Since I recommended Gatekeeper Systems (OTCPK:GKPRF) (TSXV:GSI:CA) to Seeking Alpha readers (and bought shares myself) in June, shares have dropped 20%. I’m writing with a brief update on why they’ve fallen. The company reported slower revenue growth and swung to a loss in fiscal Q3. But as I’ll argue below, this represents lumpiness in business results and should not distract from the medium-term prospects of the business.
Initial Thesis
Gatekeeper Systems is a Canadian microcap selling video surveillance hardware and accompany software, primarily to municipal governments, for school buses and trains. Their tag line is “protecting people in transit.” Both of these markets have seen growth in recent years. School bus surveillance has grown due to bullying, sexual harassment, and other problems among schoolchildren (and problems around buses, such as stop-arm violations).
There are similar dynamics at play in trains, where the federal government is now mandating video surveillance by 2027. Owner-operator Doug Dyment owns 10% of Gatekeeper and has been a pioneer in this space since the 1990s. Since he took Gatekeeper public a decade ago, revenue has grown at a 21% CAGR and operating leverage has translated this into growth into bottom-line profitability.
The company only achieved consistent profitability in the last two years, and I believe that they are primed for an inflection point where revenue growth at historical rates drives outsized earnings growth in the next two years. In current slang, Gatekeeper is at an inflection point.
Q3 Results
Q3 results disappointed the market, largely explaining the 20% decline. Revenue was only up 9% YOY, and the company reported a $0.5m loss. If growth were permanently slowing and the company was going to start posting losses again, I agree that this drop would be justified.
But first, Q1-Q3 revenue is still up 27% YOY. In a business of this size, we should expect results to be lumpy. It was probably irrational for the market to have gotten so excited over blow-out numbers last quarter, and it is probably irrational for the market to get so scared about slower growth this quarter. Contract wins are lumpy, and so is revenue growth. This drop-off in growth can also be explained by the same reason that costs rose in the quarter, driving the company into loss:
We have ramped up our sales and marketing expenses by approximately 50% and during this calendar year we will be presenting our solution suite at approximately 50 industry trade shows throughout North America. We have launched several new products and established a data center for our AI-based video analytics hosted service offerings.
In other words, the company spent Q3 building out their data center, hiring new sales staff, and preparing for a massive sales push in the next ~6 months. This is only bad news if you are very, very short-term oriented. Looking out over the next 12 months, I see no other reason that Gatekeeper should not stay on track for the growth targets I laid out in my initial article, which offered a two-year price target of $1. With a lower entry point, the risk-reward has only become more attractive.
Solvency & Risk
As a microcap, Gatekeeper’s share price movements are fairly extreme, and there are additional risks. Shares are fairly illiquid, and so investors need to consider their exposure accordingly. As for the ultimate risk of insolvency, it seems in this case relatively low, since Gatekeeper has $6.8 million in cash vs. $0.8 million. While results have been somewhat lumpy, the company has also generated positive free cash flow for most of the quarters since Q1 2023.
Given Dyment’s investment in the business and Gatekeeper’s solid balance sheet, the risk of bankruptcy seems very low to me here. The more substantive set of risks are of course with execution. It remains unclear exactly how robust Gatekeeper’s sales pipeline really is, and to what extent they will be able to win competitive bids for contracts.
While I am encouraged that the company has made substantial investments in future growth over the last two years, it remains to be seen whether this growth will return to levels seen earlier this year. If this quarter is indicative of a more lasting slowdown, shares might go nowhere for some time.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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