Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant
is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨
No x
Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes x No
¨
Indicate by check mark whether the registrant
has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to
submit such files). Yes x No ¨
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth
company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting
company,” and “emerging growth company” in Rule 12b–2 of the Exchange Act.
If an emerging growth company, indicate
by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting
and non-voting common equity held by non-affiliates of the registrant’s most recently completed second quarter ended as of
June 30, 2019 was $35,951,825.
As of March 30, 2020, 8,876,553 shares of the registrant’s
common stock were issued and outstanding.
Portions of the definitive
Proxy Statement to be delivered to stockholders in connection with the registrant’s 2020 Annual Meeting of Stockholders
scheduled to be held on May 18, 2020 are incorporated by reference into Part III of this report.
This annual report
contains forward-looking statements within the meaning of the federal securities laws, including Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
These statements relate to either future events or our future financial performance. In some cases, you may be able to identify
forward-looking statements by terms such as “may,” “should,” “expects,” “plans,”
“anticipates,” “believes,” “estimates,” “predicts,” “potential,” “projects,”
“outlook” or “continue,” or the negative of these terms or other synonymous terminology. These statements
are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks in the section
entitled “Risk Factors,” that may cause our or our industry’s actual results, levels of activity, performance
or achievements to be materially different from any future results, levels of activity, performance or achievements expressed
or implied by these forward-looking statements.
Because these forward-looking
statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results, events
or developments to differ materially from those expressed or implied by these forward-looking statements, including our plans,
objectives, expectations and intentions and other factors discussed in “Part I—Item 1A. Risk Factors” contained
in this Annual Report. Risk factors that could cause actual results to differ from those contained in the forward-looking statements
include but are not limited to risks related to:
All forward-looking
statements are made only as of the date hereof. Except as required by applicable law, including the securities laws of the United
States, we do not intend, and we do undertake any obligation, to revise or update any of the forward-looking statements to match
actual results. Readers are urged to carefully review and consider the various disclosures made in this report, which aim to inform
interested parties of the risks factors that may affect our business, financial condition, results of operations and prospects.
PART I
Overview
AudioEye is an industry-leading
software solution provider delivering website accessibility compliance at all price points to businesses of all sizes. Our solutions
advance accessibility with patented technology that reduces barriers, expands access for individuals with disabilities, and enhances
the user experience for a broader audience. We believe that, when implemented, our solution offers businesses and organizations
the opportunity to reach more customers, improve brand image, build additional brand loyalty, and, most importantly, provide an
accessible and usable web experience to the expansive and ever-growing global population of individuals with disabilities. AudioEye
provides an always-on testing, remediation, and monitoring solution that continually improves conformance with the Web Content
Accessibility Guidelines (WCAG), helping businesses and organizations comply with WCAG standards as well as applicable U.S., Canadian,
Australian, and United Kingdom accessibility laws.
AudioEye stands out
among its competitors because it delivers machine-learning/artificial intelligence (“AI”)-driven accessibility without
fundamental changes to the website architecture. Our technology publishes more than one billion remediations daily, and our solution
is trusted by some of the largest and most influential companies in the world, including Uber, ADP, Tommy Hilfiger, AMI and more.
Government agencies, both at the federal level and state and local levels, have also integrated our software in their digital
platforms.
AudioEye generates
revenue through the sale of subscriptions for our software-as-a-service (“SaaS”) accessibility solution plans. Plans
range in scale from “do-it-yourself” to “do-it-for-me.” All are backed by the power of AudioEye’s
machine-learning/AI-driven technology that finds and fixes the most common accessibility errors. Do-it-yourself plans, AudioEye
Starter and Pro, also equip site owners with the remediation tools needed to fix remaining issues, ensuring accessibility standards
are met. Do-it-for-me, AudioEye Managed and Enterprise, is for those who want AudioEye to continuously ensure legal compliance
and accessibility for users of all abilities. Managed and Enterprise also come with the AudioEye Trusted Certification, our attestation
of a site owner’s commitment to digital inclusion as defined by WCAG success criteria, which mitigates a customer’s
risk of a costly digital accessibility-related legal action.
AudioEye customers
may purchase tiered plans directly through the AudioEye marketplace, in a platform partner marketplace, through a vertical Content
Management System (“CMS”) authorized reseller, or by working directly with the AudioEye sales team:
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The AudioEye marketplace offers Starter, Pro and Managed plans
ideal for customers in any industry and is most effective for sites built on supported CMS platforms;
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Certain platforms, such as Duda, natively integrate AudioEye
Pro and Managed plans into their marketplace, enabling web creators to immediately build legally compliant, fully accessible
websites;
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Vertical CMS authorized resellers provide a website-hosting
platform for their end-user customers, selling either AudioEye Pro or Managed accessibility solutions; and
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Organizations with non-platform custom websites seeking a fully
managed solution, engage directly with AudioEye sales personnel for custom pricing and solutions.
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Industry Background
Millions of Internet
users are impacted by disabilities that prevent them from accessing and using digital content on a basis equivalent with those
who are not impacted by disabilities. If not coded properly, a website may not offer full functionality for all users, in particular
for users of assistive technology (“AT”), such as a screen reader. As a result, those sites may exclude potential
users and customers. These sites also may not comply with U.S. and foreign laws addressing equal access and digital inclusion.
Title III of the
Americans with Disabilities Act was enacted to help eliminate barriers to access. Just as building owners must implement physical
accommodations to remove any physical barrier to access, transportation, or communication, website owners must adhere to Web Accessibility
best practices in order to ensure barrier-free access to their websites and online materials. Over time, a website owner must
maintain and prove its implementation of those techniques, such as those outlined within the globally recognized WCAG.
Traditional solutions
addressing web accessibility may be costly and difficult to implement. Historically, the process for achieving compliance has
been driven by costly consulting services and has not fully utilized emerging technologies to reduce the compliance cost burden.
At the same time, web accessibility efforts have generally focused on a limited number of disability use cases, leaving many users’
accessibility needs for digital inclusion unaddressed. Businesses may have been reluctant to invest further in web accessibility
solutions due to a perceived lack of commercial return on the significant investment required to design and implement a thorough
and usable compliance solution.
Conventional solutions
have been developed to help users access websites, but these systems often require the installation of a plug-in or software on
the user’s computer. Many of these solutions are tailored to either single or a limited number of use cases and do not encompass
a more holistic approach for addressing a wider range of use cases. In some cases, these systems can be costly, unwieldy and inconvenient.
Furthermore, the assistive software’s ability to understand, process, and interpret complex and dynamic web applications
that are prevalent across the web today is dependent on the quality with which the code was designed and developed, including
the level to which the website adheres to best practices and standards.
AudioEye’s proprietary
technology and processes remove the compliance cost burden for companies and website developers. Our machine-learning technology
immediately identifies and fixes the most common accessibility errors, billions of issues daily, and addresses a wide range of
disabilities including dyslexia, color blindness, epilepsy and more. And with the rapid acceleration of AudioEye on CMS templates,
our technology advances in its recognition of errors, creating and pushing custom platform-level remediations. By working with
strategically identified resellers and platform providers, AudioEye is able to onboard more end-user customers in a shorter period
of time, leveraging economies of scale to deliver its solution in a cost-effective and highly efficient way. This strategy continues
to make accessibility available to companies that would otherwise neglect the important issue of digital inclusion altogether.
Intellectual Property
Our intellectual property
is primarily comprised of trade secrets, trademarks, issued, published and pending patent applications, copyrights
and technological innovation. We have a patent portfolio comprised of eight issued patents in the United States. We also have
two pending patent applications and two international patent applications filed via the Patent Cooperation Treaty (“PCT”)
and the European Patent Office.
We have a trademark
portfolio comprised of eight United States trademark registrations.
Our current patented
inventions relate to:
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A server-side method and apparatus that enables
users to audibly navigate websites and hear high-quality streaming audio narration and descriptions of websites. This patented
invention involves creating an audio-enabled web experience by utilizing voice talent and automated text-to-speech conversion
methods to read and describe web content.
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Systems for automatic remediation of non-compliant
webpages and user interfaces using pre-stored remediation scripts as well as form-based quickfix remediation codes. More specifically,
this patent covers various features related to crawling webpages and user interfaces to perform compliance assessments using
pre-stored remediation scripts corresponding to different compliance issues and manipulating the document object model (DOM).
This patent also covers various features related to using pre-stored accelerated remediation code blocks, including those
derived from machine learning, corresponding to different compliance issues to modify the DOM.
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Methods for providing alternative descriptions
to elements on a webpage that were previously untagged and without the appropriate tags. More specifically, this patent covers
various features related to detecting an untagged element having an associated hyperlink and using pre-existing remediation
scripts to assign an alt text description to the untagged element. In addition, this patent also covers various features related
to detecting an untagged image and assigning an alt text description based on image recognition analysis.
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Our current portfolio
has established a foundation for building unique technology solutions that contribute to the way in which we differentiate ourselves
from other competitors in the B2B Web Accessibility marketplace. We plan to continue to invest in research and development and
expand our portfolio of proprietary intellectual property.
Business Plan and Strategy
Leveraging our own
patented platform, we provide cloud-based, enterprise-grade technology solutions in conjunction with managed services as/when
needed, to fully implement our solution and position our clients’ sites to more fully conform with web accessibility best
practices. Our technology solution and service offerings may be purchased through a subscription service for either a month (exclusive
for Small & Medium sized businesses), or a one-year or multi-year term (available for both Small & Medium sized businesses
as well as Enterprise customers).
Through the sale of
managed and self-service contracts, our business model is to sell Business to Business and to secure revenue from multiple business
channels, including (but not limited to): providers of CMS, corporate website owners, publishers, web designers, developers and
operators, federal, state and local governments, educational institutions, e-learning and e-commerce websites, and not-for-profit
organizations.
In what Forrester
Research, Inc., a market research company that provides advice on existing and potential impact of technology, has called the
“age of the customer,” we believe that, by adopting our solutions, our customers gain a competitive advantage by ensuring
a superior digital experience for all of their own customers, and in particular for persons with diverse abilities. Some of the
many leading advantages of our solution include:
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Maintaining a mission of inclusion and accessibility for the
approximately 15% of the population with a disability or physical limitation who are denied full access to online digital
content;
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Increasing the client return on investment by opening access
to the spending power of the approximately 15% of the population that is denied equal access to the internet;
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Maximizing conformance with WCAG 2.1 Success Criteria;
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Deploying a cost-effective—platform-wide and fully-managed,
as applicable—solution that is scalable with rapid deployment and little to no project management;
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Consistently providing an enhanced customer experience for our
client customers by providing access to innovative and universally designed technology solutions;
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Our primary objective
is to establish and maintain a long-standing relationship with our customers, as a trusted and reliable provider of web accessibility
technology and services.
From an operational
perspective and to enable us to deliver on our objective, the business is organized functionally into Executive & Administration,
Sales, Marketing, Product development, Engineering (which includes intellectual property development), Implementation, Quality
Assurance, and Customer Experience teams. Intellectual property development is tasked with the development of new leading-edge
intellectual property.
Product Service Offerings
As the leading provider
of SaaS-based digital content accessibility solutions, AudioEye’s mission is to eradicate all barriers to digital accessibility.
With our flagship
fully managed service, AudioEye Managed, AudioEye has historically focused on providing a custom accessibility solution for enterprise-level
organizations. In November 2019, AudioEye expanded its solutions suite, launching a digital marketplace with plans more amenable,
and more affordable, to small and medium-sized businesses. The launch of the digital marketplace has better positioned AudioEye
to significantly expand its market share, now serving businesses and organizations of all sizes at all price points.
With the launch of
the AudioEye digital marketplace, every audioeye.com visitor can now also request and receive a free website accessibility scan.
By providing a URL and email address, this scan audits a sample of a visitor’s site, identifying a point-in-time list of
WCAG errors and risks. While other providers charge for a site audit, AudioEye’s scan is free.
Every AudioEye plan
enables users to fully achieve WCAG compliance, whether customers do the bulk of the work themselves, utilize AudioEye’s
tools and technology to identify and resolve issues together with AudioEye, or fully outsource the work to our experts:
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AudioEye Starter: Website owners may
accelerate digital accessibility easily and affordably with AudioEye Starter. Upon installing the AudioEye JavaScript, this
free product provides users access to a comprehensive site accessibility report, identifying all WCAG risks and errors, as
well as access to AudioEye’s free, on-site developer tools. These are the same tools AudioEye experts use to identify
and resolve accessibility errors. Starter is best for customers who wish to manage accessibility on their own, utilizing AudioEye’s
reporting and developer tools to achieve full compliance. Do it yourself digital accessibility.
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AudioEye Pro: Ideal for small and medium-sized
businesses, AudioEye Pro customers receive access to AudioEye’s on-site developer tools as well as more robust WCAG
accessibility reports. Further, upon installing the AudioEye JavaScript, AudioEye’s always-on, proprietary machine-learning/AI-driven
technology is automatically identifying and resolving approximately 35% of the most common WCAG accessibility errors. Pro
customers may then utilize AudioEye’s developer tools to resolve the remaining errors. AudioEye Pro customers receive
the AudioEye Accessibility Toolbar, which includes website personalization tools for end users, as well as a 24/7 Help Desk
for users to report any accessibility-related issues. Pro customers receive an accessibility statement, articulating their
commitment to an accessible user experience, as well as access to a library of on-demand digital accessibility training resources.
Do it together digital accessibility.
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AudioEye Managed: AudioEye Managed is
ideal for those customers interested in completely outsourcing digital accessibility compliance. Upon installing the AudioEye
JavaScript, AudioEye Managed customers benefit from AudioEye’s always-on, proprietary machine-learning/AI-driven technology
automatically identifying and resolving the most common WCAG accessibility errors (approximately 35-percent) coupled with
AudioEye’s team of digital accessibility subject matter experts monitoring, manually testing and resolving the remaining
errors. This team utilizes the most common assistive technologies on the most common website browsers to ensure site-specific
errors are resolved. Managed customers receive the full AudioEye Accessibility Toolbar, including a 24/7 Help Desk, access
to a library of on-demand digital accessibility training resources as well as invitations to live, quarterly training sessions.
Unlike any solution on the market, AudioEye provides its Managed customers a public Certification Statement, which is AudioEye’s
attestation of a site’s WCAG compliance. Managed customers also receive a Sustainable Testing & Remediation Plan
in the event they are facing legal action. Do it for me digital accessibility. AudioEye Managed is priced according to a site’s
complexity and is designed not only for small and medium-sized businesses on CMS platforms but also for enterprises with customized
websites.
