AEYE Reports Q2

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http://finance.yahoo.com/news/audioeye-inc-reports-net-incom…

Lots of good stuff here, with one particularly curious item. Unfortunately we need to see the 10-Q that will hopefully be filed later today before I can really piece together the puzzle of their cash flows this quarter.

Revenue is just over $3m as they pre announced. They’ve up’d their full year guidance to $12m which is great because that indicates that they don’t think there was one or two one-off big deals in Q2. Actually, it means they expect Q3 and Q4 to continue to grow, albeit, not quite by the 190% sequentially they experienced in Q2 vs Q1 2014. Given that total revenue for the first half of 2014 was only $4m, that means they expect to generate $8m of revenue over the next two quarters to get to $12m, which would be an average of at least $4m per quarter. This would be at least as much revenue in each of the next two quarters as they generated in the entire first 6 months of 2014. If they can keep their cost in line (and assuming most of these are “cash” sales) then that would be quite good.

Accounts Receivable has come down from $1.3m to $500k, which means they are collecting receivables pretty timely, especially considering the $3m of revenue in Q2. They also said that 10 million warrants were exercised for cash during Q2. That is interesting because the average exercise price of their warrants was 38 cents at 3/31/14. If they actually were paid 38c each for $10m warrants, that would indicate that they received $3.8 million in cash in Q2 just for the exercise of the warrants. That would probably be concerning because their cash balance didn’t grow enough to reflect both exercise of warrants at that level AND the collection of a significant portion of $3m of sales, given my estimate of what they spent this quarter (even after taking into account the unexplained $3m of new prepaid expenses which I’ll get to in a moment). Hopefully, the warrants that were exercised were very old ones at only a few cents each, and that indicates that there was still a lot of cash collected from regular receivables from new revenue (as opposed to non-cash sales like they had a lot of in Q1). In the earnings release, it seems almost like they intentionally didn’t mention the average exercise price on the $10m warrants which has me a little concerned.

Now the biggest thing that jumps out at me, besides my curiosity of the warrant exercise prices (which will help clue us into how much of the Q2 sales were for cash receivables vs non-cash “trades”) is a monster $3m of new prepaid assets on their balance sheet vs $50k in March. What are they prepaying for? Why did they need to spend the majority of their cash on this leaving them with only $500k left available at 6/30/14.

So I’ll be looking pretty closely at a few things when the 10-Q comes out and likely asking about them on the conference call

  • what portion of revenue was non-cash sales
  • what was the average exercise price (or total proceeds) from the exercise of the 10 million warrants
  • what the heck was the $3m of prepaid assets spent on and what benefits did we receive from paying for so much in advance

mekong

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Bad news folks

The earnings call hasn’t started yet but the 10-Q is out

During the three and six months ended June 30, 2014, nonmmonetary revenue of $2,925,000 and $3,825,000, respectively, was recognized. This resulted in an increase to intangible assets and prepaid expenses of $675,000 and $3,150,000, respectively.

That pretty much means that almost all of their Q2 revenue was of the non-cash variety. It actually also explains why prepaid expenses ballooned so high because they traded the licenses (and recorded them as revenue) for these prepaid services but don’t appear to feel the need to explain what the prepaid services are for in the 10-Q (I may have missed it tho, obviously haven’t had time to read the entire document).

They only received $13k for the issuance of the 10m warrants according to the cash flow which doesn’t seem right. That looks like the proceeds of the 1.3m 1 cent warrants that were exercised in Q1, but I don’t see any cash in Q2 that pertains to the 10 million warrants they claimed in the earnings release were exercised for cash in Q2???

I just sold all of my shares. If I hear something on the call that makes me think this is ok, I’ll consider buying back in, but right now, I’m just not comfortable having my funds invested here.

mekong

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Call just ended. There were a decent number of analysts asking question, one from Morgan Stanley and I forget who the other firms were. None of them asked what the prepaid expenses were for. I got the impression that none of them realize that all of the Q2 sales were “traded” for these prepaid expenses (which will likely flow through expense over the next 12-24 months on the company’s income statement). I tried asking a question but didn’t get put through. They stopped the call because they said they had run out of time, so I have no idea if they were specifically excluding questions from private investors.

