Avigilon Profit and Stock Price Drops Q2 2014

Battered by the controversy over their CFO's badly timed exit and a report questioning their revenue recognition, Avigilon further disappointed investors with their Q2 2014 performance.

In this note, we examine these results including 2 geographic areas where growth declined sharply and concerns about slowing expansion.

Q2 2014 Results Overviewed

The most positive aspect of Avigilon's financial results was top line revenue up 66% year over year, to $65.1 million USD for the quarter. However, that was below some analyst's prediction.

The most concerning financial aspect was net margins dropping in half from nearly 10% in Q2 2013 but under 5% for this quarter. Indeed, despite revenue growing 66%, total profits were lower this quarter than one year ago. On the contrary, Avigilon's management continued to emphasize that top line growth is the focus, not short term profits.

Drivers of Profit Drop

Profits dropped primarily because operating expenses (OPEX) increased faster than revenue (84% vs 66%).

Sales and marketing costs increased at slightly more than revenue. However, it is not certain which of the two grew faster because Avigilon just stopped reporting sales and marketing costs separately. That noted, based on recent history, it appears marketing costs were trending down while sales are increasing relatively.

The main increase in operating costs appears to be from the VideoIQ and RedCloud acquisitions, which added to both G&A and engineering costs. G&A costs were up 126% while gross R&D expenses were up 130%.

These increases in expenses may ultimately prove good investments for the company but it clearly surprised investors who were expecting significantly higher profits. 

Hiring Slowed and HR Employees Exit

Despite Avigilon projecting a 'rough doubling' of employees in 2014, Avigilon only added 30 total employees in Q2 2014, up just 5% for the quarter (586 vs 556).

Avigilon responded that what is, "Paramount is hiring A players and B players that we feel we can develop into A players and so its quality first and quantity second." Of course, they need those bodies (A, B, etc.) to maintain their growth rate. It could be that Avigilon simply needs to do a better job of recruitment or it may be that A players, especially in sales, are concerned about the company's reputation.

In the midst of the hiring slowdown, Avigilon has lost 3 key HR employees. Avigilon has not replaced the HR executive who left in March 2014. The job listing is still open [link no longer available], but, ironically, the Avigilon HR person who posted it, just left Avigilon herself [link no longer available]. These two join another HR senior manager and self proclaimed Team Avigilon's #1 fan who also recently left [link no longer available]. With so many HR people exiting, this is likely to impact hiring efforts. 

Growth Sharply Down - Latin America and Canada

The two disappointing markets were Canada, with an industry average 19% rate, and Latin America, with a far below average, 12%. Canada, their earliest and home market, is likely reaching saturation. However, Latin America, with an annual run rate of less than $8 million is an important growth market for Avigilon. They will need to turn in far better results here. Likely related, the Avigilon Sales Director of Latin America left [link no longer available] in May.

US Growth Strong

On the positive side, US revenue was up an astounding 93%, to $35 million for the quarter, now representing 54% of Avigilon's total revenue. What will be interesting to see is how much more can US revenue grow, since Avigilon has increasingly saturated the US with dozens of RSMs. For example, Avigilon now has a single RSM dedicated to just North Carolina [link no longer available] and another to the scarcely populated Wisconsin / Upper Michigan region [link no longer available].

Underwater Options

Avigilon granted 264,000 options in the first half of 2014. Unfortunately, with an average strike price of $29.54, they are significantly underwater.

Though the company's supporters trumpet how rich Avigilon has made its employees, the ongoing stock price decline, if it continues, will have a materially impact on employee compensation and interest in the company. Combined with the company's active disparagement of its ex-employees (1, 2) and this might hurt recruitment and retention.

Enterprise Sales Strong

Avigilon had its best ever quarter in enterprises sales,with $11.5 million in total enterprise sales, 18% of all revenue. Avigilon defines such sales as "projects that have budget spend or a system design that calls for $250,000 or greater."

In recent quarters Avigilon noted that enterprise sales percentage was as high as 12% and low as 6%, cautioning, "Next quarter could easily be five percent or it could be 25% it’s really very lumpy I think if you look at it year-over-year basis we are trending up."

Enterprise sales, however, is an area that the company has been focusing on growing.

Channel Stuffing Denied

In response to the forensic accountant report citing significant risks of channel stuffing, Avigilon's CEO denied it:

"Many of our integrators if not most don’t stock Avigilon product. And that’s one of our competitive advantages, so that they don’t have the outlay of cash and so the answer is there is not need to track that because there effectively is no stocking of Avigilon inventory in the channel, essentially we get order as they need to be filled. We typically fill ordered within 72-hours and we typically ship overnight and then product gets installed typically within days of delivery."