More Problems at Knightscope - A Supplemental Report

Initial Disclosure: After extensive research, we have taken a short position in shares of Knightscope Inc (NASDAQ: KSCP). This report represents our opinion and is not financial advice. Do your own due diligence and don't take financial advice from strangers on the internet. Please read our full disclaimer at the bottom of this report.

• Large scale dilution: shares outstanding increased by more than 50% in 3 months.
• Despite spending big on robots, the most of the revenue growth isn’t from robots sales.
• Stock price is supported by heavy promotion targeting retail investors.
  • Almost daily PRs of new contracts with no details
  • Google ads
• Knightscope stopped reporting important KPIs after Q3 2021. We believe this is an intentional effort to obscure the true economics of the business and hide poor performance. 2021, 2020, 2019, 2018
• Sales of call boxes is subsidizing the failed robot biz.
• Call boxes are a highly competitive, low-margin business.
• We believe the company has insufficient cash-on-hand to service its existing contracts and will need to raise more capital.
• From reviewing Knightscope contracts and speaking with customers, we believe Knightscope is discounting their products to boost sales.
• Sales are further boosted through expensive financing deals to help customers afford the robots.
• On top of the finance discount, when a customer defaults on their financing, Knightscope assumes 50% of the loss.
• The financing deals worsen the unit economics of the business which already has negative gross margins.
• Snuck in a Bond offering to retail of $10mln (Noteworthy they mentioned this at the very end of a prerecorded video but unheard in their earnings report)
• Knightscope’s independent auditor, BPM, included a going concern warning with their opinion.
• If Knightscope goes bankrupt, like Li’s previous company, common shareholders will get nothing because they’re liquidation rights are superseded by debt holders and 4 classes of preferred shares.
• We believe the interests of management are not aligned with other shareholders and that common shareholders bear substantially all the risk of the Company failing.
• While the company performed poorly in 2022, CEO Li and his wife were paid over $2 million by Knightscope. Li even received a substantial raise.
• Management owns a minority of shares but has virtual control of the Company through super-voting shares that get 10 votes each.
• There are numerous red flags which indicate accounting issues and lead us to question the accuracy of the Company’s financial statements.
• Knightscope disclosed material weaknesses in internal controls over financial reporting in years 2022[1][2], 2021, 2020, 2019, 2017, 2016, 2015, 2014.
• On January 26, 2023, half of the non-employee directors voluntarily resigned from the Company’s board.
• After repeated accounting challenges, Knightscope hired Mallorie Burak as CFO, who was fired from her last role for what the CEO alleged were significant material weaknesses in internal control.
• CFO Mallorie Burak is neither a licensed CPA nor a CFA.
• Knightscope changed auditors on Nov. 2 2020 while the annual audit was likely underway. The Company switched from E&Y to the less reputable firm BPM LLP.
• Knightscope’s new auditor, BPM LLP, was censured and fined $50k less than a month ago by the PCAOB. The partner in question is the same one responsible for the Knightscope audit.

Dilution Update

ATM

As per our initial report, we were confident Knightscope would have to dilute shares through its ATM agreement. And as expected they did. From July 1, 2023 to August 11, 2023, the Company sold 3,764,215 shares of Class A Common Stock.

source: https://www.sec.gov/Archives/edgar/data/1600983/000141057823001838/tmb-20230630x10q.htm

In just the last 3 months, shares outstanding increased from 43,917,405 to 67,267,946! (May 2nd to August 5th)

Convertible Notes

Company has also resorted to doing toxic convertible note deals which allow shares to be issued at a discount to the market in this case the deal was done at 85% of the VWAP of the Common Stock. In essence Note holders would always be converting and selling shares for a profit. The lower the price goes, the more shares can be issued. And as of the latest 10-Q we can now see the extent to which this caused dilution.

This led to 10,432,428 shares being converted and sold into market, for just $6 million at a conversion price of ~0.58

After all this dilution, Knightscope’s balance sheet is still in bad shape. Knightscope 10-Q 2023-06-30

Problems With Cash Flow

In our original report we reiterated the fact that one of Knightscope’s main issues is their cash burn and low levels of cash on hand. Based on the Q2 numbers, we estimate they have ~$2.9m cash on hand as of Aug 15 2023. Barely enough to last until the end of the quarter.

To alleviate their cash problem, Knightscope has been selling their future income streams to a financing company for up-front cash. This has allowed the company to continue operating despite mounting losses. The big problem is, the company is spending money that it needs to service the contracts it’s already sold. This strategy is not sustainable, and we believe the company will need to raise significant amounts of capital to fill the growing deficit.

Problems With Margins

Net Margin Q2 2023 vs. Q1 2023: The net margin worsened from -84.41% in Q1 2023 to -134.61% in Q2 2023. For a company with negative margins and limited revenue growth, profitability looks like a distant dream.

Disappearing KPIs for Robot Business

After Q3 2021, Knightscope stopped reporting essential KPIs for the robot business. We believe this is an intentional effort to obscure the true economics of the business and hide poor performance. 2021, 2020, 2019, 2018

Discounting Robots and Bad Financing Practices

To generate sales, Knightscope is heavily discounting their products. Additionally, when a customer finances their purchase, Knightscope applies another 9-12% discount to compensate the financing company, Dimension Funding LLC.

source: https://www.sec.gov/Archives/edgar/data/1600983/000110465921059135/tm2113857d1_ex6-6.htm#:~:text=15.,Pricing

On top of the 9-12% financing fee, Knightscope assumes 50% of the loss when a customer defaults

source: https://www.sec.gov/Archives/edgar/data/1600983/000110465921059135/tm2113857d1_ex6-6.htm#:~:text=14.,Default

Revenue Contribution from Robotics

Despite being a robotics-oriented company, Knightscope’s robotics (ASR) revenue remains relatively modest. In the most recent reporting period, revenue directly attributed to ASRs increased by approximately $0.1 million. This indicates that while robotics is a central aspect of their branding, it currently accounts for a relatively small portion of their overall revenue.

