Audioeye Inc: Form 10-Q for the period ended Sep 30, 2024

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, should be read in conjunction with our consolidated financial statements and related notes in Part I, Item 1 of this report.

As used in this quarterly report, the terms “we,” “us,” “our” and similar references refer to AudioEye, Inc., unless otherwise indicated.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, including Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In some cases, you may be able to identify forward-looking statements by terms such as “may,” “should,” “will,” “forecasts,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “potential” or “continue,” the negative of these terms and other similar expressions that predict or indicate future events or trends or that are not statements of historical matters. These forward-looking statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions and speak only as of the date on which they are made.

Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results, events or developments to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed in “Part I, Item 1A. Risk Factors” contained in our most recent Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. Risk factors that could cause actual results to differ from those contained in the forward-looking statements include but are not limited to risks related to:

• the uncertain market acceptance of our existing and future products;
• our need for, and the availability of, additional capital in the future to fund our operations and the development of new products;
• the success, timing and financial consequences of new strategic relationships or licensing agreements we may enter into;
• rapid changes in Internet-based applications that may affect the utility and commercial viability of our products;
• the timing and magnitude of expenditures we may incur in connection with our ongoing product development activities;
• judicial applications of accessibility laws to the internet;
• the level of competition from our existing competitors and from new competitors in our marketplace; and
• the regulatory environment for our products and services.

Readers of this report are cautioned not to rely on these forward-looking statements, since there can be no assurance that these forward-looking statements will prove to be accurate. Forward-looking statements speak only as of the date they are made, and we expressly disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. This cautionary note is applicable to all forward-looking statements contained in this report.

AudioEye Solutions

At its core, AudioEye’s offering provides an always-on testing, remediation, and monitoring solution that continually improves conformance with Web Content Accessibility Guidelines (“WCAG”). This in turn helps businesses and organizations comply with WCAG standards as well as applicable U.S. and foreign accessibility laws. Our technology is capable of immediately identifying and fixing most of the common accessibility errors and addresses a wide range of disabilities including dyslexia, color blindness, epilepsy and more. AudioEye also offers additional solutions to provide for enhanced compliance and accessibility, including periodic auditing, human assisted technological remediations and legal support services. Our solutions may be purchased through a subscription service on a month-to-month basis or with one or multi-year terms. We also offer PDF remediation services and mobile application and audit reporting services to help our customers with their digital accessibility needs.

Intellectual Property

Our intellectual property is primarily comprised of copyrights, trademarks, trade secrets, issued patents and pending patent applications. We have a patent portfolio comprised of twenty-three (23) issued patents in the United States and three (3) pending US patent applications. The commercial value of these patents is unknown.

We plan to continue to invest in research and development and expand our portfolio of proprietary intellectual property.

Our Annual Report filed on Form 10-K for the year ended December 31, 2023 as filed with the SEC on March 7, 2024 provides additional information about our business and operations.

Legal and Regulatory Framework Update

On April 24, 2024, the U.S. Department of Justice (“DOJ”) published a rule to add specific requirements about web and mobile application accessibility under Title II of the ADA that would apply to state and local governments. On May 9, 2024, the U.S. Department of Health and Human Services (“HHS”) published a rule to add, among other things, specific requirements about web and mobile application accessibility under Section 504 of the Rehabilitation Act that would apply to recipients of Federal financial assistance.

Executive Overview

AudioEye is an industry-leading digital accessibility platform delivering Americans with Disabilities Act (“ADA”) and WCAG compliance at scale. 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 the three and nine months ended September 30, 2024, we continued to focus on product innovation, expanding revenue and managing expenses.

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 mobile application reporting services and PDF remediation services that provide non-recurring revenue.

For the nine months ended September 30, 2024, total revenue increased by 9% over the prior year comparable period. As of September 30, 2024, Annual Recurring Revenue (“ARR”) was approximately $36.2 million, which represented an increase of 19% year-over-year. Refer to Other Key Operating Metrics below for details on how we calculate ARR.

As of September 30, 2024, AudioEye had approximately 126,000 customers, an 18% increase from 107,000 customers at September 30, 2023. The increase in customer count is attributed to both our Partner and Marketplace and Enterprise channels.

In the nine months ended September 30, 2024, revenue from our Partner and Marketplace channel grew 12% over the prior year comparable period. This channel represented about 58% of ARR at the end of September 2024. In nine months ended September 30, 2024, total Enterprise channel revenue grew 5% over the prior year comparable period. The Enterprise channel represented about 42% of ARR at the end of September 2024.

