AITX Analysis – IP and the Effect on Gross Margin Ft. Knightscope Part 2

Continuing from my previous post, we have now spoken in detail about KS, now we can move onto AITX.

AITX – How do they Compare?

See below AITX’s financials over (as close as the SEC allows me) the same period:

Side-by-side with KS, we are seeing the same heavy losses operating margins. However, AITX is making hefty returns at the gross level. Why is this happening? This is sort of self-explanatory, but all of the issues KS is having above, just change flip them around and that’s what’s happening with AITX. Steve and Mark at AITX/RAD are running a lean, tight ship, over at the REX. Some examples explaining this may include:

  • Lean manufacturing processes
  • More efficient headcount on the manufacturing line
  • Interchangeable parts and common pieces
  • Shrewd supplier selection and negotiation
  • Products are not over-engineered

The CEO has talked about it on many Q&A’s, etc., so I’m less inclined to re-hash those now. But he has specifically mentioned many of the above bullet points.

Let’s talk about one more thing I mentioned above, product pricing. This is probably more key than I’m making it out to be. The CEO has mentioned several times he does not do “foot in the door pricing”. This is the strategy where you sell an initial batch of products at a huge discount just to get the customer using your products, service, etc. Then when it’s time for the customer to order more, you start charging more, build volume etc.

From my consulting days, this strategy almost never works unless your whole business model is thin margins i.e. Wal Mart. What tends to happen is when it comes time to buy more, the customer is so used to their nice low prices that they won’t renew at a higher price. In the corporate world, if you go to your managers and ask for more budget, 50% of the time they say no, 50% of the time they ask “what am I getting that’s new, and what’s the incremental benefit”.

The annoying fact of the corporate world is we allocate capital at relatively stagnant amounts. The question “how much did we spend last year?” should be the motto of the corporate world. If AITX low-balled on a one-year contract, the product does great, the head of security at X company will simply say “I can only spend what I got last year sorry”. And then that low ball price just becomes the price. Period. Budgets only significantly change with new leadership, a macro level event (think 9/11 to the security world), or the rare company that allows for more freedom of spend.

Technology like this is not a thin margin business; you spend millions on R&D in order to earn an excess return. They’re not making toilet seats, they’re making robotics. I absolutely LOVE that AITX prices this way. Sure, they are losing out on volume, but they are letting the products speak for themselves. Long term, they’ll have customers actually buying products not because they’re cheap, but because they work. They can demonstrate value and earn a high margin at the same time, and it is an incredibly sustainable model.

Accounting Notes

You’ll notice I added depreciation to the bottom of my figure. One thing to note is, Knightscope owns their facility, whereas AITX leases the REX. Therefore, Knightscope is depreciating an asset at roughly 750k for six months. AITX records their lease as on operating expense of approx. 150k for six months (3 months of 75k*2 as the REX wasn’t open all of Q1).

While this does skew down KS’s gross margin significantly, if AITX were to include their lease expense (presumably near their depreciation amount), we would still see them earning a healthy gross margin. Conversely, if KS had been leasing its facility, we would still see an extremely low gross margin versus AITX. KS’s lag here can also be attributable to their insistence on manufacturing in Mountain View, CA, which is one of the most expensive places in the country from a property and salary cost perspective. This is in contrast to AITX, which left California and chose a more prudent location in suburban Detroit.

Closing Thoughts

Long-term, and that’s the ONLY investing I am interested in, it seems that if AITX can achieve high gross margins as a small business, it means their two sets of IP (product and manufacturing processes) are legitimate and the market/financials reflect that. Customers are seeing the value in paying a premium, couple that with a tight, highly engineered, manufacturing process, and we get AITX making pharmaceutical type gross margins (seriously, check out the gross margins of $ABBV or $NVO, where the IP is something that literally saves a life).

This then begs the question, if they can hit this kind of scale at this small size, what would it look like as a large company. That, I’m afraid, is pure speculation. However, past logic and years of economic thinking would say that as AITX grows, they would ideally maintain this same 70-80% gross margin level and perhaps even exceed it by applying this same suite of IP across the next dozen REX’s they would have to build.

So, in the cutthroat world of capitalism, do you want to invest in a company that’s already manufacturing at scale before they’re even expected to? Or do you want to put your money in a company that is notmanufacturing at scale when they’re expected to, and roll the dice that one day they will? I, once again, must leave that up to you.

So, where’s the risk you might be asking?? AITX to the moon?! Well, that’s the thing with these small businesses, AITX and KS are still burning money right now trying to grow. Both posted 600%+ negative operating losses. There will be many more articles on this, so I will keep it short. But if AITX cannot keep growing sales and their gross profits to cover their OPEX, they will eventually run out of money having exhausted their investor options. So, when you invest in a company like this, remember you have high upside, but you can’t have the upside without the downside. You might make 10x returns, or you might lose everything.

Is that risk worth it? That’s up to you to decide.

For further reading and AITX analysis, check out all of my articles HERE as well as in the sidebar.


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