AudioEye: Read The Fine Print Before You Invest (NASDAQ:AEYE)

I was initially very excited to update my analysis on AudioEye, Inc. (AEYE). After all, the stock has skyrocketed since my last article on this company, up a phenomenal 128%.

(Source: Seeking Alpha/MS Paint)

On the surface, it appears that there are many positive factors at play with this company It has experienced revenue growth in excess of 100% in the last year. However, despite the huge growth, the free cash flow margin is still very negative but there are great strides being made.

(Source: Portfolio123/MS Paint)

The trailing twelve-month (TTM) free cash flow margin has risen to -24%, still a long way from break-even, but much better than the -54% from six months ago. In any case, management is promising to become cash flow positive in 2021.

The gross profit margin is gradually rising over time as the business scales and now sits at 72%. The gross profit margin is expected to continue rising once the technology base is moved from Atlanta to Portland, apparently to allow the business to further scale.

(Source: Portfolio123/MS Paint)

And finally, the SG&A expenses are dropping like a rock. The following chart shows just how dramatically these expenses are falling. Note that the following chart includes R&D and SBC as part of SG&A.

(Source: Portfolio123/MS Paint)

In my opinion, the SG&A expenses are now similar to other very high-growth software companies, although operating at such a high level may be risky during a prolonged recession.

So these are the positive aspects of the AudioEye business, but before you click on the “BUY” button, I suggest that you consider the ongoing concerns, mostly highlighted in the quarterly report.

Is AudioEye a Going Concern?

The most glaring and concerning statement in the quarterly report is in regards to the company’s liquidity:

As of June 30, 2020, the Company had cash and cash equivalents of $2,130,000 and a working capital deficit of $1,893,000. In addition, the Company used actual net cash in operations of $791,000 during the six-month period ended June 30, 2020. The Company has incurred net losses since inception. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

Paycheck Protection Program

This management opinion comes after the company made arrangements for a Paycheck Protection Program (“PPP”) loan under the CARES Act back in April 2020. The load was for $1.302 million. Further on in the quarterly report, it is stated that:

No assurance can be provided, however, that we will elect to pursue forgiveness of all or a portion of the PPP Loan or that we will be eligible for and obtain forgiveness of all or a portion of the PPP Loan. If we elect not to pursue or are unable to qualify for or obtain forgiveness of all or a portion of the PPP Loan, our liquidity could be reduced, and our business, financial condition and results of operations may be adversely affected.

Technology Base is Moving

It will be very interesting to see how this plays out, given that the company has fired some employees in order to move its technology base to Portland from Atlanta. The idea of the PPP is to maintain employee paychecks, not fire the employees.

As part of the Company’s strategic shift to build a more modern, scalable technology stack, we are building our technology center in Portland, Oregon. As a result, along with executive changes, there will be an impact on our current employees as well, mostly in the technology function. We have already started hiring personnel in Portland, and will continue to do so in the near future. The Company expects to pay approximately $400,000 in separation costs, including severance and accrued vacation, of which approximately $70,000 has been accrued as of June 30, 2020.

I find it perplexing that this company can afford not only the expense but to let go of technology staff in order to move from one city to another. This is a high-tech company after all. Is the technology that easily ported? Is this not a significant disruption to business operations?

Bad Deal in 2019?

One might think that AudioEye’s financial problems started with the pandemic. It is a reasonable assumption, but an incorrect one. It appears that AudioEye made an unusual, if not bad, deal back in August 2019 that highlights the troubled operations. AudioEye literally gave Sero Capital LLC a warrant that could be exercised for 146,667 shares of the company at a price of $6. They gave Sero Capital the warrant in exchange for a loan facility of $2 million at an interest rate of 10%. Note that the loan facility was never used and Sero Capital has now exercised the warrant.

Preferred Dividends

It appears that preferred shareholders are owed but were not paid dividends, also highlighted in the quarterly report:

As of June 30, 2020 and December 31, 2019, the Company had 100,000 and 105,000 shares of Series A Convertible Preferred Stock (the “Preferred Stock”) outstanding, respectively, which was issued at $10 per share, paying a 5% cumulative annual dividend, and convertible into the Company’s common stock at a price of $4.385 per share. For the six months ended June 30, 2020, preferred stockholders collectively earned, but were not paid, approximately $26,000 in quarterly dividends, which is equivalent to 5,835 shares of common stock based on a conversion price of $4.385 per share. As of June 30, 2020 and December 31, 2019, cumulative and unpaid dividends were approximately $258,000 and approximately $245,000, respectively, which is equivalent to 58,949 and 55,927 shares of common stock, respectively, based on a conversion price of $4.385 per share.

Ballooning Accounts Receivable

The pandemic has been creating havoc with the economy and AudioEye has not been immune. The accounts receivable has ballooned from $2.5 million in Q1 to $4 million in Q2. This is a substantial increase and is primarily attributable to delayed payments by customers. It remains to be seen how much of this will ultimately be collected.

As a result of the pandemic, some of our customers have requested shorter term contracts, asked us to accept delayed payments or to forgive payments, and have sought price reductions. These factors have adversely affected, and may continue to adversely affect our revenue and collections and may become more material in the future if economic conditions worsen.

Nobody knows how long the current business environment will persist. However, it is our expectation that some of our COVID-19 related programs will need to continue for some time. In that case, it would be reasonable to expect more meaningful negative impacts to our financial and operating performance. More generally, based on what we know right now, we anticipate at least a near-term impact on our revenue, and collections as we expect our Account Receivables aging will continue to worsen. This in-turn may put further pressure on our liquidity in the short- to medium- term.

Is Sero Capital Taking Over?

The ultimate indicator that something is amiss at AudioEye is that the tenure of CEO Heath Thompson was short-lived. In fact, the earnings call was handled by Executive Chairman Carr Bettis. Now leading the company on an interim basis is Sero Capital founder and AudioEye investor David Moradi. He is also the new Chief Strategy Officer. If this doesn’t spell t-r-o-u-b-l-e, then what does?

Is All Forgiven With the New Share Offering?

AudioEye is now making a public share offering for 411,513 shares of its common stock at $17.75/share (below the current share price). On the surface, this will ease concerns regarding company’s liquidity and its status as a going concern.

However, it remains to be seen whether or not the root cause of the company’s financial problems have been addressed. As I mentioned earlier, the problems started prior to the pandemic, although the pandemic didn’t help the situation. If the problems were strictly a result of the pandemic then I wouldn’t be nearly as concerned about ending up in the same situation a year from now.

Summary and Conclusions

AudioEye brings out my entire emotional spectrum. On one hand, this very small company has a huge SaaS opportunity in the website accessibility compliance market niche. This company is growing revenue by more than 100% annually. But it has also been mismanaged with exceptionally high SG&A expenses and extremely negative free cash flow margin.

The company entered into what I believe was a bad agreement with one of its investors, Sero Capital LLC, essentially giving away a warrant that can be exercised for shares, in exchange for a high interest rate loan facility.

The company owes dividend payouts to preferred shareholders, has a PPP loan that may not be forgiven, and has a very high accounts receivable that the company may have trouble recovering, especially if the economy does not improve.

The company has fired technology staff and moved the technology base to a different city. This will increase expenses on a short-term basis and certainly cause a distraction from operations. And what about the loss of technical expertise as a result of this change? Is the prime investor qualified as a Chief Strategy Officer, or as CEO for that matter?

On the bright side, the new management is demonstrably bringing down expenses and increasing the gross profit margin. And the new share issue will alleviate the immediate liquidity concern for the company as a going concern.

If the company can get through the pandemic and demonstrate positive cash flow, as management promises it will, then it will be worth having a new look at AudioEye as an investment. Until then, I am giving this company a neutral rating.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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