Seeing Machines — Update 12 November 2015

FY15 revenues rose 13% to a record A$19.0m as the company shipped 1,828 units of its mining and fleet products, up from 1,059 in FY14. The adjusted loss before tax was A$9.4m (we forecast a $10.7m loss) while the net loss was A$11.3m and the group finished FY15 with A$14.2m in cash (we had A$15.3m) and SM has no debt.

Product sales slipped 5% to A$13.0m, largely reflecting the depressed mining sector, but showed growth in H2 as the new de-ruggedised SM Fleet product came on stream. SM announced the first order for its new fleet product in early June, with IUM, its distributor in South Africa. IUM ordered 750 units to offer its customers, with the expectation that the product will reduce accidents and associated insurance costs. Around 650 of these units have already been deployed, including c 70 that have replaced the ruggedised DSS mining product, and a further 750 could potentially ship to this client in FY16, taking the total to 1,500. Sales via the Caterpillar alliance made progress, despite the weakness in the commodities sector, including 47 DSS units deployed at a major oil sands deposit in Canada, and completion of the roll-out at the 90-strong haul truck fleet at BHP’s Mount Arthur coal mine in Australia. Services revenues jumped by 91% to A$6.0m as SM expanded its recurring revenue 24/7 monitoring, reporting and analytics solutions. The mining segment generated growth of 7% to A$15.4m, with the growth due to the expansion in services.

Employee headcount rose from 90 to 159 over the year, including 18 from the acquired Chilean business. Most of the other roles added were software engineers.

In September, SM signed a new agreement with Caterpillar that covers product development, manufacturing, licensing and distribution. The deal supersedes the previous four-phase agreement that SM signed with Caterpillar Global Mining in May 2013. The new deal involves a front-loaded US$17.5m fee paid over four years, along with ongoing royalties on product sales and services. The deal strengthens the group’s relationship with the US blue chip construction equipment maker, expanding the partnership into product development and across new sectors. Further, it underpins SM's near-term cash flow, enabling SM to expand its R&D programmes and to shift sales resources to target the commercial road transport space.

Caterpillar will exclusively market the DSS and Seeing Machines Fleet products at a corporate level with its Caterpillar dealers within the agreed Caterpillar industries. This extends the opportunity well beyond the mining sector, to industries including construction, agriculture, quarry and forestry. Caterpillar will take over the manufacturing, marketing and sales of SM’s existing DSS rugged off-road product. It will also purchase SM’s inventory of DSS units and current DSS customer service contracts will be transitioned. Further, SM will provide engineering services to extend product functionality and develop new computer vision-related technologies for Caterpillar. The technology will be supported by regional Caterpillar dealers along with related services, system monitoring and data analysis by Caterpillar Safety Services. Additionally, Caterpillar will distribute SM’s Fleet product, exclusively within agreed industries and non-exclusively outside these industries. SM and its other partners will continue to market the Fleet product into the broader commercial road transport market globally. This new agreement does not include the rail sector, which is covered by an agreement with Caterpillar subsidiary EMD, announced in September 2014.

Under IFRS accounting rules, the revenue from the US$17.5m fee has to be recognised in the first year as there are no conditions on the payments. The payment timeline is front-end loaded with A$12.5m due to be received in FY16, A$4.5m in FY17, A$4.5m in FY18 and the balance of the A$23.3m (ie $17.5m as A$0.75/US$) in FY19.

SM specialises in operator performance and safety through real-time monitoring and intervention. The group’s IP is based around three sets of algorithms – head tracking (eg, monitors for distraction, or if the subject is not facing in the correct direction), eye aperture (eg, microsleeps/fatigue monitoring) and eye gaze (eg for device control). SM is focusing on applying this IP to five safety-related areas where the IP can be used to enhance operator safety and performance. These sectors are mining, commercial road transport (aftermarket), consumer automotive (OEM), rail (both OEM and aftermarket) and simulators (which includes aviation). It is also seeking business in consumer electronics through licensing/royalty relationships.

Seeing Machines operates in a high growth market. A recent report from Tractica, a specialist market intelligence firm, forecasts the computer vision market to grow from $5.7bn in 2014 to $33.3bn by 2019, for a compound annual growth rate (CAGR) of 42%. This follows similarly bullish industry reports on the ADAS market by Strategy Analytics and inward-facing cameras in vehicles by ABI Research.

1) Mining (via Caterpillar, includes other sectors including construction, quarry and forestry)

SM’s traditional target market is c 38,500 giant haul trucks. The deal with Caterpillar extends the potential market to c 3.5m Caterpillar vehicles as well as to an even greater number of non-Caterpillar vehicles. This includes the many light vehicles that operate on mining, construction and other sites. SM plans to work with Caterpillar to develop new products for this significantly enlarged market. As with the haul truck market, this is an entirely new market, and we believe there is a potential to develop bespoke operator monitoring solutions for specialised Caterpillar vehicles and various operational environments. SM has not yet elaborated what this could involve. One possibility is in monitoring when a driver working on a construction site leaves his vehicle – the software acknowledges this and subsequently switches the vehicle off. It could also be used to identify the driver, and only allow the vehicle to operate if an approved person is in the driver’s seat.