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AudioEye continues
to offer other digital accessibility solutions for both dynamic and static documents (PDFs) as well as mobile applications.
Customers
Our potential customer
base includes a very broad range of private and public sector customers, including:
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Small & Medium sized businesses,
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Federal, state, and local governments and agencies,
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The Company had one
major customer (including such customer’s affiliates) which accounted for approximately 10% of its revenues in the year
ended December 31, 2019. The Company had one major customer which generated approximately 11.8% of its revenue in the fiscal year
ended December 31, 2018.
Small & Medium sized customers
We have recently expanded
our offerings via our Marketplace and via partnerships with Duda to capture a much larger market of Small & Medium sized customers.
Our solutions are
sold by our partnership sales team through strategic partnerships, resellers and via our eCommerce platform (Marketplace). This
strategy enables us to address all the broad markets covered by our technology and allows for a depth and market penetration that
we could never approach on our own.
Our CMS platform partners
and resellers are critical for us to reach this customer segment to both penetrate deeper and more broadly (into multiple industry
verticals) by partnering with us to spread awareness and offer a unique solution to make their digital content & websites
accessible.
Corporate Enterprises
Corporate Enterprises
are larger customers who are served through our enterprise sales team. These companies tend to have more complicated and customized
websites that need a deeper resolution to ensure they are compliant with WCAG guidelines. We serve them through multiple offerings.
Our Managed services is the biggest part of that offering-set. We also offer PDF remediation and MobileApp guide solutions for
them. We believe that the AudioEye products provides a business advantage for our clients by enabling them to better reach the
large population of customers who are not able to gain equal access to our clients’ content, products, and services delivered
via their websites
Government and Not-for-Profit Organizations
Federal and state
laws require that the information and services made available across government agency websites meet the diverse and unique needs
of all site visitors. Conforming to Web Accessibility best practices and guidelines helps ensure public access to government information
and improves the value of agency investment in their websites and online services.
The Rehabilitation
Act of 1973 (“Rehabilitation Act”) requires that individuals with disabilities, who are members of the public seeking
information or services from a federal department or agency, have access to and use of information and data that is comparable
to that provided to the public without disabilities. The federal government also requires vendors selling to the government to
be compliant under Section 508 of the Rehabilitation Act, unless covered by a provable exception. Canada and the European
Union have similar requirements.
Seniors and print-impaired
individuals need the Internet’s critical access to fundamental state, local and federal government services and information
such as tax forms, social programs, emergency services and legislative representatives. In addition, the roughly 120,000 federal
employees with disabilities require Internet accessibility for workplace productivity. The AudioEye Reader in the cloud provides
an intuitive Internet experience across all Internet-enabled devices without imposing any additional costs on end-users. For government
site administrators, our Digital Accessibility Platform is designed to be user-friendly so that sites can be made accessible and
maintained as part of any web management process.
Over 100 governments
have signed and ratified the UN Convention on the Rights of Persons with Disabilities. The Company’s certification seal
demonstrates a website owner’s commitment to meeting internationally accepted accessibility standards. As a result, our
management believes that providing accessibility services for website owners and developers has become a significant market opportunity
in view of the potential demand across millions of internet websites.
The AudioEye solution
provides a unique approach to solving a pervasive issue that has inhibited government agencies from embracing efficiencies gained
through adopting new cost-effective technological capabilities. More and more federal agencies are beginning to embrace cloud-based
service offerings and to leverage the capabilities afforded through the adoption of third-party cloud-based service providers.
Implementing the AudioEye solution allows federal, state, and local governments to provide constituents with a reliable, scalable,
and fully accessible web environment. By pairing the AudioEye Solution with other disparate SaaS offerings, organizations can
more readily comply with the ADA standards. Implementing AudioEye mitigates risk of non-conformance and goes beyond basic levels
of compliance through the inclusion of free cloud-based assistive tools, which lives up to the spirit of ADA - a noble and necessary
aspiration for all federal, state and local government agencies.
Our solutions are
sold by our enterprise sales team and through strategic partnerships and resellers. This strategy enables us to address all the
broad markets covered by our technology and allows for a depth and market penetration that we could never approach on our own.
Our management believes
that the government market imposes certain barriers to entry to new potential entrants. However, our management believes that
the potential for recurring revenue generation, the data value appreciation that occurs over time, and low turnover upon establishment
of government business all contribute to ideal long-term conditions that make this a good market for us to conduct direct sales.
The federal government
boasts nearly 2,000 top-level .gov domains and 24,000 websites of varying purpose, design, navigation, usability and accessibility.
Including the 50 states and all local government websites, there are over 600,000 government websites in the United States.
Potential additional
market segments or verticals of focus include, but are not limited to:
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Finance & Banking Institutions;
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Travel & Hospitality;
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Public & Private Transportation Companies;
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Retail and Ecommerce Companies;
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Educational Institutions (K-12 and universities as a result
of frequent and recent settlement agreements involving and structured by the Department of Justice);
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Food Services; and
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SaaS Providers.
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Marketing and Sales
In addition to our
enterprise sales team, we use strategic business partnerships and development referral partners, for introductions to C-level
executives and key stakeholders that directly influence the buying decision of our technology and services. Success in all these
efforts is not only critical in order to meet our sales objectives, but also raises market awareness of the Company’s products
and brand.
We also have a Partnership
sales team that focuses on building and maintaining relationships with CMS providers focused on either specific verticals (e.g.
Dealer.com) or who are vertical agnostic (e.g. Duda).
Our increased focus
is now to further strengthen our digital marketing by enhancing the content we share with potential customers and by also ensuring
that our Brand image continues to improve as we satisfy our customers and expand our reach and market share in this growing space.
The Company also attends
selected accessibility and industry trade conferences, maintains memberships with key, industry-specific organizations, serves
as a subject matter expert within well-attended panels covering industry-related topics, leverages paid search engine optimization
for those looking online to learn about or purchase accessibility products or services, and a variety of other conventional marketing
and social marketing techniques.
Competition
Website accessibility
can be achieved in one of two ways.
The traditional approach
is called a “Shift Left” strategy. On the continuum of an organization’s software development life cycle, shift
left refers to integrating universal design and accessibility testing and analysis as early on in a project (the design and development
process) as possible. The idea is to prohibit inaccessible content from reaching production environments. For many businesses
and organizations with the right resources and afforded a healthy amount of time, this is absolutely the right thing to do. Without
a doubt, websites should be designed, developed, and created with web accessibility in mind. This is why AudioEye offers the Digital
Accessibility Platform and provides resources for organizations seeking to empower internal stakeholders to become the subject
matter experts. This approach, however, does little to assist organizations being sued based on websites that are already live
and public facing. No one has ever been sued for a website that was being built. By the thousands, per year, businesses are being
sued because of the sites they have, today, and not the sites they are looking to build in the future.
AudioEye makes websites
accessible. Our solution identifies and remediates accessibility issues with both automated and manual testing and engineering
and provides on-going monitoring to ensure sites meet or exceed legal compliance with ADA-related laws and substantially conform
with the WCAG, which is the internationally recognized benchmark used to ensure the needs of individuals of disabilities are addressed
when it comes to creating and publishing websites and digital content.
