AUDIOEYE INC (AEYE) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our audited consolidated financial statements and the related notes for the years ended December 31, 2023 and 2022 that appear elsewhere in this annual report on Form 10-K. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include but are not limited to those discussed below and elsewhere in this annual report on Form 10-K, particularly in “Risk Factors.” The forward-looking statements included in this annual report on Form 10-K are made only as of the date hereof.
Executive Overview
AudioEye is an industry-leading digital accessibility platform delivering website accessibility compliance at all price points to businesses of all sizes. Our solutions advance accessibility with patented technology that reduces barriers, expands access for individuals with disabilities, and enhances the user experience for a broader audience. In 2023, we continued to focus on product innovation, expanding revenue and managing expenses.
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We have two sales channels to deliver our product, the Partner and Marketplace channel and the Enterprise channel. AudioEye continues to focus on recurring revenue growth in both channels, while still offering our Website and Native Mobile App report services and PDF services that provide non-recurring revenue. For the year ended December 31, 2023, total revenue increased by 5% over the prior year. As of December 31, 2023, Annual Recurring Revenue (“ARR”) was approximately $31.2 million, which represented an increase of 7% from December 31, 2022. Refer to Other Key Operating Metrics below for details on how we calculate ARR.
As of December 31, 2023, AudioEye had approximately 110,000 customers, an increase from 86,000 customers at December 31, 2022. The increase in customer count was driven by additions in the Partner and Marketplace channel.
In the twelve months ended December 31, 2023, revenue from our Partner and Marketplace grew 13% from prior year comparable period. This channel represented about 60% of ARR at the end of December 2023. In the twelve months ended December 31, 2023, total Enterprise revenue, inclusive of revenue from the acquisition of BOIA in March 2022, decreased by 5% due to the reduction in revenue from one large customer. The Enterprise channel represented about 40% of ARR at the end of December 2023.
We had one major customer (including the customer’s affiliates reflecting multiple contracts and a partnership with the Company) which accounted for approximately 17% of our revenue in each of the years ended December 31, 2023 and 2022.
The Company continued to invest in Research and Development in 2023. Total Research and Development cost, as defined under Research and Development section in the Results of Operations below, was 29% of total revenue in 2023. Total research and development cost increased primarily due to additional investments in engineering and product talent.
With revenue for the twelve months ended 2023 increasing 5% from prior year comparable period, both Sales and Marketing expense and General and Administrative expense decreased from 2022. This decrease was mainly driven by efficiencies implemented during the year in these areas and lower stock compensation expense and litigation expense.
We provide further commentary on our Results of Operation below.
Results of Operations
Our consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP” or “GAAP”). The discussion of the results of our operations compares the year ended December 31, 2023 with the year ended December 31, 2022. Our results of operations in these periods are not necessarily indicative of the results which may be expected for any subsequent period. Due to rounding, numbers presented throughout this document may not add up precisely to the totals provided and percentages may not precisely reflect the absolute figures.