We had one customer (including the customer’s affiliates reflecting multiple contracts and a partnership with the Company) which accounted for approximately 16% of our total revenue in each of the nine months ended September 30, 2024 and 2023.

The Company continued to invest in research and development in the third quarter of 2024. Total research and development cost, as defined under Research and Development Expenses section in the Results of Operations below, was 20% of total revenue in the nine months ended September 30, 2024. Total research and development cost decreased from the prior year comparable period primarily due to the completion of significant initiatives in research and development.

In the nine months ended September 30, 2024, selling and marketing expense decreased from the prior year comparable period. This decrease was mainly driven by efficiencies in selling and marketing. The increase in general and administrative expenses in the nine months ended September 30, 2024 was due primarily to transaction costs incurred in connection with the acquisition of ADA Site Compliance, as well as an increase in litigation expenses.

We provide further commentary on our Results of Operation below.

Results of Operations

Our unaudited 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 three and nine months ended September 30, 2024 with the three and nine months ended September 30, 2023.

Our results of operations in these interim 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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Revenue

The following tables present our revenues disaggregated by sales channel:

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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 and revenue attributable to ADA Site Compliance, which was acquired in September 2024.

For the three and nine months ended September 30, 2024, total revenue increased by 14% and 9%, respectively, over the prior year comparable periods. The increase in Partner and Marketplace channel revenue for the three and nine months ended September 30, 2024 was primarily due to continued expansion with existing partners. The increase in Enterprise channel revenue for the three and nine months ended September 30, 2024 was driven primarily by an increase in Enterprise customers.

Cost of Revenue and Gross Profit

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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 three and nine months ended September 30, 2024, cost of revenue remained consistent with the prior year comparable periods.

For the three and nine months ended September 30, 2024, gross profit increased by 17% and 11%, respectively, over the prior year comparable periods. The increase in gross profit was a result of increased revenue.

Selling and Marketing Expenses

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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 three months ended September 30, 2024, selling and marketing expenses increased by 9% over the prior year comparable period. The increase in selling and marketing expenses resulted primarily from higher third-party marketing and stock compensation expense. For the nine months ended September 30, 2024, selling and marketing expenses decreased by 3% over the prior year comparable period. This decrease resulted primarily from a reduction in online media and third-party marketing expenses.

Research and Development Expenses

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Research and development (“R&D”) expenses consist primarily of compensation and related benefits, independent contractor costs, and an allocated portion of general overhead 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 three and nine months ended September 30, 2024, research and development expense decreased by 41% and 36%, respectively, from the prior year comparable periods. These decreases were driven by lower personnel cost associated with a realignment in our product and development teams following the completion of significant initiatives in R&D. For the three and nine months ended September 30, 2024, capitalized research and development cost decreased by 10% and 7%, respectively, over the prior year comparable periods. These decreases to capitalized research cost were the result of engineering personnel spending less time on product development than in the prior year comparable periods. For the three and nine months ended September 30, 2024, total research and development cost, which includes both R&D expenses and capitalized R&D costs, decreased by 35% and 30%, respectively, from the prior year comparable periods.

General and Administrative Expenses

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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, occupancy and transaction costs.

For the three and nine months ended September 30, 2024, general and administrative expenses increased by 46% and 11%, respectively, over the prior year comparable periods. The increases in general and administrative expenses were due primarily to transaction costs incurred in connection with the acquisition of ADA Site Compliance, as well as an increase in litigation expenses. For the three and nine months ended September 30, 2024, litigation expenses totaled $840,000 and $1,339,000, respectively.

Interest Income (Expense)

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For the three and nine months ended September 30, 2024, interest expense, net consisted primarily of interest on our term loan borrowed in the fourth quarter of 2023, which was partially offset by interest income from investment in money market funds. For the three and nine months ended September 30, 2023, interest income, net consisted primarily of income from investment in money market funds.

