AEYE operating on fumes

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I am just looking at the 2014 Q1 10Q. The company’s cash position was down to just under $500K from $1.85M just 3 months prior. Also, their receivables just about matched their payables. There is great financial risk with this company. They need working capital to operate and they will need lots of capital to grow their business. We should expect another equity raise soon. Let’s hope they can raise the money. I think they probably preannounced that they expect to beat the $8M revenue target in order to help with the next financing round.

Chris

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Chris, with only a 4% cost for $3 million in sales, they took in roughly $2.88 million in gross margin in the second quarter. That’s way more than their operating expenses and they will be quite cash flow positive. Hard to see the need for a secondary. You are basing on last quarter revenue which was only a third of this quarter’s. And revenue should just go up from here.

Just my opinion and I could be all wrong.

Saul

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Hi Chris,

I don’t understand why they need lots of capital to grow the business.

Just trying to understand the business model.

Thanks,Iain

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Chris, with only a 4% cost for $3 million in sales, they took in roughly $2.88 million in gross margin in the second quarter. That’s way more than their operating expenses and they will be quite cash flow positive. Hard to see the need for a secondary. You are basing on last quarter revenue which was only a third of this quarter’s. And revenue should just go up from here.

Saul,

I have to partial agree and partial disagree. Yes, they are rapid growing revenue and they do have recurring revenue. This should add to the cash balance. This is the part I agree with and it’s a great problem to have because it validates the business case and helps to attract new investors.

However…

Every company needs working capital in order to operate. $500,000 is almost nothing. There are always timing differences between receivables and payables. Just look at what happened to AR from the end of Q4 2013 to the end of Q1 2014! Despite growing sales at 10x over the prior year, the company burned through the majority of their cash in just one quarter. And working capital requirements grow as the company gets larger. Also, the company only had 18 full time employees as of 12/31/2013. And 1/3 of them were executives…their salaries allow will cost $1.2M. They will need to hire more people, invest in technology, prosecute more patents, etc., etc. The growth they are experiencing requires investment and capital. I’m sorry but $500K in the bank just isn’t going to cut it. In the past the company got away with deferring salaries and paying for services with stock. We want to see them getting away from this practice and funding growth with cashflow generation. However, when you have almost no cash you just can’t do it. My guess is that the company will raise another round this year. Hopefully, the stock will get a boost and they can raise at a decent valuation.

Chris

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It will be interesting to see what the cash position is after this quarter. One would think it would be better than 3 months ago. The “non-cash stock compensation” expense does not hit cash. Assuming they do another quarterly conference call the cash position would be a logical question/talking point. It really comes down to how they can manage cash flow during the second half of the year.

Part of the answer to this is also how much of the revenue goes to accounts receivable. This number growing too rapidly, may indicate phantom (or uncollectable) income. It will grow, but bears watching.

Hopefully we can get answers on their conference call.

Z-Bar

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Part of the answer to this is also how much of the revenue goes to accounts receivable. This number growing too rapidly, may indicate phantom (or uncollectable) income. It will grow, but bears watching…

As long as revenue is growing fast then the AR will also grow along with it. Especially if they tend to close more sales in the last month of the quarter which is often the case. I would worry a lot more if the AR increases but sales are flat.

That said, it looks like they have to be careful to manage their cash as any issue to collect that AR could cause them pressure on payroll or other expenses. It would be nice to have a bit more buffer

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Every company needs working capital in order to operate. $500,000 is almost nothing.

Chris,

That’s a straw man you put up to knock down. Their revenue this quarter (June) was $3.0 million. Their gross margin the first quarter was 96%. It should be higher this quarter with so much more revenue, but just for the sake of argument, let’s say it dropped, for some bizarre reason, to 92%. That means that $2.76 million dropped down to operations.

Now let’s look at their cash operating expenses last quarter.

Selling and Marketing costs were $495,000.
R&D costs were $130,000.
Cash G&A costs were $860,000.
Total Cash expenses were $1.485 million in the first quarter.

Say these operating expenses increased 20% sequentially this quarter (which is a lot but certainly possible). That would come to $1.782 in operating expenses, and give them a million dollars in Cash from Operations!!! In one quarter. And give them a 33% Operating Margin!