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| | | Year ended | | | ||||||||
| | | December 31, | | Change | ||||||||
| (in thousands) | | 2023 | | 2022 | | $ | | % | ||||
| Revenue | $ | 31,316 | $ | 29,913 | $ | 1,403 | | 5 | % | |||
| Cost of revenue | | (6,974) | | (7,219) | | 245 | | (3) | % | |||
| Gross profit | | 24,342 | | 22,694 | | 1,648 | | 7 | % | |||
| Operating expenses: | | | | | | | | | | |||
| Selling and marketing | | 11,781 | | 13,657 | | (1,876) | | (14) | % | |||
| Research and development | | 6,989 | | 6,085 | | 904 | | 15 | % | |||
| General and administrative | | 11,537 | | 13,381 | | (1,844) | | (14) | % | |||
| Total operating expenses | | 30,307 | | 33,123 | | (2,816) | | (9) | % | |||
| Operating loss | | (5,965) | | (10,429) | | 4,464 | | (43) | % | |||
| Interest income (expense), net | | | 93 | | | (4) | | | 97 | | (2,425) | % |
| Net loss | | $ | (5,872) | | $ | (10,433) | | $ | 4,561 | | (44) | % |
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Revenue
The following table presents our revenues disaggregated by sales channel:
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|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Year ended December 31, | Change | ||||||||||
| (in thousands) | | 2023 | | 2022 | | $ | | % | ||||
| Partner and Marketplace | | $ | 18,027 | | $ | 15,972 | | $ | 2,055 | | 13 | % |
| Enterprise | | 13,289 | | 13,941 | | (652) | | (5) | % | |||
| Total revenues | | $ | 31,316 | | $ | 29,913 | | $ | 1,403 | | 5 | % |
Partner and Marketplace channel consists of our CMS partners, platform & agency partners, authorized resellers and the Marketplace. This channel serves small & medium sized businesses that are on a partner or reseller’s web-hosting platform or that purchase our solutions from our Marketplace.
Enterprise channel consists of our larger customers and organizations, including those with non-platform custom websites, who generally engage directly with AudioEye sales personnel for custom pricing and solutions. This channel also includes federal, state and local government agencies.
For the year ended December 31, 2023, total revenue increased by 5% over the prior year. The increase in Partner and Marketplace channel revenue was the result of continued expansion with existing partners and execution of new partnerships agreements in the period. The decrease in Enterprise channel revenue was driven primarily by the reduction in revenue from one large customer.
Cost of Revenue and Gross Profit
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|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year ended December 31, | | Change | ||||||||
| (in thousands) | | 2023 | 2022 | $ | % | |||||||
| Revenue | | $ | 31,316 | | $ | 29,913 | | $ | 1,403 | | 5 | % |
| Cost of revenue | | (6,974) | | (7,219) | | 245 | | (3) | % | |||
| Gross profit | | $ | 24,342 | | $ | 22,694 | | $ | 1,648 | | 7 | % |
Cost of revenue consists primarily of compensation and related benefits costs for our customer experience team, as well as a portion of our technology operations team that supports the delivery of our services, fees paid to our managed hosting and other third-party service providers, amortization of capitalized software development costs and patent costs, and allocated overhead costs.
For the year ended December 31, 2023, cost of revenue decreased by 3% over the prior year. The decrease in cost of revenue is primarily due to efficiencies achieved from infrastructure platform improvements and lower overhead costs from facilities.
For the year ended December 31, 2023, gross profit increased by 7% over the prior year. The increase in gross profit was a result of increased revenue with a corresponding decrease to cost of revenue.
Selling and Marketing Expenses
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| | Year ended | | | |||||||||
| | | December 31, | | Change | | |||||||
| (in thousands) | | 2023 | 2022 | $ | % | |||||||
| Selling and marketing | | $ | 11,781 | | $ | 13,657 | | $ | (1,876) | | (14) | % |
Selling and marketing expenses consist primarily of compensation and benefits related to our sales and marketing staff, as well as third-party advertising and marketing expenses.
For the year ended December 31, 2023, selling and marketing expenses decreased by 14% over the prior year. The decrease in selling and marketing expenses resulted primarily from a reduction in online media and third-party marketing expenses and a reduction to stock compensation expense which was partially offset by higher personnel costs.
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Research and Development
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| | | Year ended | | | ||||||||
| | | December 31, | | Change | | |||||||
| (in thousands) | 2023 | 2022 | $ | % | ||||||||
| Research and development expense | | $ | 6,989 | | $ | 6,085 | | $ | 904 | | 15 | % |
| Plus: Capitalized research and development cost | | 1,946 | | 1,160 | | 786 | | 68 | % | |||
| Total research and development cost | | $ | 8,935 | | 7,245 | | $ | 1,690 | | 23 | % |
Research and development (“R&D”) expenses consist primarily of compensation and related benefits, independent contractor costs, and an allocated portion of general overhead costs, including occupancy costs related to our employees involved in research and development activities. Total research and development cost includes the amount of research and development expense reported within operating expenses as well as development cost that was capitalized during the fiscal period.