Caterpillar has been putting increased pressure on its c 185 dealers (independent companies that distribute Caterpillar’s products across the globe) to generate additional revenues because of the weakness in Caterpillar’s traditional markets. In early 2014, Caterpillar launched the “Across the Table” initiative to help its distributors boost their combined revenue by between $9bn and $18bn. This would be achieved partly through better exploiting the dealerships’ customer relationships along with the wealth of real-time customer data. In our view, the decision by Caterpillar to sign the contract with SM indicates that Caterpillar regards SM’s technology as part of this initiative. An operator monitoring solution will potentially be a much easier sell during the current challenging environment in the mining sector, than selling brand new $5m haul trucks. We note that Caterpillar specifically launched an operator fatigue technology review project in January 2006, and in 2008 a document was published that identified 22 different solutions that it was testing. Interestingly, Mobileye was a contender, as the system could potentially use variation of lane deviation as well as vehicle motion as a fatigue measure. In May 2013, Caterpillar selected SM as its fatigue monitoring solutions provider.

2) Vehicle fleet market (via SM’s sales team and resellers)

During FY15 SM developed and launched a new lower-cost product (essentially a de-ruggedised version of its mining product) for the vehicle fleet market. This product has been trademarked SM Fleet. Prior to the launch, SM had already sold around 1000 units of its DSS mining product to the fleet market, primarily used in trucks that venture onto mining sites to load, but mainly travel on highways. The lower price of the new product will dramatically expand the sales opportunity.

At the time of the results in September, SM indicated it had some 10,000 units in its SM Fleet pipeline. Interestingly, none of these are in the US – the market we expect to be the primary sales focus – but instead are in Australia, Asia and South Africa. This is because SM has made sales in Australia to its local transportation and logistical companies, which includes Toll Group (recently acquired by Japan Post) and Qube Logistics. Toll has indicated it wants to extend the DSS across its fleet of vehicles. We understand the IUM opportunity in South Africa and several Middle Eastern prospects all approached SM. Nevertheless, we expect SM’s initial sales drive to be on the US market and SM has established a highly experienced sales team to target this market. We expect the initial focus to be on the dangerous goods fleet vehicle market, as such vehicles will have the strongest commercial basis for driver monitoring.

We understand the sales pipeline has continued to grow apace, as has been indicated in the Seeing Machines Fleet Quarterly newsletter. SM has developed a 60-day assessment package (essentially a fatigue and distraction trial) for its prospective SM Fleet customers. Those currently on the assessment package include Coach USA, Basic Energy Services, Public Transport Authority (Dubai). Dubai Taxi Corporation, Empresa Nacional de Energia (ENEX), BENCINA Transport Company, Kalari, Toxfree and Greenfreight. Additionally, DP World has completed a successful assessment in Korea and is planning a programme of targeted assessments across multiple countries and marine terminals. SM says that IUM has added five new client assessments and a complete fleet roll-out in the last quarter, and hence is on track to place an order for additional SM Fleet units in early 2016. Fleetsafe, SM’s distributor in New Zealand, has signed up five new client assessments scheduled for completion in Q415.

3) DMS Automotive (OEM channel, primarily via Takata)

SM’s formalised a 15-year alliance with Takata in September 2014, and has been working with more than 10 major auto OEMs through this alliance. Six of these OEMs are prime targets to move to commercial projects in the next five years and SM has been working with one major global OEM for around two-and-a-half years. This project is scheduled to take another 18 months to complete, with revenues expected to begin to flow from 2016. SM’s second-generation product is scheduled to go to the market with this customer in 2019.

While the functionality of forward-facing cameras has been improving (eg, identifying everything from road signs to traffic lights, pedestrians, animals and bicycles) ADAS (Advanced Driver Assistance Systems) technology still has high failure rates, as highlighted by recent controversies with Tesla’s self-drive mode, which was filmed 'endangering passengers'. Evidently, this means that someone must always be in a position to take over control of the vehicle at a moment’s notice. SM’s DMS Automotive face tracking technology can be used to ensure that the person in the driver’s seat is always ready. While highly-automated vehicles, such as those being demonstrated by Google and Daimler and others, may be in operation in 2020 according to SM, it is possible that they will only operate in good weather conditions and on certain road type.

SM has been experiencing strong interest from automotive OEMs in functionality well beyond the plain vanilla driver monitoring for fatigue and distraction events. This potential interest ranges from driver identification (or generic information including his/her sex) and emotional state to precluding the reversal of a vehicle unless the driver is watching the rear vision mirror, and to in-vehicle infotainment control, relating to 3D holographic entertainment.

A key priority is to establish validation data for marketing purposes, as the major automotive OEMs typically request validation data. During FY15, Prof Michael Lenné joined SM as GM of Human Factors. His role includes analysing the realms of data generated both from customer installations and academic research projects in conjunction with universities. SM has established two R&D programmes to generate the validation data, in combination with the data generated from existing SM Fleet customers. One of these is with a university and another is with nurses. As well as paying the subjects, SM also is hiring students to tag the data. These projects are a major reason for the significant rise in R&D spend in FY16e. Combined with the information from the SM Fleet product (DSS Mining is only applicable to the off-road environment) SM is building a wealth of data, which is replicating what Mobileye has achieved in the outward-facing camera space. We note that Mobileye has generated validation data for more than 10m miles.