We can argue about the 20% rise in expenses and whether it should be 25% or 30%, but none of that would change the results in any significant way. And since revenue has been increasing sequentially by leaps and bounds, it should only go up from here. Very hard for me to see how they are “operating on fumes”.

Best

Saul

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a million dollars in Cash from Operations!!!

Not exactly. You are assuming that all orders are converted to cash. Last quarter they were not as their AR went up. When the plane is almost scrapping the tree line with almost no fuel, the most important thing is getting that fuel in the tank. I don’t dispute that revenue is growing extremely fast. However, at this stage revenue is less important than cash in the bank. Q2 is now done but not yet reported. Let’s hope that they collected those ARs from Q1 and are already collecting ARs from Q2. With this company, we can’t just watch revenues (i.e. orders); we must watch the balance sheet and statement of cash flows very closely. The Q2 report will be pivotal.

I also invest in start-up companies and financing risk is one of the biggest risks. Financing risk is the risk that the company runs out of money before it can either 1) generating its own, or 2) before it can raise more.

AEYE clearly has a MUCH, MUCH higher financing risk that the typical company discussed on this board. I am posting this because people who are not used to investing in tiny company might overlook this very real risk. The management team’s ability to raise capital is more important with AEYE than with probably any other company in Saul’s portfolio. The last round was financed by a group of accredited investors (an accredited investor is someone who has $1M in net worth excluding their primary residence OR earns more than $200K in annual income) who may or may not be willing (or able, perhaps due to limited resources) to invest again. Thus, the CEO’s (or someone else on the team) ability to sell himself and the company to current and future investor could make the difference between success and failure.

Now, with that said, I did put some money into AEYE. But until I see that their cash balance begins to increase, I am reluctant to put in more.

Chris

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Very hard for me to see how they are “operating on fumes”.

Hi Saul et al,

In my post upstream, #2532, I neglected to encase the first 2 paragraphs in italics so maybe everyone missed it. Those 2 paragraphs were taken from the most recent 10Q and clearly state:

In view of our working capital position, continuing operating losses and limited cash, we will be required to raise additional capital
through the sale of equity or debt securities or borrowings from financial institutions or third parties or a combination of the foregoing to
continue to fund operations.

So they suggest they will be diluting or borrowing or something to increase their cash. I want to speculate that when they wrote the above paragraph, they had not landed the AZ school contract (His brother may have helped him there) which might possibly explain the surge in revenue.

Interesting company.

My other question was how the CEO went from a marketing student to CEO and inventor. I’m not saying that’s not possible, only that somebody like Robert Pera’s rise doesn’t surprise me, but this one does. (Just looking for come color.) Probably a great Horatio Alger story here.

Mykie
PS Saul, you’re right, he has no inventing degree or for that matter any other type of degree.

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Very hard for me to see how they are “operating on fumes”.

They are in a tenuous position.
Net income is negative and a bigger loss than in Q1 2013.
That doesn’t mean the end is near because a lot of operating expense can be non- cash and what looks disastrous may not be. In the case of audio eye its semi-disastrous

Look at the cash flow statement and you will be able to tell what kept them afloat in the most recent quarter

even after adding back all those non -cash expenses that made net income negative, cash generated from operations is negative. In fact it’s $1.3 million in the red compared to $65K last year.

When you don’t have any cash from operations, then you are forced to find the money to stay in business somewhere. Common places to beg for cash are banks for notes or term loans or you go to the market and sell some shares hoping you pick a point where the share price is high.

At the end of 2013, they issued $3.2 million in shares seriously diluting shareholders but raised the cash and repaid some debt with shares. They ended up with $1.8 million.

fast forward to Q1 2014

Again they had negative net income and negative cash from operations. So how did they pay for the quarter? Cash flow was a negative $1.3 million. part of the problem was a very large increase in receivables meaning the inventory was sent to customers but there were lagging payments and that costs the company in working capital.

They paid for it with the cash raised from selling shares in 2013. Cash is now down to $493,000 which doesn’t look like enough to pay for things as long as CFFO is negative. I think they are going to have to either issue shares of take on debt unless revenue starts to outpace expenses by a bunch.

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They are in a tenuous position. Net income (in Q1 2014) is negative and a bigger loss than in Q1 2013.