For the year ended December 31, 2023, research and development expenses increased by 15% over the prior year. This increase was driven by higher personnel cost. For the year ended December 31, 2023, capitalized research and development cost increased by 68% over the prior year. The increase to capitalized research cost was the result of engineering personnel spending more time on product development than in previous comparable periods. Total research and development cost, which includes both R&D expenses and capitalized R&D costs, increased 23% from 2022 to 2023.
General and Administrative Expenses
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|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Year ended | | ||||||||||
| | | December 31, | | Change | | |||||||
| (in thousands) | | 2023 | 2022 | | $ | % | ||||||
| General and administrative | | $ | 11,537 | | $ | 13,381 | | $ | (1,844) | | (14) | % |
General and administrative expenses consist primarily of compensation and benefits related to our executives, directors and corporate support functions, general corporate expenses including legal fees, and occupancy costs.
For the year ended December 31, 2023, general and administrative expenses decreased by 14% over the prior year. The decrease in general and administrative expenses was due primarily to lower legal expenses towards non-recurring litigation and lower stock compensation expense.
Interest Expense
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| | | Year ended | | | | |||||||
| | December 31, | Change | ||||||||||
| (in thousands) | | 2023 | 2022 | | $ | % | ||||||
| Interest income (expense), net | | $ | 93 | | $ | (4) | | $ | 97 | | (2,425) | % |
For the year ended December 31, 2023, interest income, net consisted primarily of income from investment in money market funds, which was partially offset by interest on our term loan acquired in the fourth quarter of 2023. For the year ended December 31, 2022, interest expense consisted of interest on our finance lease liabilities.
Other Key Operating Metrics
We consider annual recurring revenue (“ARR”) as a key operating metric and a key indicator of our overall business. We also use ARR as one of the primary methods for planning and forecasting overall expectations and for evaluating, on at least a quarterly and annual basis, actual results against such expectations.
We define ARR as the sum of (i) for our Enterprise channel, the total of the annual recurring fee under each active contract at the date of determination, plus (ii) for our Partner and Marketplace channel, the monthly fee for all active customers at the date of determination, in each case, assuming no changes to the subscription, multiplied by 12. This determination includes both annual and monthly contracts for recurring products. Some of our contracts are cancelable, which may impact future ARR. ARR excludes revenue from our PDF remediation services business, one-time Website and Mobile App report services business and other miscellaneous non-
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recurring services. As of December 31, 2023, ARR was $31.2 million, which represents an increase of 7% year-over-year, driven by growth in our Partner and Marketplace channel.
Use of Non-GAAP Financial Measures
From time to time, we review adjusted financial measures that assist us in comparing our operating performance consistently over time, as such measures remove the impact of certain items, as applicable, such as our capital structure (primarily interest charges), items outside the control of the management team (taxes), and expenses that do not relate to our core operations, including transaction and litigation-related expenses and other costs that are expected to be non-recurring. In order to provide investors with greater insight and allow for a more comprehensive understanding of the information used in our financial and operational decision-making, the Company has supplemented the consolidated financial statements presented on a GAAP basis in this Annual Report on Form 10-K with the following non-GAAP financial measures: Adjusted EBITDA, Adjusted EBITDA margin, and Adjusted earnings (loss) per diluted share.
These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of Company results as reported under GAAP. The Company compensates for such limitations by relying primarily on our GAAP results and using non-GAAP financial measures only as supplemental data. We also provide a reconciliation of non-GAAP to GAAP measures used. Investors are encouraged to carefully review this reconciliation. In addition, because these non-GAAP measures are not measures of financial performance under GAAP and are susceptible to varying calculations, these measures, as defined by us, may differ from and may not be comparable to similarly titled measures used by other companies.
Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Earnings (Loss) per Diluted Share
We define: (i) Adjusted EBITDA as net income (loss), plus (less) interest expense (income), plus depreciation and amortization expense, plus stock-based compensation expense, plus non-cash valuation adjustment to contingent consideration, plus certain litigation expense, plus certain acquisition expense, plus executive team restructuring cost, and plus loss on disposal or impairment of long-lived assets; (ii) Adjusted EBITDA margin as Adjusted EBITDA as a percentage of GAAP revenue; and (iii) Adjusted earnings (loss) per diluted share as net income (loss) per diluted common share, plus (less) interest expense (income), plus depreciation and amortization expense, plus stock-based compensation expense, plus non-cash valuation adjustment to contingent consideration, plus certain litigation expense, plus certain acquisition expense, plus executive team restructuring cost, and plus loss on disposal or impairment of long-lived assets, each on a per share basis. Adjusted earnings per diluted share would include incremental shares in the share count that are considered anti-dilutive in a GAAP net loss position. However, no incremental shares apply when there is an Adjusted loss per diluted share, as is the case for one of the periods presented in this Annual Report on Form 10-K.
Adjusted EBITDA, Adjusted EBITDA margin, and Adjusted earnings (loss) per diluted share are used to facilitate a comparison of our operating performance on a consistent basis from period to period and provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone. All of the items adjusted in the Adjusted EBITDA to net loss and the Adjusted earnings (loss) per share calculations are either recurring non-cash items, or items that management does not consider in assessing our on-going operating performance. In the case of the non-cash items, such as stock-based compensation expense and valuation adjustments to assets and liabilities, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are expected to be less susceptible to variances in actual performance resulting from expenses that do not relate to our core operations and are more reflective of other factors that affect operating performance. In the case of items that do not relate to our core operations, management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact does not reflect ongoing operating performance.
Adjusted EBITDA is not a measure of liquidity under GAAP, or otherwise, and is not an alternative to cash flow from continuing operating activities, despite the advantages regarding the use and analysis of these measures as mentioned above. Adjusted EBITDA, Adjusted EBITDA margin, and Adjusted earnings (loss) per diluted share, as disclosed in this Annual Report on Form 10-K, have limitations as analytical tools, and you should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP; nor are these measures intended to be measures of liquidity or free cash flow for our discretionary use.
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To properly and prudently evaluate our business, we encourage readers to review the consolidated GAAP financial statements included elsewhere in this Annual Report on Form 10-K, and not rely on any single financial measure to evaluate our business. The following table sets forth reconciliations of Adjusted EBITDA to net loss, the most directly comparable GAAP-based measure, and Adjusted earnings (loss) per diluted share to net loss per diluted share, the most directly comparable GAAP-based measure.