They did explain the warrant exercise. They were exercised after the end of Q2 which is why I don’t see them on the Q2 cash flows (it was actually properly mentioned in the subsequent events footnote). Looking back at the earnings press release, it did specify that the highlights related to both Q2 and the period subsequent to the end of the quarter, so it was accurate.

They actually received proceeds of $3.6 million from the exercise of those options which is good and should fund the business for a while. One of the analyst questions was whether they expected to need to raise money again soon and they replied that because they just got the $3.6m from the warrant exercise, that they don’t expect to need to raise more cash.

They said that they revenues should grow sequentially by 25-30% for the “foreseeable future”. This right in line with their expectation to get to $12m revenue for 2014. That would be great if they were actually selling their licenses and receiving cash for the sales, but until it appears that revenue can actually turn into cash, I can’t see myself buying back in. I lost a bit on this investment, but I’m just not comfortable having my cash invested here until 1) sales can turn into cash and 2) I understand what the prepaid assets actually represent.

mekong

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it should say in my last post, received $3.6m from the exercise of “warrants” (not “options”)

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From the conference call:

The warrants for about 10 million shares were execized after the end of the quarter. They now have about 3.5 million cash on hand. It was pointed out that they did receive a cash receivable of about half a million in the last couple of days.

They did talk about being cash flow positive within six months.

It sounded like landing some gov’t contracts will occur in the Sept-Oct timeframe.

Also talks with 2 of the 3 largest telecommunications companies are ongoing. Also talks with 2 $50 billion biomedicals are ongoing.

Average deal is about $175,000 ranging from $3million to $1,000. Total pipeline is about $300 million. about 3/4 of it could realistically be converted into sales.

The $3 million of prepaid expenses/licenses obtained from sales will be expensed as used up in coming quarters.

Revenue guidance for 2014 was raised from $8 million to $12 million.

Z-Bar

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“The 3.5 million cash on hand should be enough to cover cash needs for about a year”

Z-Bar

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Total pipeline is about $300 million

I thought they said $30 million, but I may have mis-heard it

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Hi mekong. I listened to the call as well and also tried to ask a question, but time ran out. There seems to be a lot of interest in the company from several analysts. I take that as a good sign, especially given the small size of the company.

They said that they revenues should grow sequentially by 25-30% for the “foreseeable future”.

Just want to point out that this will be sequentially by quarter and not by year. They also said that they will be cash flow positive by the end of the year. The CFO initially said by Q3, but said definitely by year-end. I too am disappointed about the amount of revenue that was paid via licenses instead of cash. I understand some of it coming through this way if it makes business sense, the majority is concerning. However, if they are going to be cash flow positive then it sounds like they are expecting future sales to be via cash. They also said they collected a $450,000 receivable after June 30, so plus $3.1M in warrants makes about $3.6M received after the end of Q2. The last analyst asked about needing to do a secondary and they said they would not need one.

They also mentioned that there is about $30M of contracts in the pipeline. I believe they said that they consider it in the pipeline if they have at a 75% chance of closing.

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Yes they stated the pipeline was over $30 million not $300 million - my bad.

Also they stated revenue per employee is up from $100,000 at 2013 year to $160,000 for the last six months, equating to more than $300,000 per employee for 2014.

They have targeted more than 50% of all federal agencies for their product(s).

Z-Bar

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I too am disappointed about the amount of revenue that was paid via licenses instead of cash.

Hi wouter

keep in mind that their Q2 sales were exchanged for these unknown prepaid expense assets. This is different from the Q1 non-cash revenue which was exchanged for other licenses.

They sit on different lines of the balance sheet and cash flows. The new prepaids most likely will hit expense faster than the Q1 licenses they received because I believe the Q1 licenses were 3 year assets while the new prepaids appear to be 12-24 months only. Also can’t tell if they new prepaids will hit a typical EBITDA add back line like depreciation (or like amortization for the Q1 licenses received) or if they will just flow through as opex, reducing EBITDA.

mekong

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Looks like most of the revenue was exchange of licenses for services. That was $2.9 million and apparently won’t ever come in as cash. Don’t know what the services were or whether they were worth the cost. They did $3.8 million of noncash exchange for six months.