Hi Monster Fluff,

I hope that this will be my last post on this subject so I’ll try to be comprehensive. First of all, I may be wrong and you may be right. I’m just writing about the way it seems to me.

Let’s get started. I think that you and Chris are anchoring on the past, while I am talking about the present and the future. You are basing all your worries on their results from the last quarter. It seems to me that that is like basing conclusions TODAY, when considering some other slower growing normal company, on what their results were, say, four years ago when their revenues were a third of what they are now. And then saying that the company is in trouble NOW because of what their revenues and earnings were four years ago. It would totally ignore what has happened in the past four years while they tripled their revenues.

Now AEYE has tripled their revenues in one quarter, instead of four years, moving revenues from $1 million to $3 million, but that doest change my argument. Basing your analysis on what their results were back when they only had $1 million in revenue, is just as inappropriate. (By the way, I wouldn’t have bought with the same enthusiasm, if at all, when they only had $1 million in quarterly revenue and were losing money. Three million in revenue for a quarter, and becoming profitable, changes everything).

Next point, Of course they had negative operating margin in the first quarter. That’s what a negative net income means by definition. They were just a start-up then. But you (and Chris) are ignoring that the company said they were “PROFITABLE” (my caps) in the June quarter. Not adjusted earnings profitable. Just plain profitable! That means cash flow positive. It means they probably may not need to raise money at all. They may do it anyway, to raise a cushion, but they won’t NEED to, and that makes all the difference

Then the issue of rising receivables. You guys seem to feel they won’t be able to collect them. But wait a minute. Who are their customers? They aren’t selling to Joe Blow in the general public. Their customers are hospital groups, school districts, corporations, government agencies, and the like. They may not pay in 15 days by return mail, but what in the world makes you think that customers like this won’t pay their bills?

Next, companies with high cost of goods sold (COGS), and thus low gross margins, can triple their revenue and still burn cash. That’s what I pointed out about WPRT back two years ago when they had a 25% gross margin. They could quadruple their revenue and still not break even, because only a quarter of that revenue dropped down to the operating margin level. But AEYE has a 94% gross margin. When they triple their revenue, basically it all drops down.

WPRT also had $30 million or so (just guessing) in quarterly cash operating expenses. Tripling their revenue still wouldn’t cover their operating expenses. AEYE had just $1.5 million in operating expenses last quarter. This quarter they have $3.0 million in revenue, with negligible cost of goods sold, so almost all of that $3.0 million can cover their operating expenses. How can you even dream that they will be burning cash? Or that their situation is “tenuous” and “semi-disastrous”? I mean, really???

You are analyzing them based on their revenue when it was a third of what it is now, like analyzing a normal slow growing company on the basis of what their revenue was four years ago.

I’m not saying that AEYE is a shoo-in for a success. As I pointed out, a lot of their plans and hopes are still that, just plans and hopes. But, to analyze them as if they are in danger of going bust just seems silly to me. Sorry, just my opinion.

Saul

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Saul,

I think a few comments have been misinterpreted. The main reason for me posting warnings is that this company was operating so close to running out of cash (as of March 31, 2014). I don’t know if that was the cash low point or if it dropped lower in April or May. What is the cash balance now? I simply don’t know because the numbers are not yet available because they haven’t reported the June quarter yet. And now we’re almost 1/3 of the Sept quarter.

Next point, Of course they had negative operating margin in the first quarter. That’s what a negative net income means by definition. They were just a start-up then. But you (and Chris) are ignoring that the company said they were “PROFITABLE” (my caps) in the June quarter. Not adjusted earnings profitable. Just plain profitable! That means cash flow positive.

