In this next article on AITX, I wanted to take a deeper dive into AITX’s income statement again. I have already written detailed articles, linked below, analyzing AITX and its competitor Knightscope down to gross profit. Today’s article will focus on AITX from gross profit through operating income. We’ll talk about operating expenses in general, where AITX spends most of its operating expenses today, and what this means for the company now and in the future as it potentially grows with scale.
Below I’ve presented AITX’s 6-month financials for the periods ended August 31, 2021 and August 31, 2020.
General and Administrative
First, AITX spends most of their operating expenses (“OPEX”) on General & Administrative expenses, or G&A. Just to be clear, they are likely including their selling expenses here, so let’s call it SG&A. What is AITX’s SG&A? SG&A is basically any expense for operating the business that does not pertain to R&D (we’ll get to that) or manufacturing costs like materials, manufacturing labor, etc. So SG&A would include things like their salespeople, any management (like the CEO), accounting/finance expenses, legal expenses, IT costs, and HR, to name a few.
This should have stood out to you, but AITX’s SG&A spend over the six months ended August 31, 2021 is more than 6 times its revenue. That’s right, for every one dollar the company earns, more than six dollars go right back out to pay its employees. And this doesn’t even include all of the employees! SG&A also outpaced the growth of revenue of the comparable period, with revenue growing about 400% and SG&A growing about 432%.
This must be troubling for investors, right? It is, and it isn’t. More to come on that.
Research and Development
Research and Development (“R&D”) are expenses that the company deems are for the development of their intangible assets. These types of expenses are expensed immediately as incurred, as opposed to capitalized on the balance sheet and amortized over the life of the intangible asset. These personnel likely include the fees paid for Steve’s minority owned R&D company in Canada, as well as any engineers employed by AITX.
Like SG&A, we see that R&D far exceeds AITX’s revenue. This seems like the R&D isn’t working, right? They can’t even cover their spend to develop products. That’s true, but R&D is an investment in the company’s technology for the future. So, in the ideal scenario, we expect these R&D expenditures to return tenfold (for example) months and years down the road.
You might be thinking, why are we only going down to operating income? Aren’t there other costs further down the income statement, like interest expense and financing costs? We’ll get to those in another article.
The purpose of looking at operating income is that it provides one of the clearest pictures of how the business operations are performing, hence the name operating income. It’s sort of the litmus test answering the question of “how well does the business perform before I consider the financing costs I incur to invest in the business?”
AITX’s business clearly does not make money right now, there is no getting around it. What does this mean for the company?
Implications for the Present
It doesn’t take a financial expert to realize that AITX spends more than it makes, so the money must come from somewhere. Right now, AITX is completely reliant on new investment to fund the growth of the company, generally through the issuance of new shares. I’ll have more article is on share issuances, but essentially, they sell shares in the company in return for cash.
Implications for the Future
So, all of the hard numbers above paint a pretty bleak picture on the company, doesn’t it? They lose a ton of money, costs are increasing at a higher rate than revenue, and they can only fund this company through selling shares. It’s not all bad, and here’s why, it’s a startup company.
AITX’s current startup phase is key for why AITX can still be an attractive investment, at the right price, even though they are metaphorically burning money right now. When a startup is successful, at some point revenue growth will outpace OPEX growth, thus growing operating income. This is a lofty example, and I’m not saying AITX is going to do this, but see below Tesla’s financials from its first filing in 2008 until 2021 (annualized from Q3).
Note OPEX as a percent of revenue. Notice how high it was in the early years from 2008-2012? Seems a lot like AITX’s, doesn’t it? After those start-up years, notice how the company begins to grow at scale and OPEX begins to become a smaller and smaller portion of revenue, with the company turning an operating profit for the first time in 2020, and breaking even in 2019. So it took them about 12 years to turn an annual operating profit!
So, if you truly believe in AITX’s future, you should be factoring in a model that looks something like this. AITX is currently burning cash, but long run, that’s not so certain. The company could continue at this pace and they’re unable to sell enough products. Conversely, the company could achieve exponential growth in a form like Tesla, or any other startup, and you will see revenue far outpacing their increase in operating expenditures.
The next two years are critical for the success and failure of AITX. The key sign demonstrating that the company’s strategy is working is if we start seeing that magic ratio, OPEX / Revenue, decreasing. If that happens, then we will start seeing the snowball move as such: more revenue means less cash needed from outside investment, new investment options become cheaper and non-dilutive to shareholders, the company can re-invest at more efficiently, the company eventually turns profits, investors (hopefully) make money. I believe the CEO uses the phrase, “the dam breaking”, but the concept is the same!
If we do not see this type of movement, barring some sort of phoenix rising from the ashes moment, we will likely see the end of AITX. A company only has so much runway in the startup phase. Eventually, new investors will deem the company too risky or not believe in the products if they take too long to catch on with customers. My prediction is the climax point will be in two years, about when the F Series preferred shares become exercisable.
The bottom line is you are investing in a startup. This is what the income statement of a startup looks like. Many companies at one time or another were startups losing money as the company invested and grew. The trick to investing in a startup is to put your money in the companies that have the best probability of success. You can never be guaranteed that a startup will become the next Tesla, Apple, etc. But what you can do is do your due diligence about the company, management, vision, etc.
So is their OPEX spend troubling? Yes. Is it out of the ordinary? Absolutely not. What this income statement signals is a high-risk, high-reward company. This is a company you are making an educated investment in based on your belief in the company and management to do great things with. Like I always say, you may make a ton of money, you may lose everything, so only put your money in a company you believe in. If you do believe in them and their vision, don’t be put off by losses today.
For further reading and AITX analysis, check out all of my articles HERE as well as in the sidebar.
DISCLAIMER – I CURRENTLY HOLD A LONG POSITION IN $AITX. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES.