AEYE - AudioEye: Microcap SaaS With Big Potential

Summary

• AudioEye has made progress in improving expenses and moving toward profitability.
• The market potential appears to be substantial in digital accessibility.
• I'm initiating coverage with a hold, I look forward to the next quarterly report.

The market opportunities for cloud companies are well-documented. I've written recent articles showing some of the big winners, companies that are effectively household names among anyone working in the corporate world. As a change of pace, today I'm going to cover AudioEye ( AEYE ), which will be the first time I've ever written an article on a company this small. Microcaps can be exciting, as minor adjustments in the company's operations can have outsized impact, and with a market capitalization of $68M, the sky is the limit for how big a company like this can become. That being said, be sure to recognize that companies this size represent a significantly higher risk than investing in a megacap.

AudioEye was founded in 2005 and as recently as 2013 had only 10 employees. The company has grown to a head count of 111 last year, and the stock has had quite the ride since 2020. As recently as 2021, AudioEye was trading north of $40 a share riding the tech bubble wave. Today, the stock is trading at under $7 a share, and presents a much better opportunity now that the bubble has burst. The company is not founder-led, and actually relatively recently cycled through multiple CEO's over a relatively short time. Current CEO David Moradi has been with the company since 2020, and it would be good to see some continuity in that seat providing a unified vision for the company.

AudioEye has transformed its operations to a SaaS model over time and hopes to capture a market-leading position in digital accessibility. The company's core offering will test, monitor, and fix accessibility issues for its subscribing customers. The company sells this product via two channels, Enterprise and Partner and Marketplace. As of the most recent earnings call, revenues were effectively split between the two due to Enterprise revenues from the recent acquisition of the Bureau of Internet Accessibility. That company's offerings have since been rolled into AudioEye's core product, but Partner and Marketplace revenues are the major growth driver here.

In that segment, the company partners with technology providers that resell the platform to their clients. Two recent examples from an earnings call were Celerant, an omnichannel retail POS provider and Vendasta, a platform for digital solutions to SMB's. This has proven lucrative for AudioEye based on recent results, and looks to provide meaningful growth going forward. The CEO discussed the company could see the results from these partnerships over multiple quarters and AudioEye has meaningfully increased its customer count to 82,000 as of the end of 2021.

The most exciting and unpredictable growth avenue for the company is the possibility for additional government legislation requiring more websites and other IoT-type products to provide additional accessibility. The winds certainly seem to be blowing that way, and from an altruistic perspective, it would be nice to know the internet is accessible to everyone. A couple of snippets from CEO David Moradi on recent earnings calls:

In October, Senator Tammy Duckworth and Representative John Sarbanes introduced the Websites and Software Applications Accessibility Act in the United States Senate and House of Representatives. While the bill is still in draft form and changes will likely be made, the passage of the bill will put further emphasis on truly solving web accessibility. If passed, we also expect it to have a material impact on digital accessibility demand as only 3% of websites are currently accessible.

In the press release announcing the bill, AudioEye Board member, Tony Coelho, the author and architect of the ADA which passed 32 years ago, had this to say. "The bill is as significant as the introduction of the ADA and shows the cooperation and support from the disability community. As President Bush said, on the signing of the ADA, the walls of exclusion need to be taken down. This is another step in that direction."

...There's just a growing trend here with legislation, the DOJ, companies requiring accessibility in their front contracts. So we look at this as a multibillion-dollar TAM opportunity. I don't know the timing of the legislation. It could be next year but I think it's a positive in conjunction with all these other things.

Discussing this as a multi-billion dollar TAM is definitely one end of the spectrum of what could happen. That being said, I don't like to invest in companies hoping Congress will force a solution, and investors should be confident in AudioEye's ability to gain market share regardless of legislation.

In that regard, results have been mostly positive. With a company this size, I'm looking for strength in the balance sheet, and growth with an eye to profitability. Who am I kidding, I'm looking for that in every company. Here's the press release:

So, revenue growth was strong, and the company's sales have shifted to almost entirely recurring at this point (6% remain on legacy offerings). The company reported non-GAAP profitability for the first time, which is not nothing. Lastly, the company is in a net cash position, albeit a relatively small one with no debt on the balance sheet.

Looking at the trend in operating expenses from the 10-K, a few things jump out with massive growth. Obviously, R&D quadrupled, but $5.3M on $24M in revenues isn't unheard of. However, S&M and G&A adding up to higher than revenues alone is alarming. Looking at the 10-Q for the most recent quarter will show how the company has progressed on their initiative to gain profitability.

As the company has worked through 2022, the CFO detailed in the most recent earnings call a 13% reduction in operating expenses overall while growing revenues 24%. S&M expenses decreased as the company made efforts to gain efficiencies, which is good to see. R&D reduced to 24% of revenues from 32% of revenues in the same quarter of 2021, as well. However, G&A remains outsized and is a black eye on the balance sheet. In a perfect world, a company like AudioEye would have outsized R&D expenses as it drove improvements in its product versus G&A. However, G&A includes litigation, and the CEO discussed the closing of litigation in the most recent quarter, which should show up on the next 10-Q and merits watching.

For a company this size with strong revenue growth, it's no surprise to see the share count marching upwards. In fact, I don't mind seeing it in this case as the company can use share issuance to maintain cash and drive market share growth. What I don't like to see is stock buybacks. I understand the thought, detailed below from the CEO:

We're looking at a variety of factors. First, the stock is extremely cheap at -- I think less than 2 times revenue if you take out the cash from the NOL. So we're hard pressed to find many opportunities like this, especially when you look at the private market, we see transactions that are very similar to us anywhere from 8 times to 12 times even in the current market environment. And so that's the reason for the stock repurchase. We can't give you exact levels of where we're going to go in and buy, and it to change at any time. And so I don't really want to talk about what we're doing intra quarter.

However, this market is relatively new and growing quickly. There will be fierce competition from digitally native companies, and AudioEye's priority should be on capturing as much of the market as possible to fend off competition.

Management has stated that only 3% of websites are considered "accessible", and legislation seems to be moving in the direction of forcing the issue in years to come. Verified Market Research projects a $480M market growing to $770M by 2028, but the amounts vary, and it's not entirely clear what the TAM is here other than it's much larger than AudioEye's current slice of the pie. What's also not perfectly clear is how well AudioEye can scale. The company has shifted its business to monitoring and attempting automated fixes as part of a subscription business, but does still discuss its accessibility experts on its website. There's a possibility as the offering grows, the company has to provide more hands-on solutions which dilutes the cloud SaaS allure. However, so far AudioEye has maintained a solid gross margin of 75%, and so long as that number doesn't start to drift downward substantially, the path to profitability resides in expense management.

In conclusion, I'm interested in AudioEye as an investment. There are a ton of unknowns and risks, but that's the name of the game looking at companies this size. Management is making progress on cleaning up the balance sheet, and on the most recent call, discussed the expectation that litigation expenses will materially decline which will aid the company's GAAP results and G&A expenses. Growth is strong but not eye-popping, the potential market is substantial, and I'm looking for a little more progress on future quarters before I'm willing to open a position. If any meaningful legislation passes, it will be interesting to see how well the company capitalizes, and it could easily prove a massive tailwind. It's a hold here.

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