Profitable does not at all mean cash flow positive. A company can be profitable and still be cash flow negative. We know that AEYE has announced that they were profitable in Q2. Were they cashflow positive? We don’t know that yet from the information that was provided. When a company is so close to running out of cash, one would be very wise to keep an eagle on the cash. The earnings announcements usually won’t tell you what’s going on so you have to look in the 10K or 10Q. The Balance Sheet will tell you the cash balance at they end of the period (it is just a snapshot of a single point in time). The Income Statement and Statement of Cashflows are the two documents that tell you what happened during the reported period. To reiterate, a company can be profitable and cashflow negative at the same time. This is because there are other items (besides revenue, COGS, and OpEx) that can affect cash. An important one also is that revenue does not mean cash in the door. A company receives and order and delivers the product or service. Usually, revenue is recognized when the product or service is shipped. But the company must then send an invoice to the customer and then the customer has a certain period of time to pay. It is common to give a customer 30 days (called net30), but sometimes customers have longer like net60 or net90. I could not find anywhere what AudioEye is giving its customers. Normally, for the stocks I own, I do not pay much attention to cash because the companies that I usually invest in have enough working capital (working capital is the cash that is needed as a cushion for the timing differences between cash in and cash out; as a company grows in size, working capital needs also grow) and excess cash to make this a non-issue. For non-publicly traded companies that I have invested in, cash is much more important because they are less stable and can come close to running out of cash. Currently, AEYE is more like investing in a start-up than in a typical public company.

So again, my main point was that with AEYE we must pay very close attention to cash and the details thereof. Simply reading the earnings announcement and earnings call transcript is ok for companies like UBNT and SYNA but not advised for AEYE. One should really dig into the financial statements to understand the financial risk with this company.

Who are their customers? They aren’t selling to Joe Blow in the general public. Their customers are hospital groups, school districts, corporations, government agencies, and the like. They may not pay in 15 days by return mail, but what in the world makes you think that customers like this won’t pay their bills?

I would guess that their customers are reliable in paying their bills. They have targeted the federal government as their main targeted customer. However, until we see the AR details from Q2, we simply don’t know.

Next, companies with high cost of goods sold (COGS), and thus low gross margins, can triple their revenue and still burn cash. That’s what I pointed out about WPRT back two years ago when they had a 25% gross margin. They could quadruple their revenue and still not break even, because only a quarter of that revenue dropped down to the operating margin level. But AEYE has a 94% gross margin. When they triple their revenue, basically it all drops down.

If one assumes that revenue = cash in. That wasn’t true for Q1. What happened to cash in Q2? We don’t know yet. Remember, profit doesn’t mean cash because profit looks at revenue whether or not the cash actually came in.

WPRT also had $30 million or so (just guessing) in quarterly cash operating expenses. Tripling their revenue still wouldn’t cover their operating expenses. AEYE had just $1.5 million in operating expenses last quarter. This quarter they have $3.0 million in revenue, with negligible cost of goods sold, so almost all of that $3.0 million can cover their operating expenses. How can you even dream that they will be burning cash? Or that their situation is “tenuous” and “semi-disastrous”? I mean, really???

The whole point was that they had almost no cash. $3M in revenue does not mean cash in (sorry to belabor this but there may have been a misunderstanding of this point). A more minor point is we don’t know what else they spent on in Q2. Some of the executives did not get paid in 2013. What other expenses did they defer and what things did they not spend on that they would have if they would have had cash? They have a third rate accounting firm. Are they switching to another firm (which is a larger expense than their current one)? Do they need to make substantial investments in technology, equipment, etc to support their growing sales? Do we really understand how their business will scale? The point being there could be expenses to tripling revenue in one quarter. We won’t know until the Q2 financial statements come out. When a company is low on cash they cut back to conserve cash, then as cash comes in they spend on the things they needed but did without.

You are analyzing them based on their revenue when it was a third of what it is now, like analyzing a normal slow growing company on the basis of what their revenue was four years ago.

That’s not what I was looking at. I was looking at their cash.

I’m not saying that AEYE is a shoo-in for a success. As I pointed out, a lot of their plans and hopes are still that, just plans and hopes. But, to analyze them as if they are in danger of going bust just seems silly to me.

I don’t think they are in danger of going bust. I think, though, that they will raise more cash soon. I think their ability to raise cash should be high because they are growing so fast and investors will want to invest in that. However, I think further dilution is coming. Management is well aware of the cash situation. The founders deferred salaries in 2013 and got paid in stock in 2014.

I will become more comfortable when the Q2 financials come out and their cash balance increases over the $492K they had left on 3/31/2014.

I hope this post clarifies some of the financial risk (financial risk is defined as the risk that the company will be able to in the future have sufficient capital to fund its operation and its growth).