4) Rail (via Caterpillar subsidiaries EMD/Progress Rail)

SM announced a collaboration agreement with Progress Rail, part of Caterpillar, and its unit Electro Motive Diesel, in September 2014. This agreement is expected to cover both OEM (integration into EMD’s systems including Intellitrain) and the aftermarket (retrofit). SM and its partners decided to keep this agreement separate from the revised Caterpillar agreement for reasons of practicality, since the rail market and the product offering are significantly different to the standard DSS markets. SM has several pilots planned with US carriers and Australian mines, and the initial rail trial equipment is set to be installed imminently. The initial installations will involve generating a significant amount of validation data to build a better understanding of the operator in the rail vertical.

5) Simulators and airlines (via Boeing)

SM has been working collaboratively with Boeing Research and Technology (BR&T) for three years, providing the eye tracking technology in a prototype tool that monitors and measures a pilot’s situation awareness. Earlier this year, a jointly-developed solution was installed in a Boeing Flight Services 737 Full Motion Flight Simulator at Brisbane International Airport.

6) Electronics (Samsung)

Seeing Machines (SM) signed an MOU with Samsung Electro-Mechanics Corporation (SEMCo) in September 2014 to jointly development face and eye tracking technology for the consumer electronics industry. While the market is potentially enormous, SM’s allocation of resources to this sector remains modest, and there is currently no visibility on product offerings or revenue.

We have made a number of significant changes to our forecasts. In all, we forecast revenues to rise by 132% to A$44.1m in FY16 (previously A$32.2m), boosted by the Caterpillar deal. This slips to A$42.0m in FY17 (previously A$45.8m), as lower DSS Mining forecasts, partly due to the subdued mining sector, outweigh higher SM Fleet forecasts. Stripping out DSSmining, revenues rise by more than 350% in FY16 to A$16.2m, and nearly double again in FY17 to A$31.7m. We forecast a pre-tax profit of A$0.7m in FY16 (previously A$9.5m loss), boosted by the Caterpillar licence, returning to a loss of A$8.7m in FY17 (previously A$1.7m profit), with strong profitability thereafter.

We forecast the group to end FY16 with net cash of A$6.7m, moving to A$0.5m net debt a year later and returning to A$8.9m net cash at the end of FY18. However, we note that our forecasts are potentially very conservative, as one large SM Fleet sale over the next 18 months would dramatically boost the financials. Further, we believe that SM should be able to securitise its debtor book (ie recurring revenues from the SM Fleet product).

DSS Mining: for the Caterpillar deal we have assumed that A$22m of revenue is recognised in FY16 (based on an exchange rate of US$0.75/A$). The amount is discounted, with the difference released through as a credit in the financing line over the next four years. This increases our net interest line by c A$0.5m in FY16, A$0.4m in FY17 and A$0.3m in FY18. We have also assumed a modest A$0.9m of royalty revenue from the Caterpillar alliance in FY16 relating to sales of hardware and services. We note that it could take a while for Caterpillar to organise logistical aspects, as well as training and selling through the dealerships. Hence, our forecasts are based on sales of 300 units in FY16, rising to 5,000 in FY17 and to 7,500 in FY18. We have assumed A$2m of SM Direct revenue in FY16, as the group transitions its outstanding contracts to Caterpillar. We have also assumed that the remaining DSS product stock will transfer to Caterpillar at a premium.

SM Fleet: we have moved up our forecasts, given the strong pipeline, and signing the Caterpillar deal enables SM’s sales team to refocus on SM Fleet. Our forecasts are based on sales of 6,000 units in FY16, rising to 18,000 in FY17 and to 24,000 in FY18.

DMS automotive: we assume revenues begin to flow from FY17, with the initial customer coming on stream from FY17 and another two from FY18.

Rail: we assume revenues begin to flow from FY17.

Simulators (including airlines): as we have no near-term visibility, we have conservatively ignored this segment.

Electronics: since there is no clarity on any potential revenue streams, we have ignored this.

Integration services: this category represents customer-funded development projects relating to the various divisions. There was one major DMS automotive project in FY15, and we expect another two to come on stream in FY16. We anticipate further projects in FY17, along with potential projects for rail and aviation. This revenue line also includes the legacy faceLAB/FOVIO and faceAPI business, which we now expect to contribute very modest revenues going forward.

Research and development: A$6.6m was expensed in FY15, with a further A$1.5m capitalised, for a total budget of A$8.0m. We expect the total R&D cost to rise to A$12m in FY16, A$14m in FY17 and A$15m in FY18. We assume that 20% of the R&D spend is capitalised and amortised over the subsequent five years.

We assume there are Australian government grants of A$2.5m in FY16, but none thereafter, as the grants no longer apply when Australian revenues exceed A$20m.