We believe that other
competitive solutions are insufficient when it comes to actually achieving substantial conformance with WCAG and removing access
barriers that may impede or limit access for individuals with disabilities. These other solutions include:
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Automated Testing Tools. These tools are insufficient
and not always a viable solution. There are a vast number of automated testing tools. These solutions provide businesses that
tend to have very little knowledge of the issues with insights into, approximately, 35% of the overall potential access barriers.
Unfortunately, they do not assist businesses in understanding true access barriers and may even provide misleading evidence
(e.g. false positives) that further delay product stakeholders time (assuming the business even controls its website –
i.e. many businesses rely on outsourced niche CMS providers, which leaves their hands tied when it comes to meeting compliance
requirements). At the very best, these tools offer potential insight to assist internal stakeholders with information as to
how to find and potentially fix, up to only 35% of the issues that are detected by the automated testing suite. The remaining
issues require subject matter experts to uncover issues through manual accessibility (AT) testing.
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Accessibility Toolbars. These tools are insufficient
and not a viable solution by themselves. For as many automated testing tools that can be found in the marketplace, there are
just about as many low-cost accessibility toolbars, many of which emulate the leading edge, industry-first web personalization
tools that AudioEye supplies free with the Managed Service. On their own, these solutions provide businesses with only incremental
benefits that address a small percentage of potential access barriers. Automatic remediation (if any) narrowly addresses WCAG
Success Criteria, which provides very little benefit for AT users, who are the ones filing lawsuits against businesses for
non-compliance. This approach has worked well in countries outside of the U.S. as evidenced by the large number of international
firms attempting to enter the market in the U.S. Until these tool providers achieve validation from U.S.-based security organizations
and can pass stringent due diligence examinations, they face an uphill climb. Further, and more importantly, until these tool
providers are able to securely and reliably deliver human-based remediation as delivered through their dynamic remediation
technology, U.S. companies will gain limited benefit by incorporating and using these highly limited solutions.
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In summary, our management
believes that the Company’s technology and solutions will primarily compete against the following:
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Web Accessibility Assessment Technology Providers and Automated
Testing Tools. There are a small number of Web Accessibility audit and tracking platform providers, but we do not believe
their technology solutions offer the specific end-to-end services offered through the AudioEye Digital Accessibility Platform.
Furthermore, their solutions are currently more standalone in that, unlike the Company, they are not combined with a cloud-based
tool with a full suite of assistive tools for end-users.
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Web Accessibility Remediation Technology Providers. Currently,
other technology providers that utilize technology to apply compliance remediation through a server-side technology do not
effectively deploy human-based remediations, nor do they pair their solution with the full breadth of services offered through
the AudioEye Managed Platform product suite, including, for example, assistive tools for end-users. These providers are therefore
limited in their capacity to provide a fully inclusive user experience for the customers adopting the technology.
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Web Accessibility Consulting Service Providers. There
are a substantial number of consulting service providers in the Web Accessibility industry. Each generally provides an analysis
of the various compliance issues associated with its clients’ websites. They ultimately provide resources and assistance
in applying fixes and changes at the source. While we provide these services, we also provide tools that empower an end-to-end
fully managed service, as well as tools that empower self-directed developers to fix issues without requiring source-code
remediation.
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Cloud-Based Assistive Technology Providers and Accessibility
Toolbars. There are other cloud-based assistive technology providers. However, they do not offer a reliable and trusted
solution with compliance detection and remediation for users of existing, native assistive technologies, such as screen readers.
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Competitive Strengths
Our management believes
the following competitive strengths will enable our success in the marketplace:
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Unique patented technology. First and foremost, AudioEye
builds all its products with the primary goal of enhancing the user experience, in every way possible, regardless of the end-user’s
individual disability or physical limitation. AudioEye is a marketplace technology leader providing what we believe to be
unparalleled Web Accessibility solutions for our clients’ customers through our Managed Platform products. We
own a unique patent portfolio comprised of six issued patents in the United States and we have additional U.S. patents pending.
Our portfolio includes patents and pending patent applications in the United States with over 60 issued claims.
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Freemium model. A Freemium model that enables all website
owners to leverage our free tools as well as very reasonably priced offerings all the way to our customized enterprise grade
solutions. We believe that having a full-suite of offerings is a competitive differentiator for AudioEye, but the Company
must continue to try and differentiate our offerings from a growing list of companies competing in various ways.
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Unique combination of technology and specialized managed
service. Our management believes that AudioEye has addressed the problem of Web Accessibility, holistically, and provides
a combination of leading-edge technology and high-quality specialized managed service. Our combined solution is designed to
provide our clients with access and usability across their digital infrastructure, and to lead to cost-savings and reduced
time-to-market for our customers. Our management believes that the AudioEye solution allows our customers to focus not only
on achieving compliance, but also on maintaining compliance throughout the life of the subscription.
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Our current portfolio
has established a foundation for building unique technology solutions that contribute to the way in which we differentiate ourselves
from other competitors in the B2B Web Accessibility marketplace. In this continued pursuit of expanding the capabilities of our
technology and meeting the demands of our customers, AudioEye is committed to growing its IP portfolio.
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Highly experienced inventors, technologists and product development
team. Our team is comprised of experienced software, e-commerce, mobile marketing and Internet developers and technologists
that have worked together for over fifteen years. During their careers, this team has developed several technologies programs
for Fortune 500 organizations; federal, state and local governments in the United States, and several leading organizations
across the global marketplace.
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Patent and Trademark Rights
Our intellectual property
is primarily comprised of trade secrets, trademarks, issued, published and pending patent applications, copyrights and technological
innovation. We have a patent portfolio comprised of eight issued patents in the United States. We also have two pending patent
applications and two international patent applications filed via the Patent Cooperation Treaty (“PCT”). The patents
have been extended and cover a period from 2002 through 2038.
We have eight registered
trademarks with the U.S. Patent and Trademark Office. The commercial value of these patents is unknown.
Legal Landscape and Government Regulation
Government regulation
in the United States that affects the market and commercial potential for our products and services includes the Rehabilitation
Act, the ADA, Section 508 of the Rehabilitation Act, Section 504 of the Rehabilitation Act, the Twenty-First Century Communications
and Video Accessibility Act of 2010 (“CVAA”), the Air Carrier Accessibility Act (“ACAA”), and various
State Laws.
The Rehabilitation
Act requires that individuals with disabilities, who are members of the public seeking information or services from a federal
department or agency, have access to and use of information and data that is comparable to that provided to the public without
disabilities. The federal government also requires vendors selling to the government be compliant under Section 508 of the
Rehabilitation Act, unless covered by a provable exception. Canada and the European Union have similar requirements.
The ADA was passed
to ensure equal opportunity for people with disabilities. It applies to employment, transportation, state and local government
services, and businesses that provide public accommodations or facilities.
Title II and Title
III of the ADA prevent discrimination on the basis of disability in services, programs, and activities provided by public entities
(Title II) and private entities considered to be places of public accommodation (Title III). Title II and Section 504 of the Rehabilitation
Act continue to be actively enforced by the Office of Civil Rights (“OCR”), who has entered into hundreds of resolution
agreements with School Districts and Education Institutions requiring conformance to WCAG 2.1 Success Criteria as managed and
monitored through an OCR-validated Accessibility Auditor.
