Audioeye Inc Q2 FY2023 Earnings Call

Good afternoon, and welcome to AudioEye's Second Quarter 2023 Earnings Conference Call. Joining us for today's call are AudioEye's CEO, Mr. David Moradi, and CFO, Ms. Kelly Georgevich. Following their remarks, we will open the call for questions from the Company's publishing analysts. I would like to remind everyone that this call will be recorded and made available for replay via a link available in the Investor Relations section of the Company's website at www.audioeye.com. Before I turn the call over to AudioEye's Chief Executive Officer, the Company would like to remind all participants that such statements made by AudioEye management during the course of this conference call that are not historical facts are considered to be forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for such forward-looking statements. The words believe, expect, anticipate, estimate, confidence, will, and other similar statements of expectation identify forward-looking statements. These statements are predictions, projections, or other statements about future events and are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of the factors discussed in today's press release and the comments made during this conference call and in the Risk Factors section of the Company's annual report on Form 10-K, its quarterly report on Form 10-Q and its other reports and filings with the Securities and Exchange Commission. Participants on this call are cautioned not to place undue reliance on these forward-looking statements, which reflect management's belief only as of the date hereof. AudioEye does not undertake any duty to update or correct any forward-looking statements. Further, management's remarks today will include certain non-GAAP financial measures. A reconciliation of the most directly comparable GAAP financial measures to these non-GAAP financial measures is available in the Company's earnings release posted in the Investor Relations section of its website at www.audioeye.com. Now, I'd like to turn the call over to AudioEye's Chief Executive Officer, Mr. David Moradi. Sir, please proceed.

Thank you, operator. Welcome, everyone, and thank you for joining us. There have been several developments over the last three months, and I'm excited to talk with you about them today. But before I do, I want to highlight our solid financial performance and continued focus on efficiencies. We are pleased to announce record revenue of $7.84 million in the second quarter. At the end of the second quarter, annual recurring revenue, or ARR, was $29.7 million. As discussed previously, our results in the first half of 2023 were impacted by certain contract renegotiations. Despite these renegotiations, we are pleased with sequential revenue and ARR growth and are excited about expected ARR acceleration in the second half. In the second quarter, gross margins were 77%, and gross profit increased to $6 million versus $5.7 million year-over-year, representing a 100% flow-through of additional revenue into gross profit. Continuing to focus on efficiencies, we expect to increase gross margin further in 2024 as we grow revenues. Revenue increased by 4% year-over-year while operating expenses decreased by 3%. Our CFO, Kelly, will discuss the financial performance in more detail shortly. As we have said, we believe we are in the early innings of digital accessibility. 97% of websites today remain inaccessible to people with disabilities despite increased litigation under the Americans with Disabilities Act. Last week, the Department of Justice issued a proposed rule on website accessibility under Title II of the ADA. The rule would help ensure people with disabilities have equal access to web content and mobile apps. The proposed rule will drive more awareness and compliance, and we are well positioned as we already work with over 900 government organizations and school districts. As a reminder, the European Accessibility Act previously required all EU member states to adopt laws for companies offering many types of products and services, including websites and e-commerce services to ensure accessibility. In the EU, companies must provide accessible websites by June of 2025, and the act requires member states to enforce the accessibility requirements. In June, AudioEye shared findings from a collaborative initiative with accessibility experts from the disability community on the effectiveness and impact of generative AI on identifying, fixing, and communicating accessibility issues that typically require expert review. AudioEye's accessibility experts, including those who rely on assistive technology, found that AI could reduce the time needed to assess and correct complex accessibility issues, such as determining whether a link is clear and accurate, by up to 10 times. We are currently incorporating AI into our processes and believe there is tremendous potential to increase speed and accuracy in the future. The North Star for AI is when someone with a disability can't distinguish between an experience crafted by an accessibility expert or created by an expert using AI. That's the only bar that will allow anyone to claim they solve digital accessibility at scale with AI, and make no mistake, it's a very high bar. We only meet this need by involving the disability community from day one, getting continuous feedback, and actively investing in improving our capabilities over time. In addition to our findings and initiatives on AI, we recently announced the development and expansion of AudioEye's digital accessibility platform with new enterprise-grade accessibility offerings. The expansion of our product solution includes AudioEye's new accessibility maturity management program and the accessibility health advisers. These program controls use our team of certified experts to assess the company's current level of accessibility and help define the investments required to make measurable, sustainable progress in accessibility. Our accessibility maturity management program identifies the people, culture, processes, and system changes an organization needs to perform to make accessibility a first-class concern and track progress towards these goals. When new regulations change accessibility guidelines, the health adviser notifies the company of any changes required to comply. This first-of-its-kind program, corresponding tools, and the further development of AI automation will be powerful drivers in increasing accessibility at scale. In addition to our R&D efforts this quarter, I am pleased to confirm that we recently completed the integration of the Bureau of Internet Accessibility, which was acquired in March of '22. We are delighted to have fully integrated BoIA, which will help enable retention and upsells and result in cost savings in the near term. Going forward, we expect the product offering to primarily generate ARR under our subscription model instead of nonrecurring audit revenue. The impact of the integration of BoIA will reduce third quarter revenue by approximately $200,000 as we transition one-time audits into recurring revenue. Each quarter, we continue to bring on talent and advocates that contribute to AudioEye's success in the future. In July, we were thrilled to announce the addition of former United States Congresswoman for Arizona's 8th Congressional District, Gabby Giffords, to our advisory board. Gabby Giffords is a retired United States politician who resigned from Congress in 2012 after sustaining a severe brain injury during an assassination attempt. Today, she helps raise awareness about disabilities. Gabby's influence in the disability community and her passion for change will help AudioEye continue to make great strides in building solutions that close the digital accessibility gap. Moving on to guidance, we are guiding revenue of between $7.8 million and $7.9 million for the third quarter of 2023, which is flat sequentially. As mentioned, the impact of the integration of BoIA will reduce third-quarter revenue by approximately $200,000 as we transition one-time audits into recurring revenue. Business momentum is strengthening, and we anticipate that ARR will increase by approximately $1 million sequentially, representing the fastest growth rate in several quarters. We expect ARR growth to be driven by an acceleration in our reseller channel and an improvement in our enterprise channel. While the first half of 2023 saw a low single-digit growth rate in ARR as we renegotiated specific contracts, we are pleased to have that process behind us and continue to forecast a return to a higher trajectory in the second half of the year, which we expect will accelerate going forward. We expect to generate a non-GAAP profit of approximately $100,000 in the third quarter with a further improvement into the fourth quarter. Cash on hand is sufficient to fund our ongoing operations, and we expect to see cash burn decrease going forward. We also expect cash flows to inflect positively by the fourth quarter of the year depending on items such as working capital.