Chris

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I think a few comments have been misinterpreted. The main reason for me posting warnings is that this company was operating so close to running out of cash (as of March 31, 2014). I don’t know if that was the cash low point or if it dropped lower in April or May. What is the cash balance now? I simply don’t know because the numbers are not yet available because they haven’t reported the June quarter yet.

Thanks Chris, that post gave me a much better understanding of what you meant.

I realize that I was thinking about a company with stable revenue. For example, a company with roughly $100 million revenue every quarter takes in $100 million in payments every quarter, even if it takes 90 days on average for them to get paid. (For example, if it takes 3 months for them to get paid, they collect the $100 million in the June quarter that they billed in the March quarter, etc, assuming full collections for simplicity).

I see now that for a rapidly growing company like AEYE, it will be quite different. For the sake of discussion lets assume that their billed revenue for the first and second quarters of $1 million and $3 million was divided like this:

Jan — $200,000
Feb — $300,000
Mar — $500,000
Apr — $700,000
May — $1,000,000
Jun — $1,300,000

That gives them $1 million in the first quarter and $3 million in the second quarter and seems like a pretty logical progression, at least.

If their average collection time was 30 days (very optimistic), they would have collected Mar, Apr, and May billings in the June quarter, but not June billings. That would give them $2,200,000 in collections – which would well cover their operating expenses and leave some cash left over.

Note that, even with this very optimistic collection schedule, their receivables will rise by an enormous $800,000 ($3 million less $2,200,000), but that, with this kind of accelerating growth, this is TOTALLY normal, and doesn’t send up any red flags at all.

If their average collection time was 60 days (which seems more likely in dealing with large enterprises) they would have collected Feb, Mar, and Apr billings, but not May and June. That would give them $1,500,000 in collections – which would just cover their operating expenses, or not quite if they have grown, and they would use a little cash perhaps.

Note that, with this more normal collection schedule, their receivables will rise by an astounding $1,500,000 ($3 million less $1,500,000), but that this would still be TOTALLY normal and expected, and still doesn’t send up any red flags.

However, this would be the bottom of their cash crisis, and if they haven’t done a secondary or raised money in May, June, or July, why would they do it in August or September? A secondary dilutes them primarily, as they undoubtedly own most of the stock.

The reason I say it would be the bottom of the cash crisis is that (assuming 60 day average collections) in July they would collect May’s billing of $1,000,000 and they’d be out of the woods. Then in August they’d collect June’s $1,300,000, and in Sept they’d collect July’s, etc. Even assuming no sequential growth in July billing after the huge growth in the second quarter, they’d take in cash of $1.0, $1.3, and $1.3 million in the third quarter that we’re in now, for $3.6 million. At this point Cash will be rising no matter how you look at it.

The bigger question I see is whether June’s huge results were due to a single large sale that won’t be reproduced in the next quarter. Their pre-announcement press release didn’t even hint at a single huge sale, although they talked about $1.0 million in contracts with leading health care companies. Another question is how much of their revenue is recurrent. Do they have a model with a lot of cash up front, or a small amount up front and a monthly lease? (I wrote and asked them that question.) Perhaps we’ll find out more. In their press release they talked about a current annual run rate of $12 million, which certainly sounds as if the $3 million in the quarter wasn’t based on a one-time sale, and also implies that a lot, at least, is recurrent. Personally, I think this stock will turn out to be a very good pick, but who knows?

Saul

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The reason I say it would be the bottom of the cash crisis is that (assuming 60 day average collections) in July they would collect May’s billing of $1,000,000 and they’d be out of the woods. Then in August they’d collect June’s $1,300,000, and in Sept they’d collect July’s, etc. Even assuming no sequential growth in July billing after the huge growth in the second quarter, they’d take in cash of $1.0, $1.3, and $1.3 million in the third quarter that we’re in now, for $3.6 million. At this point Cash will be rising no matter how you look at it.

If they are in a cash crisis position, they also have the option to factor their Accounts Receivable. Basically they can sell them for cash today at a discount and the buying gets the collection. Any non-collectable AR usually will go back to the company. I have seen it done for long-term AR that is payable in 90 days or more.

Given that their customers seem to be hospitals and government, I would think they have a pretty reasonable expectation of collection but probably extended terms or lagging.

For those executives that deferred payment, do we know the accrued liabilities that still need to be paid back?

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