Under the previous
administration, the Department of Justice (“DOJ”) was in the process of formulating rules regarding the accessibility
of websites and mobile applications. The DOJ had divided its rulemaking into two efforts: the first was intended to provide guidance
to state and local entities to comply with Title II, and the second was intended to establish rules for private entities to comply
with Title III. Under the new administration, the DOJ has placed the issuance of those rulemakings on the inactive list. However,
we believe the absence of any rulemaking will only increase the prevalence of lawsuits filed by plaintiffs seeking issue resolution
in continued pursuit of their civil rights as protected under ADA. According to a leading ADA law firm, Seyfarth Shaw, with over
2,258 federal lawsuits filed, federal ADA Title III lawsuits increased by 17% in 2018 due largely to Website Access Lawsuits.
This trend is expected to increase in 2020.
Learn more at www.ada.gov.
Section 508 of the
Rehabilitation Act Requires that federal agencies’ electronic and information technology is accessible to people with
disabilities, including employees and the public.
The U.S. Government
Access Board has updated the requirements to Section 508 compliance standards, commonly referred to as the “Section 508
ICT Refresh,” further formalizing the mandate to adhere to specific web accessibility best practices, namely those outlined
under the WCAG, the international standards for web accessibility. Already, a growing number of legal mandates and recent settlements
point to the WCAG 2.1 standards as well as making it a requirement to hire third-party Accessibility Subject Matter Experts to
maintain an accessibility audit and provide certification – sources range from the DOJ, the U.S. Access Board, and the OCR.
For more information,
visit www.section508.gov.
Section 504 of the
Rehabilitation Act entitles individuals with disabilities to equal access to any program or activity that receives federal subsidy
– this includes Web-based communications for educational institutions and government agencies.
In October 2010,
the CVAA was enacted to update existing federal laws requiring communications and video programming accessibility and to fill
in any current gaps in accessibility to ensure the full inclusion of people with disabilities in all aspects of daily living through
accessible, affordable and usable communication and video programming technologies.
Per the Department
of Transportation, the ACAA (49 U.S.C. 41705) prohibits discrimination by U.S. and foreign air carriers on the basis of physical
or mental disability. The Department of Transportation, in interpreting and implementing the ACAA, has issued a rule setting forth
the standards of service which air carriers are expected to provide to disabled individuals.
Beyond the federal
level, many states have enacted accessibility laws and, going further, internationally, over 100 Governments have signed and ratified
the UN Convention on the Rights of Persons with Disabilities.
As an example, the
California Unruh Civil Rights Act, among other things, prohibits discrimination based on disability. More recently, a new law
enacted in California, Assembly Bill 434 State Web Accessibility, states that prior to July 1, 2019, each State Agency Director
or its Chief Information Officer must post on the homepage of its agency a declaration that the site has been made accessible
by meeting the WCAG standards.
Given the many government
regulations in place and/or in process, actions must be taken for businesses to comply with best practices and international standards.
This presents a significant business opportunity as more pressure is being put on businesses and organizations to improve the
accessibility of their web environments. In addition, from a risk mitigation standpoint, it is best if they consistently and reliably
track and demonstrate their level of conformance to these internationally recognized standards over time, the WCAG 2.1.
Disabilities advocates
won a major victory recently after the U.S. Supreme Court left in place an appeals court ruling arguing that Domino’s website
and app must abide by the same rules of accessibility as brick-and-mortar shops. The top court refused to hear a federal
appeals court ruling that Domino’s website and app have to follow Americans with Disabilities Act (ADA) regulations and
be accessible to people with visual or other impairments. The decision could have broad implications for the restaurant industry,
in particular. Chains such as Domino’s are taking a lot more orders through their website and smartphone apps, making
them key places of doing business. The ruling suggests restaurants could be subject to ADA lawsuits if that ordering technology
isn’t accessible to people with disabilities. The case is one of several that disabilities advocates have filed against
companies’ websites, seeking to push them to comply with federal accessibilities regulations.
Employees
As of March 30, 2020,
we had 84 full-time employees. None of our employees is subject to a collective bargaining agreement and we believe that relations
with our employees are very good. We have a sincere focus on developing each team member to allow the team member to grow professionally
and personally during his or her time with AudioEye.
Corporate Information
AudioEye, Inc.
was formed as a Delaware corporation on May 20, 2005. On August 1, 2018, the Company amended its Certificate of Incorporation
to implement a reverse stock split in the ratio of 1 share for every 25 shares of common stock and to reduce the number of authorized
shares of common stock from 250,000,000 to 50,000,000. As a result, 186,994,384 shares of the Company’s common stock were
exchanged for 7,479,775 shares of the Company's common stock. Our financial statements have been retroactively restated to reflect
the reverse stock split.
Our principal executive
offices are located at 5210 East Williams Circle, Suite 750, Tucson Arizona, 85711, and our telephone number at that address is
(866) 331-5324. We maintain a website at www.audioeye.com (this reference to our website is an inactive textual reference only
and is not intended to incorporate our website into this report). We file reports with the Securities and Exchange Commission
(“SEC”) and make available, free of charge, on or through our website, our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to those reports
filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the SEC. In addition, the SEC maintains a website at www.sec.gov containing reports,
proxy and information statements and other information regarding issuers that file electronically with the SEC. Information on
the SEC’s website does not constitute part of this report. Our website also contains copies of our corporate governance
guidelines, code of business conduct and ethics, related party transaction policy and whistleblower policy, and copies of the
charters for our audit committee, compensation committee and nominating and corporate governance committee.
On February 25, 2020,
the Board of Directors (the “Board”) of AudioEye, Inc. appointed Heath Thompson as the Company’s Chief Executive
Officer, effective upon the commencement of his employment with the Company. Mr. Thompson, age 60, joined the Company on March
23, 2020. On February 25, 2020, the Company and Mr. Thompson also entered into an Executive Employment Agreement (the “Employment
Agreement”), effective as of March 23, 2020, pursuant to which the Company will employ Mr. Thompson as its Chief Executive
Officer on the terms and conditions set forth therein. The Employment Agreement provides for an initial one-year term (the “Initial
Term”), with automatic renewals for a one-year term (the “Subsequent Term”) immediately following the Initial
Term, and automatic renewals for successive one-year terms immediately following the Subsequent Term, unless the Employment Agreement
is terminated as provided therein or either party provides a nonrenewal notice at least 30 days prior to the expiration of the
then-current term. A copy of the Employment Agreement is filed as Exhibit 10.48 to this annual report. Mr. Thompson’s principal
place of employment will be in the Atlanta, Georgia metropolitan area.
On January 13, 2020,
Todd Bankofier, Chief Revenue Officer of AudioEye, Inc. (the “Company”), notified the Company of his resignation,
effective as of the close of business on January 17, 2020, as Chief Revenue Officer and as an employee of the Company. In connection
with the termination of Mr. Bankofier’s employment, Mr. Bankofier and the Company entered in to a Severance Agreement and
General Release of Claims dated as of January 17, 2020 pursuant to which Mr. Bankofier received certain severance compensation
and benefits. A copy of the Severance Agreement and General Release of Claims is filed as Exhibit 10.47 to this annual report.
