Q2 2023 AudioEye Inc Earnings Call
Participants
David D. Moradi; CEO & Director; AudioEye, Inc.
Kelly Georgevich; CFO, Principal Financial Officer & Principal Accounting Officer; AudioEye, Inc.
George Frederick Sutton; Partner, Co-Director of Research & Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Scott Christian Buck; MD & Senior Technology Analyst; H.C. Wainwright & Co, LLC, Research Division
Zachary Cummins; Equity Research Analyst; B. Riley Securities, Inc., Research Division
Presentation
Operator
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 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 as 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 Chief Executive Officer. Mr. David Moradi. Sir, please proceed.
David D. Moradi
Thank you, operator. Welcome, everyone, and thank you for joining us.
There have been several developments over the last 3 months, and I'm excited to talk with you about 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 from 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 role 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 assisted technology found AI could reduce the time needed to assess and correct a complex accessibility issue such as determining whether a link is clear and accurate by up to 10x. We are currently incorporating AI into our processes and believe there is tremendous potential to increase feed and accuracy in the future.
The north star for AI is when someone with a disability can't distinguish between an experience handcrafted by an accessibility expert or created by an expert trained AI. That's the only bar that will let anyone claim they solve digital accessibility at scale with AI. And make no mistake, it's a very high bar. We'll only meet it by involving the disability community from day 1, 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 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 Advisor. These programs and tools 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, process 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 if any changes required to comply. This first-of-its-kind program, corresponding tools with 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 onetime audit 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 Congressman 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 onetime 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 forming United States Congressman men 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 onetime 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 flow to inflect positively by the fourth quarter of the year depending on items such as working capital.
I'll now turn the call over to AudioEye's CFO, Kelly?
Kelly Georgevich
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 2 revenue channels are continuing 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 to deploy these same products for their SMB customers. In the second quarter of 2023, this revenue channel grew 13% year-over-year and represented approximately 56% of revenue and 60% of ARR.
We continue to recognize opportunities for expansion in our existing partners. Overall, we expect to continue to seeing this channel 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 with 1 larger customer contract renegotiation having an impact on total enterprise revenue in the quarter. Excluding this renegotiation, we continue to grow enterprise ARR year-over-year. We also continue to see great logo retention rates in 2023, with Q2 similar to 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 approximately 76,000 customers on June 30, 2022, and 95,000 customers on March 31, 2023. The expansion of platforms was the most material 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 4% over the comparable period of prior year, operating expenses decreased approximately 3% or $300,000 to $8.1 million. The decrease was the result of continued efficiencies in sales and marketing and G&A, offset by continued investment 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 33% of our revenue this quarter versus 23% last year. As David mentioned, the investment in our R&D has allowed us to develop new enterprise grid technology and programs like our accessibility maturity management program, accessibility health advisers and new AI automation and expert audit.
Net loss in the second quarter of 2023 was $2 million or $0.17 per share compared to $2.6 million or $0.23 per share in the same year ago period. Total net loss decreased 24% or $600,000 from the comparable period of prior year, thanks to the increase in gross profit as well as strategic and 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 adjustment to GAAP earnings and EPS for Q2 2023 were noncash share-based compensation, depreciation and amortization and nonrecurring items. We are pleased to see nonrecurring items decreased substantially in Q2 2023 from the comparable period of prior year.
Cash decreased $1.2 million in the quarter, which was a result of 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 from other operating activities.
With that, we open up the call for questions.
Operator, please give instructions.
Question and Answer Session
Operator
(Operator Instructions)
Our first question comes from Zack Cummins from B. Riley.
Zachary Cummins
David, just starting with the outlook for ARR, I mean, increasing in Q3. I mean can you just talk about some of the factors that are driving that expansion there? 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?
David D. Moradi
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. Really a lot of improvement in processes, systems and people. We're seeing great traction in the partner channel as well, and our partners are seeing a lot of success in selling the product.
The renegotiations you mentioned did slow growth earlier this year. But as we move away, those core growth -- the core growth is there, and we expect to accelerate even more -- and I think with the new enterprise products, those are a game changer in the industry as they start to ramp up, we should really start to accelerate.
Zachary Cummins
Understood. And can you just 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 do that integration?
Kelly Georgevich
Yes, I'm happy to talk about that a bit back. 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 onetime audits that are onetime in revenue, and we see opportunity to upsell like the same customers and retain customers with our set of products and some of the automation and additional things we can offer to them. It does have a onetime impact in Q3, but we see the value in recurring revenue, both for the customers with their recurring product and automation and also on our end. Be an ARR tick up from BoIA customers going forward.
Zachary Cummins
Got it. And final question is really just around the expenses going forward. I mean, company expecting to flip to positive non-GAAP income in Q3 and positive free cash flow in Q4. Are you expecting to see a ramp down in development expenses now that you have some of these AI products and enterprise expanded capabilities out in the market? Or how should we think about investments going forward?
Kelly Georgevich
Yes. We did invest quite notably in R&D in 2023. We have a really high-performing team, and we're excited on the products we're delivering. In the last 6 months specifically, but over the last couple of years, and we do see more products coming down the pipe. And so we're happy with that investment. We do also see a large opportunity to scale up our revenue arc, especially with these new enterprise products that we're introducing. And so I think we'd expect to continue to invest in sales and marketing as we generate more profit going forward.
Zachary Cummins
Understood. Best of luck with the rest of the quarter.
Operator
Our next question comes from George Sutton from Craig-Hallum.
George Frederick Sutton
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 ANPRM 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 then how you are attacking those specific markets?
David D. Moradi
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, 1 to 2 years, you're going to see a meaningful ramp with state and local governments. And I think the DoJ is thinking about the private sector as well. I wouldn't be surprised if they take some action there, which could be very, very meaningful. With the EU, they're on track for 2025. It's pretty comprehensive. It covers many websites, except for really the smallest ones. It's a very large TAM here. We estimate the TAM of around $3 billion.
George Frederick Sutton
And more specifically, how do you go after seeing local governments today? And how might that change. And on the EU side, how are you positioned to go after opportunities there?
David D. Moradi
Yes, just blocking and tackling with the revenue work and selling -- setting up a sales office over in London, probably first quarter of next year is what we're thinking, but it's just really blocking and tackling. We have the product now. So just about going out and getting the business.
George Frederick Sutton
And lastly, to be clear on the EU when the compliance date is June of '25. My assumption is not everyone is completing that -- the end of June of '25. Can you just walk through how you anticipate seeing people beginning to comply?
David D. Moradi
Like everything in life, some will do it a year early. Some will do it a little bit late. It's all over the board is what we saw with EU in Canada. So it's really just depends on the company themselves.
Operator
Our next question comes from Scott Buck from H.C. Wainright.
Scott Christian Buck
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?
Kelly Georgevich
The purchase agreement has a cash payment. It's contingent based on 2022 and 2023 performance of the AudioEye, but it is a cash payment and the second contingent payment is like a Q2 2024 time period.
Scott Christian Buck
Great. I appreciate it. That's it for me, guys. Thank you.
Operator
At this time, this concludes our question-and-answer session. I'd now like to turn the call back over to Mr. Moradi for his closing remarks.
David D. Moradi
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.
Operator
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.