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 annualized recurring fee at the date of determination under each active contract, plus (ii) for our Partner and Marketplace channel, the annual or monthly recurring fee for all active customers at the date of determination, in each case, assuming no changes to the subscription, multiplied by 12 if applicable. Recurring fees are defined as revenues expected to be generated from services typically offered as a subscription service or annual service offering such as our automation and platform, periodic auditing, human-assisted technological fixes, legal support and professional service offerings and other services that reoccur on a multi-year contract. This determination includes both annual and monthly contracts for recurring products. Some of our contracts are terminable prior to the expected term, which may impact future ARR. ARR excludes non-recurring fees, which are defined as revenue expected to be generated from services typically not offered as a subscription service or annual service offering such as our PDF remediation services business, one-time mobile application reports, and other miscellaneous services that are offered as non-subscription services or are expected to be one-time in nature. As of September 30, 2024, ARR was $36.2 million, which represents an increase of 19% year-over-year, driven by growth in both our Partner and Marketplace channel and Enterprise channel.

Liquidity and Capital Resources

Working Capital

(in thousands)

As of September 30, 2024, we had $5,478,000 in cash and working capital of ($2,214,000). The $5.5 million decrease in working capital in the nine months ended September 30, 2024 was primarily due to the acquisition of ADA Site Compliance, for which we made an initial payment of $3.1 million, net of cash received, and recognized $2.3 million in noncurrent note payable.

In November 2023, the Board of Directors adopted a share repurchase program authorizing the repurchase of up to $5 million of our common stock through December 31, 2025. The stock repurchase program may be suspended or discontinued at any time and does not commit the Company to repurchase any dollar amount or particular number of shares of stock. Shares repurchased under the program are subsequently retired and restored to the status of authorized but unissued shares of common stock. In the nine months ended September 30, 2024, we paid $2.02 million in cash to repurchase 299,371 shares of our common stock. As of September 30, 2024, we had $1.86 million remaining for the repurchase of shares.

In the second quarter of 2024, the Company initiated an At The Market offering (“ATM offering”), under which the Company may offer and sell shares of its common stock having an aggregate offering price of up to $7.0 million from time to time. As of September 30, 2024, we had issued 162,524 shares of our common stock and raised $3,473,000, net of transaction expenses, under the ATM offering.

In the second quarter of 2024, we made a $2.4 million cash payment to settle the contingent consideration associated with the BOIA acquisition in full.

As of September 30, 2024, we had $7.0 million in noncurrent term loan which matures on November 30, 2026. As of September 30, 2024, we had Note Payable in the aggregate principal amount of $2.4 million, which matures on November 26, 2024.

As of September 30, 2024, we had 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.

Cash Flows

(in thousands)

For the nine months ended September 30, 2024, in relation to the prior year comparable period, cash provided by operating activities increased primarily due to increased revenue, cost efficiencies associated with lower personnel expense following a realignment in our product and development teams, as well as lower online media and third-party marketing expenses.

For the nine months ended September 30, 2024, in relation to the prior year comparable period, cash used in investing activities increased primarily due to the acquisition of ADA Site Compliance, for which we paid $3.1 million, net of cash acquired.

For the nine months ended September 30, 2024, in relation to the prior year comparable period, cash used in financing activities decreased primarily due to capital raised under the ATM Offering initiated in the second quarter of 2024, under which we issued 162,524 shares of our common stock and raised $3,473,000, net of transaction expenses. The decrease was partially offset by common stock repurchases totaling $2.02 million, as well as higher payouts towards the contingent consideration in connection with the acquisition of BOIA. In the nine months ended September 30, 2024, payments towards this contingent consideration totaled $2,387,000, of which $1,677,000 and $710,000 were classified as cash used in financing and operating activities, respectively. In the nine months ended September 30, 2023, payments towards this contingent consideration totaled $974,000, of which $908,000 and $66,000 were 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 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.

Our critical accounting estimates, as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, relate to stock-based compensation and goodwill, intangible assets and contingent consideration recognized in connection with a business combination. There have been no material changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that there is reasonable assurance that the information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Principal Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Exchange Act Rules 13a-15(e) and 15d-15(e). In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, projections of any evaluation of effectiveness of our disclosure controls and procedures to future periods are subject to the risk that controls or procedures may become inadequate because of changes in conditions, or that the degree of compliance with the controls or procedures may deteriorate.

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s senior management, including the Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures to provide reasonable assurance of achieving the desired objectives of the disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2024.

Changes in Internal Controls over Financial Reporting

During the quarter ended September 30, 2024, there were no material changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

You should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 (“2023 Form 10-K”), which could materially affect our business, financial condition and results of operations. There have been no material changes to the risk factors set forth in the 2023 Form 10-K. The risks described in our 2023 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.