Item 1A. Risk
Factors
In addition to
the other information included in this Annual Report, the following factors should be carefully considered in evaluating our business,
financial position and future prospects. Any of the following risks, either alone or taken together, could materially and adversely
affect our business, financial position or future prospects. If one or more of these or other risks or uncertainties materialize,
or if our underlying assumptions prove to be incorrect, our actual results may vary materially from what we have projected. Investing
in our common stock is highly speculative and involves a high degree of risk. Any potential investor should carefully consider
the risks and uncertainties described below before purchasing any shares of our common stock. There may be additional risks that
we do not presently know about or that we currently believe are immaterial which could also materially adversely affect our business,
financial position or future prospects. As a result, the trading price of our stock could decline, and you might lose all or part
of your investment. Our business, financial condition, and operating results, or the value of any investment you make in the stock
of our company, or both, could be adversely affected by any of the factors listed and described below.
Risks Relating to Our Business and
Industry
We have a history of generating
significant losses and may not be able to achieve and sustain profitability.
To date, we have not
been profitable, and we may never achieve profitability on a full-year or consistent basis. We incurred net losses of $7,783,271
for the year ended December 31, 2019. As of December 31, 2019, we have an accumulated deficit of $49,926,372. If we continue
to experience losses, we may not be able to continue our operations, and investors may lose their entire investment.
Our future development will require
additional capital, and we may be unable to obtain needed capital or financing on satisfactory terms, or at all, which would prevent
us from fully developing our business and generating revenues.
As of March 30, 2020,
our cash available is approximately $1.6M. Our business plan will require additional capital expenditures, and our capital outlays
could increase substantially over the next several years as we implement our business plan. As a result, we may need to raise additional
capital through future private or public equity offerings, strategic alliances or debt financing. Our future capital requirements
will depend on many factors, including, among others: market conditions, sales and marketing costs, mergers and acquisition activity,
if any, costs of litigation in enforcing our patents, and information technology development and acquisition costs. No assurance
can be given that we can successfully raise additional equity or debt capital, or that such financing will be available to us on
favorable terms, if at all.
We have been subject to litigation and may in the future
be subject to additional litigation, which could have a material adverse effect on our financial position or results of operations.
We may become involved
in various routine disputes and allegations incidental to our business operations. Because it is not possible to determine when
and whether these disputes and allegations may arise or the ultimate disposition of such matters, the resolution of any such matters,
should they arise, could have a material adverse effect on our financial position or results of operations.
Weakened global economic conditions
including current and ongoing microeconomic uncertainty may adversely affect our industry, business and results of operations.
Our overall performance
depends in part on worldwide economic and geopolitical conditions. The United States and other key international economies have
experienced cyclical downturns from time to time in which economic activity was impacted by falling demand for a variety of goods
and services, restricted credit, poor liquidity, reduced corporate profitability, volatility in credit, equity and foreign exchange
markets, bankruptcies and overall uncertainty with respect to the economy. These economic conditions can arise suddenly and the
full impact of such conditions can remain uncertain. In addition, geopolitical developments, such as existing and potential trade
wars and other events beyond our control, such as the Coronavirus epidemic, can increase levels of political and economic unpredictability
globally and increase the volatility of global financial markets. For example, in response to the Coronavirus epidemic, we have
shifted certain of our customer events to virtual-only experiences and we may deem it advisable to similarly alter, postpone or
cancel entirely additional customer, employee or industry events in the future. Moreover, these conditions can affect the rate
of IT spending and could adversely affect our customers’ ability or willingness to attend our events or to purchase our
software, delay prospective customers’ purchasing decisions, reduce the value or duration of their subscription contracts,
or affect attrition rates, all of which could adversely affect our future sales and operating results.
Our revenue and collections may
be materially adversely affected by an economic downturn.
Recent macroeconomic
conditions have shown signs of volatility and potential weakness. We believe commercial purchasing habits and corporate information
technology budgets have improved in recent years but remain relatively constrained and subject to such volatile and potentially
weak economic conditions. Any deterioration in prevailing economic conditions would likely result in reduced demand for our services
and products, which could have a material adverse effect on our business financial position or results of operations.
An increase in market interest rates
could increase our interest costs on future debt and could adversely affect our stock price.
If interest rates
increase, so could our interest costs for any new debt. This increased cost could make financing, including the financing of any
acquisition, costlier. We may incur variable interest rate indebtedness in the future. Rising interest rates could limit our ability
to refinance debt when it matures or cause us to pay higher interest rates upon refinancing and increased interest expense on
refinanced indebtedness.
Our success is dependent on certain
members of our management and technical team.
Our success has depended,
and continues to depend, on the efforts and talents of our senior management team and key employees, including our engineers,
product managers, sales and marketing personnel, and professional services personnel. Our future success will also depend upon
our continued ability to identify, hire and retain additional skilled and highly qualified personnel, including a new chief financial
officer, which will require significant time, expense and attention. We cannot assure you that our management will remain
in place or as to the time it will take for us to identify, hire and retain a new chief financial officer. We do not maintain
“key person” life insurance policies. The loss of any of our management and technical team members could have a material
adverse effect on our results of operations and financial condition, as well as on the market price of our common stock.
We intend to pursue new strategic
opportunities which may result in the use of a significant amount of our management resources or significant costs, and we may
not be able to fully realize the potential benefit of such opportunities.
We intend to seek
other strategic partners to help us pursue our strategic, marketing, sales, or technical objectives. Although we may devote significant
time and resources in pursuit of such transactions, we may struggle to successfully identify such opportunities, or to successfully
conclude transactions with potential strategic partners. Should we be unable to identify or conclude important strategic transactions,
our business prospects and operations could be adversely affected as a result of the devotion of significant managerial effort
required, and the challenges of achieving our objectives in the absence of strategic partners. In addition, we may incur significant
costs in connection with seeking acquisitions or other strategic opportunities regardless of whether the transaction is completed,
and in combining its operations if such a transaction is completed. In the event that we consummate an acquisition or strategic
alternative in the future, we cannot assure you that we would fully realize the potential benefit of such a transaction.
Our business plan may not be realized.
If our business plan proves to be unsuccessful, our business may fail, and you may lose your entire investment.
Our operations are
subject to all of the risks inherent in the establishment of a new business enterprise with a limited operating history. The likelihood
of our success must be considered in light of the problems, expenses, complications, and delays frequently encountered in connection
with the development of a new business. Unanticipated events may occur that could affect the actual results achieved during the
forecast periods. Consequently, the actual results of operations during the forecast periods will vary from the forecasts, and
such variations may be material. In addition, the degree of uncertainty increases with each successive year presented in our business
plan. We cannot assure you that we will succeed in the anticipated operation of our business plan. If our business plan proves
to be unsuccessful, our business may fail, and you may lose your entire investment.
We have experienced and will continue
to experience competition as more companies seek to provide products and services similar to our products and services and because
larger and better-financed competitors may affect our ability to compete in the marketplace and achieve profitability, our business
may fail.
Competition in our
market is intense, and we expect competition for our products and services to become even more intense. We compete directly against
other companies offering similar products and services that compete or will compete directly with our proposed products and services.
We also compete against established vendors in our markets. These companies may incorporate other competitive technologies into
their product offerings, whether developed internally or by third parties. There are also established consultants who offer services
to help their customers obtain compliance with accessibilities standards. In many cases these consultants compete for the same
funding from our prospective customers. For the foreseeable future, substantially all our competitors are likely to be larger,
better-financed companies that may develop products superior to our current and proposed products, which could create significant
competitive advantages for those companies. Our future success depends on our ability to compete effectively with our competitors.