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|---|---|---|---|---|---|---|---|
| | Year ended | ||||||
| | | December 31, | | ||||
| (in thousands, except per share data) | | 2023 | 2022 | ||||
| Adjusted EBITDA Reconciliation | | | | | | ||
| Net loss (GAAP) | | $ | (5,872) | | $ | (10,433) | |
| Non-cash valuation adjustment to contingent consideration | | 442 | | 346 | | ||
| Interest (income) expense, net | | (93) | | 4 | | ||
| Stock-based compensation expense | | 3,698 | | 4,566 | | ||
| Acquisition expense (1) | | — | | 247 | | ||
| Litigation expense (2) | | | 415 | | | 1,916 | |
| Executive team restructuring cost (3) | | | 247 | | | 246 | |
| Depreciation and amortization | | | 2,268 | | | 2,111 | |
| Loss on disposal or impairment of long-lived assets | | | 235 | | | 51 | |
| Adjusted EBITDA | | $ | 1,340 | | $ | (946) | |
| Adjusted EBITDA margin (4) | | | 4 | % | | (3) | % |
| | | | | | | | |
| Adjusted Earnings (Loss) per Diluted Share Reconciliation | | | | | | ||
| Net loss per common share (GAAP) — diluted | | $ | (0.50) | | $ | (0.91) | |
| Non-cash valuation adjustment to contingent consideration | | 0.04 | | 0.03 | | ||
| Interest (income) expense, net | | (0.01) | | — | | ||
| Stock-based compensation expense | | 0.31 | | 0.40 | | ||
| Acquisition expense (1) | | — | | 0.02 | | ||
| Litigation expense (2) | | | 0.04 | | | 0.17 | |
| Executive team restructuring cost (3) | | | 0.02 | | | 0.02 | |
| Depreciation and amortization | | | 0.19 | | | 0.18 | |
| Loss on disposal or impairment of long-lived assets | | | 0.02 | | | — | |
| Adjusted earnings (loss) per diluted share (5) | | $ | 0.11 | | $ | (0.08) | |
| Diluted weighted average shares (GAAP) | | 11,766 | | 11,477 | | ||
| Includable incremental shares (Non-GAAP) (5) | | | 338 | | | — | |
| Adjusted diluted shares (Non-GAAP) (6) | | | 12,104 | | | 11,477 | |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | Represents legal and accounting fees associated with the BOIA acquisition. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (2) | Represents legal expenses related primarily to non-recurring litigation pursued by the Company. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (3) | Represents severance expense associated with the restructuring in executive roles. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (4) | Net loss as a percentage of GAAP revenues, which is the GAAP-based measure most comparable to Adjusted EBITDA margin, was (19)% and (35)%, respectively, for the years ended December 31, 2023 and 2022. Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of GAAP revenue. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (5) | Adjusted earnings per adjusted diluted share for our common stock is computed using the treasury stock method. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (6) | The number of diluted weighted average shares used for this calculation is the same as the weighted average common shares outstanding share count when the Company reports a GAAP net loss and a negative Adjusted EBITDA. |
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Liquidity and Capital Resources
Working Capital
As of December 31, 2023, we had $9.2 million in cash and working capital of $3.2 million. The increase in working capital in 2023 was primarily due to our $7 million term loan acquired in the fourth quarter of 2023, and was partially offset by the $1.4 million increase in current liability associated with the contingent consideration relating to the BOIA earn-out as the final payment is expected to be settled in the second quarter of 2024.
On February 11, 2021, we entered into an At The Market (“ATM”) Sales Agreement with B. Riley Securities, Inc. (“Agent”), under which the Company may offer and sell, from time to time at its sole discretion, shares of its common stock to or through the Agent as its sales agent, having an aggregate offering price of up to $30 million. In 2021, the Company issued 471,970 shares of its common stock under the ATM offering and raised $16,534,000, net of transaction expenses. No shares of common stock were sold under the ATM offering in 2023 or 2022.
As of December 31, 2023, we had $2.4 million in current contingent consideration liability recognized in connection with the acquisition of BOIA, and $7.0 million in noncurrent term loan which matures on November 30, 2026. We have no off-balance sheet arrangements, and we believe that the Company has sufficient liquidity to continue as a going concern through the next twelve months.
While the Company has been successful in raising capital, there is no assurance that it will be successful at raising additional capital in the future. Additionally, if the Company’s plans are not achieved and/or if significant unanticipated events occur, the Company may have to further modify its business plan, which may require us to raise additional capital or reduce expenses.