CASE Acquisition

A key driver of Knightscope’s recent revenue growth stems from its strategic acquisition of CASE. The integration of CASE’s capabilities has significantly bolstered the company’s revenue. Maintenance and service revenue has increased by approximately $0.7 million. This can be attributed to services related to installed Blue Light Towers, E-Phones, Call Box products, and the deployed ASRs. This shift in revenue composition highlights the strategic importance of diversification beyond core robotic offerings.

In essence, while Knightscope’s branding highlights robotics as a central focus, the revenue generated from ASRs is relatively limited. The acquisition of CASE has emerged as a key driver of recent revenue growth and not their robots.

Accounting Problems

There are numerous red flags which indicate accounting issues and lead us to question the accuracy of the company’s financial statements.

Repeated Material Weaknesses in Internal Controls

Knightscope has disclosed instances of material weaknesses in internal controls over financial reporting in years 2022 [1][2], 2021, 2020, 2019, 2017, 2016, 2015, 2014. The company claimed repeatedly to have fixed the deficiencies only to disclose problems again soon after.

After repeated accounting challenges, Knightscope hired Mallorie Burak as CFO, who was fired from her last role for what the CEO alleged were significant material weaknesses in internal control. Further, Burak is neither a licensed CPA nor a CFA.

Prior Financials “should not be relied upon”

The company even disclosed that the financials from 2014, 2015, 2016 “should not be relied upon”.

source: Knightscope; Form 1-U; 2017-09-20

Issues with CFO

After repeated accounting challenges, Knightscope hired Mallorie Burak as CFO. Burak is neither a licensed CPA nor a CFA.

Burak’s was previously the CFO of Thin Film Electronics. Thin Film’s CEO stated that Burak was terminated for “her significant error in forecasting company cash” and for the theft of $236,000 by a computer hacker, “largely attributable to Ms. Burak’s failure to maintain adequate safeguards and approval protocols for the transfer of large sums of money”.

Burak then went on to sue Thin Film, which was on the brink of insolvency, to get liquidation preferences for her severance pay over the claims of creditors and shareholders.

source: MALLORIE BURAK VS THIN FILM ELECTRONICS INC, Case No. 20CV367979

Switched to Less Reputable Auditor

In 2020, Knightscope switched auditors from E&Y to the less reputable firm BPM LLP. This coincided with many of the accounting issues we’ve highlighted which we believe contributed to the company’s decision to switch auditors.

Switched While Annual Audit was Likely Underway

Further, Knightscope changed auditors on Nov. 2 2020 while the annual audit was likely underway. Changing auditors at the end of the year is highly unusual and often indicates problems with a company’s accounting.

source: https://www.sec.gov/Archives/edgar/data/1600983/000110465920121491/tm2035080d1_1u.htm

New Auditor Censured and Fined by PCAOB

Knightscope’s new auditor, BPM LLP, was censured and fined $50k less than a month ago by the PCAOB for falsely claiming to be an “independent” auditor when in fact the firm had been providing services to the client. The audit partner in question is the same one responsible for Knightscope’s audit.

source: Order Instituting Disciplinary Proceedings, Making Findings, and Imposing Sanctions, In the Matter of BPM LLP; PCAOB; 2023-07-28

CEO Compensation

Knightscope CEO William Santana Li presents himself to investors as a large shareholder, and often stresses how important it is for him to work on getting the stock price up.

However, while the company performed poorly in 2022, CEO Li and his wife, whose also an executive at Knightscope, were paid over $2 million by the company. Despite the company’s horrible performance and plummeting share price, Li’s pay more than doubled from the year before. Both Li and his wife received substantial bonuses.

Li’s primary goal appears to be to keep the company afloat and continue to draw an egregious compensation. His latest move is to raise funds through a “Retail Bond Offering”.

Given his outsized compensation and super-voting shares (10 votes / share), we believe Li’s interests do NOT align with other shareholders.

source: Knightscope Voting Rights

Bond Offering Targeting Retail Investors

Knightscope is looking to raise $10 million through a “Bond Offering” targeted at retail investors. Because of the deteriorating financials, we believe the Company is finding it difficult to raise from institutional investors. Adding to the Company’s difficulties, they’re paying exorbitant fees in the bond offering, lowering the actual amount raised by the company to approximately 90% of the nominal offering amount, based on estimates from the Company’s disclosures.

Going Concern Warning

Given Knightscope’s financial difficulties, we believe it’s important to note the auditor’s disclosure about “substantial doubt about the Company’s ability to continue as a going concern”.

source: Knightscope; PRELIMINARY OFFERING CIRCULAR; AUGUST 14, 2023

If Knightscope goes bankrupt, like Li’s previous company, Carbon Motors, common shareholders will likely get nothing because they’re liquidation rights are superseded by debt holders and 4 classes of preferred shares.

source: Knightscope; DESCRIPTION OF CAPITAL STOCK

Continued Stock Promotion Targeting Retail Investors

Knightscope continues to put out press releases of new contracts/deals. The PR are often vague and lack details necessary to evaluate the announced deal. We believe these PRs are designed primarily to promote the stock and lure in unsophisticated investors.

https://pressreach.com/featured/knightscope-inc/lp-s1d

Knightscope has also targeted retail investors through Google ads. In fact, when we Googled “What stock should I buy” or “Best AI Stock”, Knightscope was the first ad shown at the top of the search results.

Clicking on the ad loads a promotional fluff piece for which Knightscope is paying $260,000.

• KSCP