As a result, we may have difficulty competing with larger, established competitors. Generally, these competitors have:
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substantially greater financial, technical, and marketing resources;
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a larger customer base;
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better name recognition; and
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more expansive or different product offerings.
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These competitors
may command a larger market share than we do, which may enable them to establish a stronger competitive position, in part, through
greater marketing opportunities. Further, our competitors may be able to respond more quickly than we are to new or emerging technologies
and changes in user preferences and to devote greater resources to developing new products and offering new services. These competitors
may develop products or services that are comparable or superior to ours. If we fail to address competitive developments quickly
and effectively, we may not be able to remain a viable business.
If we are not able to adequately
protect our patented rights, our operations would be negatively impacted.
Our ability to compete
largely depends on the superiority, uniqueness and value of our technology and intellectual property. To protect our intellectual
property rights, we rely on a combination of patent, trademark, copyright, and trade secret laws, confidentiality agreements with
our employees and third parties, and protective contractual provisions. We cannot assure you that infringement or invalidity claims
(or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against us or that any such
assertions or prosecutions will not materially adversely affect our business.
Regardless of whether
any future claims are valid or can be successfully asserted, defending against such claims could cause us to incur significant
costs, could jeopardize or substantially delay a successful outcome in any future litigation, and could divert resources away
from our other activities. In addition, assertion of infringement claims could result in injunctions that prevent us from distributing
our products. In addition to challenges against our existing patents, any of the following could also reduce the value of our
intellectual property now, or in the future:
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our applications for patents, trademarks, and copyrights relating
to our business may not be granted and, if granted, may be challenged or invalidated;
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issued trademarks, copyrights or patents may not provide us with any competitive advantages;
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our efforts to protect our intellectual property rights may
not be effective in preventing misappropriation of our technology; or
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our efforts may not prevent the development and design by others
of products or technologies similar to, competitive with, or superior to those that we develop.
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Also, we may not be
able to effectively protect our intellectual property rights in certain foreign countries where we may do business in the future
or from which competitors may operate. Obtaining patents will not necessarily protect our technology or prevent our international
competitors from developing similar products or technologies. Our inability to adequately protect our patented rights would have
a negative impact on our operations and revenues.
In addition, legal
standards relating to the validity, enforceability, and scope of protection of intellectual property rights in Internet-related
businesses are uncertain and still evolving. Because of the growth of the Internet and Internet-related businesses, patent applications
are continuously and simultaneously being filed in connection with Internet-related technology. There are a significant number
of U.S. and foreign patents and patent applications in our areas of interest, and we believe that there has been, and is likely
to continue to be, significant litigation in the industry regarding patent and other intellectual property rights.
We may commence legal proceedings
against third parties who we believe are infringing on our intellectual property rights, and if we are forced to litigate to defend
our intellectual property rights, or to defend claims by third parties against us relating to intellectual property rights, legal
fees and court injunctions could adversely affect our financial condition and potentially end our business.
At present, we do
not have any active or pending litigation related to the violation of our patents. We expect an increase in the number of third
parties who could violate our patents as the market develops new uses of similar products and consumers begin to increase their
adoption of the technology and integrate it into their daily lives. We foresee the potential need to enter into active litigation
to defend and enforce our patents. We anticipate that these legal proceedings could continue for several years and may require
significant expenditures for legal fees and other expenses. In the event we are not successful through appeal and do not subsequently
obtain monetary and injunctive relief, these litigation matters may significantly reduce our financial resources and have a material
impact on our ability to continue our operations. The time and effort required of our management to effectively pursue or defend
these litigation matters may adversely affect our ability to operate our business, since time spent on matters related to the
lawsuits would take away from the time spent on managing and operating the business. We cannot assure you any such potential lawsuits
will result in an outcome that is favorable to our stockholders or the Company.
The burdens of being a public company
may adversely affect our ability to develop our business and pursue a litigation strategy.
Since we are a public
company, our management must devote substantial time, attention, and financial resources to comply with U.S. securities laws.
This may have a material adverse effect on our management’s ability to effectively and efficiently develop our business
initiatives. In addition, our disclosure obligations under U.S. securities laws may require us to disclose information publicly
that could have a material adverse effect on our potential litigation strategies.
The current regulatory environment
for our products and services remains unclear.
We cannot assure you
that our existing or planned product and service offerings will be in compliance with local, state, and/or federal U.S. laws or
the laws of any foreign jurisdiction where we operate or may operate in the future. Further, we cannot assure you that we will
not unintentionally violate such laws or that such laws will not be modified, or that new laws will not be enacted in the future,
which would cause us to be in violation of such laws. More aggressive domestic or international regulation of the Internet may
materially and adversely affect our business, financial condition, operating results, and future prospects.
As pressure of legal ramifications
from non-compliance with Web Accessibility increases, customers may be less inclined to permit or may delay AudioEye from promoting
client relationships and/or the specifics associated with those relationships, and if this restricts our public communications
with potential investors and stockholders, it may negatively impact our ability to gain interest in our business from potential
investors and stockholders.
Due to an undefined
regulatory environment and a heightened sensitivity by plaintiffs seeking retribution for inaccessible and unusable digital interfaces,
any organization may be sued or faced with legal demands claiming non-compliance. As these legal actions or demands may be initiated
with or without merit, they present a new level of risk for website owners and publishers. In an effort to avoid any potential
unwanted attention pertaining to the subject of compliance, AudioEye clients may enforce rigid stipulations pertaining to AudioEye’s
promotion of their involvement or engagement with AudioEye, regardless of the level of success or positive impact any such engagement
may have or have had on their businesses. Whether through the enforcement of non-disclosure agreements or through specific non-disclosure
language associated with client contracts, if AudioEye is not empowered to promptly make public announcements about its client
base and the adoption and success of AudioEye products and services, there may be a deleterious effect on the Company’s
capacity to accelerate its business growth or attract investment from existing or future investors and stockholders.
Our business greatly depends on
the growth of online services, Internet of Things (“IOT”), kiosks, streaming, and other next-generation Internet-based
applications, and there is a risk that such growth may not occur as expected, or at all, which would harm our business.
The Internet may ultimately
prove not to be a viable commercial marketplace for such applications for several reasons, including:
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unwillingness of consumers to shift to and use other such next-generation Internet-based
audio applications;
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refusal to purchase our products and services;
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perception by end-users with respect to product and service quality and performance;
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limitations on access and ease of use;
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congestion leading to delayed or extended response times;
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inadequate development of Internet infrastructure to keep pace with increased levels of
use; and
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increased government regulations.
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Because of these and
other factors, the growth of online services, IOT, kiosks, streaming, and other next-generation Internet-based applications may
be impeded or not occur as expected. As a result, our business and operations could be adversely impacted.
If the market for our online services
does not grow as anticipated, our business would be adversely affected.
While other next-generation
Internet-based applications have grown rapidly in personal and professional use, we cannot assure you that the adoption of our
products and services will grow at a comparable rate or grow at all.
We expect that we will experience
long and unpredictable sales cycles, which may impact our operating results.
We expect
that our sales cycles will be long and unpredictable due to a number of uncertainties such as:
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the need to educate potential customers about the current state of accessibility for those
with disabilities;
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customers’ willingness to invest potentially substantial resources and infrastructures
to take advantage of our products and services;
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customers’ budgetary constraints;
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the timing of customers’ budget cycles; and
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delays caused by customers’ internal review and procurement processes.
