Zacks Small Cap Research – AIXI: AI commercialization efforts accelerate but significant hurdles remain – Technologist

By Brian Lantier, CFA

NASDAQ:AIXI

READ THE FULL AIXI RESEARCH REPORT

Second Half and Full Year 2023 Results

Xiao-I (NASDAQ:AIXI) reported 2023 full-year results on April 30, 2024, which we have utilized to back into the six-month results for the period ending 12/31/23. Revenues for the period exceeded our forecast by about 9% or $2.6 million largely due to the strong performance of the company’s cloud business and a surprising uptick in demand for technology development services.

Total revenue jumped 22.8% to $59.2 mil for the full year of 2023 principally as a result of several new contracts signed or extended for the company’s core cloud-based AI solutions and an increased interest in the company’s large language model. The company’s cloud platform business – which accounted for 74% of revenues in the second half of 2023 – produced a sizable gross margin above 66% in the last six months of 2023, but we think that the increasingly competitive landscape in this market impacted margins slightly.

The company continues to invest very heavily in R&D related to new AI products – principally, the company’s large language model and new projects like the OOTDiffusion (an image model) and an investment tool to write financial reports like the one you are reading. R&D spending jumped to $52.4 million for all of 2023 (though declining sequentially to $22.7 million in the last six months of the year). While we expect R&D spending to remain the largest line item in the company’s expenses, we do anticipate that R&D spending as a proportion of sales will moderate as spending stays between $50-$60 million in 2024 and 2025. The company noted on its conference call that 56% of its staff are now employed in R&D positions.

The company has begun also reporting its business lines as Model as a Service (MaaS) vs. Non-Model as a Service (Non-MaaS). The company believes that by providing AI models rather than selling the model outright it can speed the adoption of AI tools. The company’s MaaS business – cognitive intelligence AI model, the image model, and the Hua Zang large language model – grew 48% in 2023 and accounted for 30% of all revenues. The company’s non-MaaS business lines include many of the business lines from the company’s legacy operations like AI Chatbots and Live Chat.

Despite the company’s strong top-line growth, customer concentration remains high with 52% of 2023 revenues coming from just 3 customers (the largest of which accounted for over 29% of revenues). Given the incredibly competitive market for AI models, we will have to monitor the company’s customer relations closely as the loss of any of these key customers could significantly impact our model and target valuation.

We believe the company will have a fairly robust pipeline of product announcements in the coming months as the company’s latest SEC filing highlighted the launch of

o An AI Try-on Product (a virtual try-on tool) using the image model in May 2024

o An AI Agent product based on the Hua Zang LLM in May 2024

o An AI Baby Crib based on the Hua Zang LLM in June 2024 and

o An AI Product for disabled persons based on the Hua Zang LLM in May 2024

Given the company’s significant losses and cash burn, investors are likely to focus on the company’s path to cash flow-positive operations. Management indicated on its conference call that if it hits a 20% revenue growth goal and controls expenses it could have positive cash flow from operations. We think the debate about when this will occur is likely to dominate most investor attention around Xiao-I. In light of the changes made to the voting structure of the company last December with the CEO now having close to 79% of the voting interest, we do think the risk of additional dilution is high for ADS holders. To meet the cash needs of the company for the next twelve months, the company has indicated that it will seek extensions on its borrowings, seek out additional bank financing, and focus on cost controls.

New projects like the previously mentioned OOTDiffusion (image model) offer some insights into ways that the company’s AI tools can be used in the real world. The project works as a virtual try-on tool principally for clothing in the examples we’ve seen but we could imagine a number of alternatives for uses in advertising and print media. While there are some limitations to the project and the produced images occasionally are distorted, it doesn’t take very long using the tools to see how a simple virtual try-on tool could be very popular with consumers and retailers.

We are adjusting our revenue forecasts slightly for 2024 and 2025 but we will monitor commercialization efforts closely during 2024. We are maintaining our price target at $2.40 for the time being, but we recognize that the risk associated with management’s control of the voting stock and the cash needs of the company could significantly impact investor sentiment. If the company seeks additional equity financing to fund operations in 2024 our target valuation would likely have to be adjusted lower.

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