Thank you, David. Q2 2023 marks the 30th straight quarter of record revenue, ending Q2 at $7.84 million, which was 4% growth year-over-year. Annual recurring revenue, or ARR, at the end of the second quarter of 2023 was $29.7 million, a $1 million increase from ARR at the end of the second quarter of 2022. As David mentioned, we expect ARR growth to accelerate in the second half of 2023, and we anticipate that ARR will increase by approximately $1 million sequentially. Overall, we are pleased with our financial results for Q2 2023, which came within revenue and net loss expectations. Our two revenue channels continue to perform well in a more cost-conscious environment. The Partner and Marketplace channel includes all revenue from our SMB-focused marketplace products and revenue from a variety of partners deploying these same products for their SMB customers. In the second quarter of 2023, this revenue channel grew by 13% year-over-year and represented approximately 56% of revenue and 60% of ARR. We continue to recognize opportunities for expansion with our existing partners. Overall, we expect this channel to contribute significantly to our growth in revenue as we build further traction and expand with larger partners. Our Enterprise revenue channel, which typically consists of our larger customers and organizations, made up 44% of revenue and 40% of ARR in the second quarter of 2023. As mentioned previously, this channel faced additional headwinds in the first half of 2023 due to renegotiations of a larger customer contract impacting total enterprise revenue in the quarter. Excluding these renegotiations, we continue to grow enterprise ARR year-over-year. We also maintain excellent logo retention rates in 2023, with Q2 mirroring Q1 2023, showing some of our best logo retention rates to date. The total customer count increased notably in Q2 2023 to approximately 104,000 customers from about 76,000 customers on June 30, 2022, and 95,000 customers on March 31, 2023. The expansion of platforms was the most significant driver of customer count increases. Gross profit for the first quarter was $6 million, or about 77% of revenue compared to $5.7 million and 76% of revenue in Q2 of last year. We are pleased to see the gross margin continue to increase year-over-year, given the significant investment in our platform products and customer success. While revenues increased by 4% over the comparable prior year period, operating expenses decreased approximately 3%, or $300,000, to $8.1 million. This decrease resulted from continued efficiencies in sales, marketing, and G&A, offset by ongoing investments in R&D. Our total R&D spend in Q2 2023 was approximately $2.6 million, with approximately $526,000 reflected as software development cost in the investing section of the cash flow statement. This total R&D spend is up to 33% of our revenue this quarter compared to 23% last year. As David mentioned, our investment in R&D has enabled us to develop new enterprise-grade technology and programs like our Accessibility Maturity Management Program, Accessibility Health Advisers, and new AI-driven automation and expert audits. The net loss in the second quarter of 2023 was $2 million, or $0.17 per share, compared to a net loss of $2.6 million, or $0.23 per share in the same year-ago period. Total net loss decreased by 24%, or $600,000, in the comparable prior year period, thanks to the increase in gross profit and strategic, efficient spending in all departments. On a non-GAAP basis, our Q2 net loss was $220,000, or $0.02 per share, compared to a net loss of $240,000, or $0.02 per share in the same year-ago period. The primary adjustments to GAAP earnings and EPS for Q2 2023 were non-cash share-based compensation, depreciation, and amortization, along with nonrecurring items. We are pleased to see nonrecurring items decrease substantially in Q2 2023 compared to the previous year. Cash decreased by $1.2 million in the quarter, resulting from cash outlays for tax payments from employee share-based grants of approximately $200,000, non-GAAP litigation expenses of approximately $200,000, software capitalization costs of $500,000, and $300,000 of net cash used in other operating activities. With that, we open the call for questions. Operator, please give instructions.

