Business context and reporting period
AudioEye, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. The company sells software, development and related services built around voice-enabled Internet access and accessibility, and also pursues technology licensing and patent enforcement. Management describes the results as not necessarily indicative of future periods.
Financial performance and position
| Metric | Three months ended Sep. 30, 2013 | Three months ended Sep. 30, 2012 | Nine months ended Sep. 30, 2013 | Nine months ended Sep. 30, 2012 |
|---|---|---|---|---|
| Total revenue, including related-party revenue | $381,539 | $223,209 | $806,068 | $278,837 |
| Gross profit | $250,768 | $156,314 | $579,507 | $58,911 |
| Gross margin | 65.7% | 70.0% | 71.9% | 21.1% |
| Operating loss | $(846,043) | $(305,280) | $(1,737,863) | $(730,364) |
| Net loss | $(870,810) | $(315,143) | $(1,796,796) | $(742,364) |
| Basic and diluted loss per share | $(0.02) | $(0.01) | $(0.04) | $(0.02) |
For the nine-month period, operating cash flow was $(676,419), investing cash flow $(9,890), and financing cash flow $748,034. Cash increased by $61,725 to $73,435. Financing included $426,346 net proceeds from a private placement and $37,188 from option exercises; debt payments and borrowings were also significant.
At September 30, 2013, current assets were $294,210 and current liabilities $688,452, producing a working-capital deficit of $394,242. The current ratio was approximately 0.43. Total liabilities were $768,252, including $167,070 of current and $79,800 of long-term notes and loans payable; related-party payables were $91,250. Intangible assets, net, were $3,161,773, and goodwill was $700,528. The company reported 44,496,699 shares outstanding at quarter-end.
Material changes versus prior comparable periods
- Nine-month total revenue increased to $806,068 from $278,837, which management attributed to increased demand for services. Related-party revenue was $57,375 versus $2,250.
- Nine-month gross profit improved to $579,507 from $58,911, but the gross margin comparisons reflect a substantial increase from the prior-year period. In the third quarter, gross margin declined to 65.7% from 70.0%.
- Operating expenses rose to $2,317,370 from $789,275 for the nine months. The filing cites higher headcount and compensation, new selling and marketing activity, and increased amortization and stock-based compensation. The nine-month net loss more than doubled year over year.
- Working-capital deficit narrowed from $2,775,216 at December 31, 2012, primarily due to lower current related-party payables and notes and loans payable. The company nevertheless remained in a deficit position.
- Debt conversions and equity financing materially changed the capital structure: approximately $1.7 million of principal and accrued interest was converted into 5,871,752 shares in connection with the merger, and shares outstanding increased from 35,192,045 at year-end 2012 to 44,496,699 at quarter-end 2013.
Outlook, risks, contingencies and unusual items
The filing provides no quantified revenue, earnings or cash-flow guidance. Management says additional equity or debt financing, or third-party borrowing, is required to address operating losses and limited cash. It cautions that adequate financing may not be available on acceptable terms; without it, the company may be unable to implement its plan or continue operations. The financial statements disclose substantial doubt about the company’s ability to continue as a going concern.
Notable items include stock-, option- and warrant-related compensation and obligations, a $150,000 note issued in August at 10% interest with a warrant, and five-year royalty and services arrangements with CMGO. In August, the company entered into executive employment agreements with stated annual base salaries totaling $895,000, before any bonuses or equity awards. Management reported routine disputes and allegations, which it did not expect to have a material adverse effect; the Risk Factors item is marked “Not applicable.”
The filing contains apparent internal inconsistencies: Note 2 gives nine-month net loss of $1,829,489 and accumulated deficit of $6,226,336, while the primary statements report net loss of $1,796,796 and the balance sheet reports accumulated deficit of $6,193,643. The filing text does not reconcile these differences.
Most important facts for investors to verify
- Reconcile the net-loss and accumulated-deficit discrepancies between Note 2 and the financial statements.
- Assess whether the company can raise sufficient capital given its $73,435 cash balance, operating cash burn, and going-concern warning.
- Review the quality and sustainability of revenue growth, including related-party revenue and receivables.
- Evaluate dilution from shares issued for debt conversion, outstanding options and warrants, and potential incentive awards.
- Confirm the effect of executive compensation commitments and CMGO royalty and commission arrangements on future cash needs and margins.