • WinningTeams: A series of initiatives focussed on delivering real and immediate value to the Company. These have included the cross selling of Smoothwall products into Family Zone’s US business plus process & back-end system changes and training programs.

Pleasingly, the integration work is ahead of schedule and is assisting both the Smoothwall and Linewize businesses to continue to exceed sales targets. Noteworthy is the launch of Smoothwall Monitor into Family Zone’sUS (Linewize) business. As of September 30, this had already resulted in $200,000 worth of contracts with a pipeline in excess of $1 million established. Work has commenced on cross-selling Family Zone’s classroom and other products into the UK with technical and general data protection regulation (GDPR) reviews now well underway. This represents a significant future revenue opportunity cross-selling into Smoothwall’s 10,500+ UK schools and positioning these offerings to all new prospects.

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The Company continues to achieve significant growth in both total and annual value of contracts. On the Linewize side, contracts with a total value of $5.56 million (42% YoY growth) and an annual value of $3.4 million (44% YoY growth) were signed. Across Linewize and Smoothwall contracts with an annual value of $5.93 million were signed in the quarter.

With the acquisition of Smoothwall and strong September quarter sales, the Company’s Annual Recurring Revenue continues to grow strongly adding net ~AU$2.5 million in the quarter. This result was pleasing given the disruption of the Smoothwall transaction/merger and the limited time available for cross sells to impact the result.

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In line with record sales in prior quarters Linewize customer collections achieved an all-time record of $6.4 million (43% YoY growth). Across the Group, $10.7 million was collected, including Smoothwall collections from 17 August 2021. It is noted that debtors at September 30 across the Group totaled $7.9 million and a significant R&D refund is anticipated.

Operating Leverage Improves

Through ongoing work on consolidating services and with the scale provided by the Smoothwall acquisition, data and hosting service costs have now dropped to circa $1.06 per student per year, well ahead of Company forecasts. This represents a 33% reduction in the quarter. Further reductions are anticipated as back-end services are consolidated and with future scale.

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During the quarter operating expenditure expanded with the acquisition of the Smoothwall business from 17 August 2021. Employee salaries and wages is the Company’s largest expenditure. Payments relating to employment including one off restructuring costs totalled $10.8 million for the quarter. The prior quarter equivalent costs were $3.5 million. The Group currently employs 325 FTEs, and this is forecast to grow modestly in the December quarter and for the rest of the financial year. Product manufacturing and operating expenditure (which includes data and hosting costs) for the quarter was $1.4 million. Whilst this expenditure increased with the inclusion of Smoothwall the cost per student decreased benefiting from the increased business scale as outlined above.

Outlook

The Company’s sales outlook is strong on a year on year basis, noting that the December quarter being a slower quarter in the annual sales cycles in the US and UK. Student’s in proof of concept trials on 30 September 2021 was a record 605,177. In addition to existing pipelines, the Company is working hard on integrating products and cross selling Smoothwall and Linewize products into each customer base. Exciting progress is being made with the launch of Monitor in the US with a pipeline exceeding $1 million. The launch of Linewize’s Classwize offering into the UK is planned for the March quarter 2022. The Company is also working towards launching their Community offerings into the UK next year.

FZO has made progress on its consumer launch into the US. The Company has launched its B2B2C consumer product into US school districts. The response from districts has been very encouraging with more than 110 districts (up from 18 last quarter) in the launch pipeline. As of 30 September, 92 districts, or 16% of FZO’s US clients had launched a Family Zone cyber safety (parent) hub. It is important to highlight that FZO is taking a deliberate staged approach to rolling out this important program considering the technical, privacy and relationship dynamics.

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We expect FY2022 to be the year where FZO’s revenues skyrocket. We expect it to go from about $9 million in FY21 to about $40 million. This growth will be fuelled by the robust market penetration in the USA. Further acquisitions may also be on the cards during this year as FZO is highly likely to keep its customer growth momentum going.

Gross profit margins have increased in FY2021. It stands at 69% and our estimates suggest that it will keep improving as the company scales.

Operating costs are decreasing and with recurring revenue expected to increase, we expect FZO to turn profitable in FY24. The road to profitability can however be seen throughout the next couple of years. We are confident that we will witness FZO consistently increasing its EBITDA and finally turn in a positive figure in FY24.

Considering the growth that lays ahead, FZO trades at relatively modest multiples. The P/E multiple is extremely misleading in this case as the company will be turning earnings positive for the first time. However, the EV/EBITDA and EV/Revenue multiples are based on the firm’s enterprise value and offer a more realistic rationale. FY24 EV/Revenue multiple of under 5x is a very lucrative value proposition given that FZO has been growing at a CAGR of 75% since IPO and continues to grow its revenues at high growth rates.

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Our initial report on FZO can be viewed by clicking here.

Technical Analysis

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Trend

Family Zone has been in a free fall since October 2017 after reaching an all-time high. FZO went down for two years in a row hitting its all-time low during the peak of the COVID-19 global market sell-off during March 2020. Since then, FZO impressively recovered by more than 860% from it’s all-time lows at 6.5 cents per share back to above the 50 cents key level. The chart is looking quite bullish on the weekly time frame despite the recent September’s correction. The pullback from September high could be a terrific opportunity to buy some FZO shares at a 28% discount. Furthermore, we have observed a tremendous volume of inflows around 65 cents which is, by the way, the near-term resistance, and the strategic range between the 50% and 61.8% Fibonacci retracement level of the last swing high.

FZO is currently sitting at a strategic support price range of 55 – 60 cents. The RSI (14) on the daily timeframe suggests an imminent rebound from this level as the oscillator is pointing up from its recent oversold territory. This could be a great opportunity to build a mid to long-term buy position.

Volume and momentum

Volume slightly decreases since the last 200-day with the 20-day volume average down by -10.5%. The price action remains neutral in the near term, evolving in a range between 55 cents and 65 cents per share.

Trade consideration

  • Market participants might be interested to enter at key support levels: 50 cents and 60 cents per share.
  • Primary target price above 81.5 cents per share.
  • Consider reducing exposure below 45 cents per share.
  • It is recommended exiting the trade below 40 cents per share

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Recommendation

Family Zone Cyber Safety has a very unique product offering that has been well received by the market. The company has grown its revenues by a CAGR of 75% since IPO and operationally, FZO has consistently grown its customers and annual recurring revenue. Importantly, with scale, FZO has also managed to decrease its customer acquisition costs. Additionally, FZO has not been shy of M&As to grow their firm, with two significant acquisitions in the recent past. All financial and operational metrics point towards a very promising future for FZO and with the recent fall in share price, we are of the opinion that this is an opportunity. We thus recommend to “Buy” FZO.

 

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