David, just starting with the outlook for ARR, I mean, increasing in Q3. Can you just talk about some of the factors that are driving that expansion? Is it mainly just continuing to ramp with some of your partners? Or are we getting a pretty meaningful bump from those renegotiated agreements coming back online here in the second half?

Yes. Good question. We expect both our Partner and Enterprise channel to contribute to the growth going forward in ARR. We have our new revenue team ramping up. The pipeline is starting to build with a lot of improvement in processes, systems, and people. We're seeing great traction in the partner channel, as well, and our partners are experiencing a lot of success in selling the product. The renegotiation you mentioned did slow growth earlier this year, but as we move away from that, the core growth is there, and we expect to accelerate even more. I think with the new enterprise products, those are game changers in the industry as they start to ramp up, we should really start to gain momentum.

Understood. Can you talk about the integration with BoIA in terms of transitioning some of that revenue into recurring in nature and kind of what sort of benefit that gives to that integration?

Yes, I'm happy to talk about that a bit. Yes, we're excited that we were able to complete the integration of BoIA and deliver more value to those customers under our model. Historically, they've been essentially one-time audits that generated one-time revenue, and we see an opportunity to upsell those same customers and retain them with our suite of products and the additional automation we can offer. It does have a one-time impact in Q3, but we see the value in recurring revenue both for the customers with the recurring products and automation and also on our end, with ARR ticking up from BoIA customers going forward.

Got it. My final question is really just around the expenses going forward. I mean, are you expecting to see a ramp down in development expenses now that you have some of the AI products and enterprise expanded capabilities out in the market? Or how should we think about investments going forward?

Yes, we did invest quite notably in R&D in 2023. We have a really high-performing team, and we're excited about the products we're delivering, especially over the last six months but also over the last couple of years. We do see more products coming down the pipeline, and we're happy with that investment. We also see a large opportunity to scale up our revenue, especially with the new enterprise products we're introducing. So, I think we'd expect to continue to invest in sales and marketing as we generate more profit going forward.

Thank you, David. I want to address the low penetration rate we've seen thus far in terms of compliance and what some of these things will do, like the NPRM from the Justice Department, relative to pursuing a much larger opportunity and then also the EU in terms of how significant that might be in that market? And how you are attacking those specific markets?

Sure. I'm not sure there's going to be a large revenue effect in the near term with the DOJ efforts, but I expect over the longer term, call it one to two years, you're going to see a meaningful ramp with state and local governments. I think the DOJ is also considering the private sector, which could be significantly impactful. Regarding the EU, they're on track for 2025, and it's pretty comprehensive. It covers many websites, except for really the smallest ones. It's a very large Total Addressable Market here. We estimate the TAM to be around $3 billion.

And more specifically, how do you go after local governments today? And how might that change? And on the EU side, how are you positioned to go after opportunities there?

Yes, just blocking and tackling with the revenue team and establishing a sales office over in London, probably in the first quarter of next year is what we're thinking. But it's really just about outreach and securing business. We have the product now, so it's about executing our strategy.

To be clear on the EU, when the compliance date is June of '25. My assumption is that not everyone will complete that by the end of June of '25. Can you just walk through how you anticipate seeing companies begin to comply?

Like everything in life, some will do it a year early, and some will do it a little bit late. It's all over the board, as we saw with AODA in Canada. So, it really depends on the companies themselves.

Just a quick one, guys. The contingent consideration, I saw that move to current assets. Is that paid in cash? Or do you have the option to pay that in stock or shares?

The purchase agreement specifies a cash payment. It's contingent based on 2022 and 2023 performance of the BoIA, but it is a cash payment. The second contingent payment is expected around the Q2 2024 time period.

Great. I appreciate it. That's it for me, guys.

Thank you for joining us today. As always, I want to thank our employees, partners, and investors for their continued support. We look forward to updating you on our next call.

Before we conclude today's call, I would like to remind everyone that a recording of today's call will be available for replay via a link available in the Investors section of the Company's website. Thank you for joining us today for AudioEye's second quarter 2023 earnings conference call. You may now disconnect.