Since there was no revenue to speak of when we flip over to the cash flow statement they used $1.7 million to operate and as predicted in July, they needed another cash raise to keep the doors open

In transactions where the Company engages in a non-cash exchange of a license of the Company for the services of the Company’s customer, the Company follows Accounting Standards Codification (“ASC”) 985-605 and ASC 985-845-10. The fair value of the technology or services exchanged or received is determined within reasonable limits and used to determine vendor-specific objective evidence.

From early July:

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.

They sold $896K worth of stock and shares increased from 43 million to 58 million diluted shares

Until they can make enough revenue to cover expenses issuing shares or debt are going to be the only way to keep the doors open. Lots of companies operate this way in the early years. Investors have to have some idea if the demand for the product/licenses is ever going to pay the bills.

Cash is now at $514K and the 10Q says they are going to have to sell more shares

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The large amount of non-cash revenue in Q2 is concerning. Not sure if it is because AEYE needs those technologies or because they have to make the concession to make the sales. But those are the initial sales and since they use SaaS model, they would have repeat revenue year over year and cash revenue?. Too bad nobody asked those questions. Wondering if they would respond to email from individual investors.

BTW, I have some vague memory that one of the accusations against Enron was creative accounting. They swapped some services/products/capacity? with another company and recorded that as revenue though there was no cash changing hands. I assume what AEYE did is legit.

-M

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hey m -

i was initially interested in this company but after some research decided to stay far away… for now at least.

BTW, I have some vague memory that one of the accusations against Enron was creative accounting. They swapped some services/products/capacity? with another company and recorded that as revenue though there was no cash changing hands. I assume what AEYE did is legit.

it may be or it may not be. i can’t say because i haven’t even looked at it. but if you are concerned – go back about a month or so on the board here to my posts about management – i will remind you that in his previous job their current CFO did some questionable things that eventually resulted in that company having to restate several years worth of financial statements with relatively significant impacts.

if you’re spotting what look to you to be questionable treatment of the financials here then I would be wary.

best of luck to all,
michael

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Mike!

You missed it!

Congrats to all on 3,000 posts!

Jeb

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keep in mind that their Q2 sales were exchanged for these unknown prepaid expense assets. This is different from the Q1 non-cash revenue which was exchanged for other licenses.

Hi Mekong (and Z),
Thanks for sharing all your work on this.

First, I am the uninitiated and have a question that might prove it. Please confirm or deny anything I wrote below so I can learn.

They are a new company and have swapped their product for some kind of expense that will allow them to NOT spend some portion of their cash on future expenses. I have to think this expense is almost as valuable as cash or why do it? In fact, if I were negotiating this kind of swap, I’d get more than my share for what I am giving since I have an undisclosed mark up in the value of my services. So isn’t that a smart play? Instead of getting the cash and spending it, they take in expenses at their product cost which lowers those expenses even more?

I guess if you think those swapped expenses were Cadillacs for the execs and a few months at a resort with escorts in tow, then it would be a problem, and thus your concern about what those expenses are. Can’t you just email or call them to find out directly?

Thanks,
Mykie

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Mykie

you’re mostly right

The fact that they passed the accounting test to allow them record these sales as revenue requires that there is a legitimate stand alone value of the assets they received in return. It’s definitely something that they received that they won’t now need to pay for in the future. But what did they get? I assume it’s not something that they would have needed to pay for anyway (like salaries, rent, sales expenses, etc). Will the services/assets that they received in the prepaid line actually benefit the company and lead to future growth, innovation, etc or is it something that has value, but isn’t particularly pertinent to the company’s business?

Right now the company needs to use what cash they have to cover their overhead while they ramp up sales (that ideally would be sold for cash in the future). And why exactly wouldn’t management want to let the owners of the company know what they received in return for accepting this in lieu of cash? Wouldn’t they want to show the owners and potential investors that they got something good in exchange?