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| | At December 31, | |||||
| (in thousands) | | 2023 | 2022 | |||
| Current assets | | $ | 14,776 | | $ | 12,966 |
| Current liabilities | | (11,529) | | (11,062) | ||
| Working capital | | $ | 3,247 | | $ | 1,904 |
Cash Flows
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|---|---|---|---|---|---|---|
| | | Year ended | ||||
| | | December 31, | ||||
| (in thousands) | | 2023 | | 2022 | ||
| Net cash provided by (used in) operating activities | $ | 318 | $ | (4,999) | ||
| Net cash used in investing activities | | (2,156) | | (5,733) | ||
| Net cash provided by (used in) financing activities | | 4,170 | | (1,330) | ||
| Net increase (decrease) in cash | | $ | 2,332 | | $ | (12,062) |
For the year ended December 31, 2023, in relation to the prior year, cash provided by operating activities increased primarily due to lower patent litigation costs and a reduction in sales and marketing costs, driven mainly by lower digital, consulting and third-party costs.
For the year ended December 31, 2023, in relation to the prior year, cash used in investing activities decreased primarily due to the acquisition of BOIA in 2022, for which we paid $4.5 million, net of cash acquired and receipts associated with net working capital adjustments. Cash used for investing activities in 2023 related primarily to cash outlays for software development costs.
For the year ended December 31, 2023, in relation to the prior year, cash provided by financing activities increased due to a $7.0 million term loan obtained in November 2023. This increase was partially offset by a $366,000 increase in stock repurchases in 2023, as well as $974,000 payment towards our contingent consideration in the first quarter of 2023 in connection with the acquisition of BOIA, of which $908,000 and $66,000 are classified as cash used in financing and operating activities, respectively.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with the accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the amounts
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reported and disclosed in our consolidated financial statements and the accompanying notes. Actual results could differ materially from these estimates under different assumptions or conditions.
The critical accounting estimates discussed below are estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations.
Stock-Based Compensation
Awards with performance conditions
Compensation expense related to performance-based options and RSUs is recognized on a straight-line basis over the requisite service period, provided that it is probable that performance conditions will be achieved. Management periodically assesses the probability of achievement of each performance condition. Expense recognition only starts when achievement is deemed probable, and the amount recognized in each reporting period varies based on the expected timing of performance completion. Changes in expectations and outcomes different from estimates (such as the achievement or non- achievement of performance conditions) may cause a significant adjustment to earnings in a reporting period as timing and amount of expense recognition is highly dependent on management’s estimate.
Awards with market conditions
We estimate the fair value and requisite service period of market-based restricted stock unit awards as of the grant date based on the Monte Carlo simulation model with the assistance of an independent third-party valuation specialist. The Monte Carlo simulation model is built on certain assumptions, including our stock volatility. We cannot predict the prices at which our common stock will trade in the future and achievement of market conditions may occur in period different that estimated. Compensation costs related to awards with market conditions are recognized on a straight-line basis over the requisite service period regardless of whether the market condition is satisfied and is not reversed provided that the requisite service period derived from the Monte-Carlo simulation has been completed.
Goodwill, Intangible Assets and Contingent Consideration recognized in connection with a Business Combination
We recognize intangible assets acquired in connection with business combinations based on their fair value at acquisition, which is determined by management with the assistance a third-party valuation specialist. Acquired intangible assets are amortized on a straight-line basis over their estimated useful.
We also recognize the contingent consideration liability resulting from a business combination based on its fair value, which is determined both initially and in each reporting period preceding the end of the measurement period using the Monte-Carlo simulation model. The model incorporates key assumptions, including non-recurring and recurring revenue metrics. Changes in estimated revenue and outcomes different from estimates could cause a significant adjustment to earnings in a reporting period as the fair value of the liability is highly dependent on management’s estimate.
Goodwill is recorded based on the excess of purchase price over the estimated fair value of net assets acquired and is not amortized. The value of goodwill is highly dependent on the assessed fair value of intangible assets and contingent consideration liability at acquisition. Both intangible assets and goodwill are evaluated periodically for impairment.
Refer to Note 2 - Significant Accounting Policies to our consolidated financial statements for a complete discussion of the significant accounting policies and methods used in the preparation of our consolidated financial statements, including our accounting policies related to stock-based compensation and intangible assets.