What’s also strange is that I don’t believe that most of the $3m revenue comes from a single customer or just two or three customers. So let’s say there were 15 customers that were involved in the transactions that generated the $3m of revenue. You’re telling me that all 15 of these customers had something valuable to exchange for the audioeye licenses in a swap? Practically every one of them? They couldn’t convince even a few of them to pay in cash to help fund the business? Did they already know that the warrants would be exercised in Q3 when doing all of the Q2 agreements (not likely)

It all just seems fishy

mekong

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“During the three and six months ended June 30, 2014, nonmmonetary revenue of $2,925,000 and $3,825,000, respectively, was recognized. This resulted in an increase to intangible assets and prepaid expenses of $675,000 and $3,150,000, respectively.”

This my guess as to what they have done with these amounts.

These are for 13 and 17 licenses at $225,000 each. AEYE has announced agreements with ImmixGroup, K3, Blue Beacon, Red River and Axia to be re-sellers to peddle the AEYE software to (primarily govt) customers. What AEYE has done is to give/sell each reseller with a certain number of licenses. In return the reseller will sell and provide services to AEYE (as a reseller) and /or the customer.

Is this really revenue? By IRS standards, I don’t know. What I’m concerned about is what this does to future revenue. Should this be really be current revenue? The next announcement that gets signed up, the sale could be through a reseller, and not generate any cash or then current revenue, because it was already booked as a sale to the reseller and then the ‘prepaid expense’ is expensed.

It does look phony.

That being said, the thing I am hanging my hat on, is their statement that they expect to be cash flow positive by the end of the year. If that is the case, obviuosly that means cash sales. On the call they did talk about different ways that the software is being used. With many different applications for their products, there is less likely to be a middleman, and more likely to be a cash sale and/or commission based contract.

I am holding onto my shares and still looking for at least $2-3 per share within 18 months.

Z-Bar

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Is this really revenue? By IRS standards, I don’t know. What I’m concerned about is what this does to future revenue. Should this be really be current revenue? The next announcement that gets signed up, the sale could be through a reseller, and not generate any cash or then current revenue, because it was already booked as a sale to the reseller and then the ‘prepaid expense’ is expensed.

It does seem to be an unusual way to book revenue. For one thing, revenue can only be recognized when their is a fixed and determinal price as well as reasonable likeness of being paid/collection. But if they sold licenses today for some future delivery of services in the future, how sure are you of delivery?

to the party on the other side of the transaction, it is unlikely they could record the revenue as it seems to be around work that needs to be performed at a later point in time.

To me, I would think they should have recorded this as deferred revenue given they won’t get cash and the “collection” is to come at a future date in some form.

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It looks to me as if they are almost like IOU’s that they have received from their distributors.

The distributors say “In exchange for the licenses you give me now, I’ll work for you for free in the future (i.e. provide $150,000 in free services) as your distributor.”

As the distributor provides services in the future (signs up a customer, for example), AEYE will “expense” the IOU’s. In other words write them down from $150,000 to $130,000, for example, if they would otherwise pay $20,000 commission, without actually paying anything for the service provided .

Looking at it like that, it makes perfect sense.

Saul

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So do we think that the revenue is for sales with distributors. I haven’t seen anything indicating that in their filings or in what they said on the earnings call so I would definitely be curious if I missed something.

This blurb from the earnings release is the closest I came to seeing who their customers were this quarter and it doesn’t sound like they are agreements with distributors:

The Company executed licenses for its technology with organizations involved in the consumer packaged goods (CPG), retail and couponing, and online job posting verticals during the most recent quarter.

I’m not sure if this health care one is actually in Q2 revenue or if this is something they “secured” and signed in Q2 but won’t actually hit revenue until later in the year. Could be either one. The company really doesn’t do a good job of explaining what’s going on, and I’m kind of in shock that the analysts weren’t asking these types of questions:

The Company secured approximately $1 million in contracts with leading national health care companies during the second quarter of 2014

mekong

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