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These factors may
create additional lead time before a sale is finalized and may lead to longer than expected and unpredictable sales cycles, which
could delay or reduce our revenue and impact our operating results.
Our expansion into new products,
services, technologies, and geographic regions subjects us to additional business, legal, financial, and competitive risks.
We may have limited
or no experience in our newer market segments, and our customers may not adopt our new offerings. These offerings may present
new and difficult technology challenges, and we may be subject to claims if customers of these offerings experience service disruptions
or failures or other quality issues. In addition, profitability, if any, in our newer activities may be lower than in our older
activities, and we may not be successful enough in these newer activities to recoup our investments in them. If any of this were
to occur, it could damage our reputation, limit our growth, and negatively affect our operating results.
We face risks related to system
interruption and lack of redundancy.
We experience occasional
system interruptions and delays that make our websites and services unavailable or slow to respond and prevent us from efficiently
providing services to third parties, which may reduce our net sales and the attractiveness of our products and services. If we
are unable to continually add software and hardware, effectively upgrade our systems and network infrastructure, and take other
steps to improve the efficiency of our systems, it could cause system interruptions or delays and adversely affect our operating
results.
Our computer and communications
systems and operations could be damaged or interrupted by fire, flood, power loss, telecommunications failure, earthquakes, acts
of war or terrorism, acts of God, computer viruses, physical or electronic break-ins, and similar events or disruptions. Any of
these events could cause system interruption, delays, and loss of critical data, and could prevent us from providing services,
which could make our product and service offerings less attractive and subject us to liability. Our systems are not fully redundant,
and our disaster recovery planning may not be sufficient. In addition, we may have inadequate insurance coverage to compensate
for any related losses. Any of these events could damage our reputation and be expensive to remedy.
Government regulation is evolving, and unfavorable changes
could harm our business.
We are subject to
general business regulations and laws, as well as regulations and laws specifically governing the Internet, e-commerce, electronic
devices, and other services. Existing and future laws and regulations may impede our growth. These regulations and laws may cover
taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic device certification,
electronic waste, energy consumption, environmental regulation, electronic contracts and other communications, competition, consumer
protection, web services, the provision of online payment services, information reporting requirements, unencumbered Internet
access to our services, the design and operation of websites, the characteristics and quality of products and services, and the
commercial operation of unmanned aircraft systems. It is not clear how existing laws governing issues such as property ownership,
libel, and personal privacy apply to the Internet, e-commerce, digital content, and web services. Unfavorable regulations and
laws could diminish the demand for our products and services and increase our cost of doing business.
We could be subject to additional
sales tax or other indirect tax liabilities.
U.S. Supreme Court
decisions restrict the imposition of obligations to collect state and local sales taxes with respect to remote sales. However,
an increasing number of states have considered or adopted laws or administrative practices that attempt to impose obligations
on out-of-state businesses to collect taxes on their behalf. A successful assertion by one or more states or foreign countries
requiring us to collect taxes where we do not currently do so could result in substantial tax liabilities, including for past
sales, as well as penalties and interest.
We may be subject to risks related
to government contracts and related procurement regulations.
Our contracts with
U.S., as well as state, local, and foreign, government entities are subject to various procurement regulations and other requirements
relating to their formation, administration, and performance. We may be subject to audits and investigations relating to our government
contracts, and any violations could result in various civil and criminal penalties and administrative sanctions, including termination
of contracts, refunding or suspending of payments, forfeiture of profits, payment of fines, and suspension or debarment from future
government business. In addition, such contracts may provide for termination by the government at any time, without cause.
If we do not successfully develop
our planned products and services in a cost-effective manner to meet customer demand in the rapidly evolving market for next-generation
Internet-based applications and services, our business may fail.
The market for next-generation
Internet-based applications and services is characterized by rapidly changing technology, evolving industry standards, changes
in customer needs, and frequent new service and product introductions. Our future success will depend, in part, on our ability
to use new technologies effectively, to continue to develop our technical expertise and proprietary technology, to enhance our
existing products and services, and to develop new products and services that meet changing customer needs on a timely and cost-effective
basis. We may not be able to adapt quickly enough to changing technology, customer requirements, and industry standards. If we
fail to use new technologies effectively, to develop our technical expertise and new products and services, or to enhance existing
products and services on a timely basis, either internally or through arrangements with third parties, our product and service
offerings may fail to meet customer needs, which would adversely affect our revenues and prospects for growth.
In addition, if we
are unable to, for technological, legal, financial, or other reasons, adapt in a timely manner to changing market conditions or
customer requirements, we could lose customers, strategic alliances, and market share. Sudden changes in user and customer requirements
and preferences, the frequent introduction of new products and services embodying new technologies, and the emergence of new industry
standards and practices could render our existing products, services and systems obsolete. The emerging nature of products and
services in the technology and communications industry and their rapid evolution will require that we continually improve the
performance, features, and reliability of our products and services. Our survival and success will depend, in part, on our ability
to:
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design, develop, launch and/or license our planned products,
services, and technologies that address the increasingly sophisticated and varied needs of our prospective customers; and
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respond to technological advances and emerging industry standards
and practices on a cost-effective and timely basis.
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The development of
our planned products and services and other patented technology involves significant technological and business risks and requires
substantial expenditures and lead time. We may be unable to use new technologies effectively. Updating our technology internally
and licensing new technology from third parties may also require us to incur significant additional expenditures.
If our products and services do
not gain market acceptance, we may not be able to fund future operations.
A number of factors
may affect the market acceptance of our products or services or any other products or services we develop or acquire, including,
among others:
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the price of our products or services relative to other competitive
products and services;
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the perception by users of the effectiveness of our products
and services;
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our ability to fund our sales and marketing efforts; and
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the effectiveness of our sales and marketing efforts.
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If our products and
services do not gain market acceptance, we may not be able to fund future operations, including the development of new products
and services and/or our sales and marketing efforts for our current products and services, which inability would have a material
adverse effect on our business, financial condition, and operating results.
We continually develop new products
and product enhancements and actively capitalize software development costs, while making educated assumptions to anticipate the
attributed revenue to be derived from each development or enhancement. If our assumptions are incorrect or if we are unable to
accurately attribute revenue to each respective product or product enhancement, we may have to account for impairment, thus causing
us to reverse the capitalized expenditures.
Our product developers
are consistently programming new products and enhancements to existing products. Under the guidance of U.S Accounting Standard,
ASC 350-40, we make determinations to estimate the useful life of each of these products and enhancements. Based on these determinations,
we amortize software expenses over a pre-determined period of time. Based on our financial forecasts and regular impairment testing,
we believe that cash flows will be realized from our product development and product enhancements and will be sufficient to recover
the value of the Company’s expenditures. Should our estimates turn out to be inaccurate or should the business fail to attract
new revenue in relation to each respective product or product enhancement, we may have to reverse or write off the related capitalized
expenses.
Our products and services are highly
technical and may contain undetected errors, which could cause harm to our reputation and adversely affect our business.
Our products and services
are highly technical and complex and, when deployed, may contain errors or defects. Despite testing, some errors in our products
and services may only be discovered after they have been installed and used by customers. Any errors or defects discovered in
our products and services after commercial release could result in failure to achieve market acceptance, loss of revenue or delay
in revenue recognition, loss of customers, and increased service and warranty cost, any of which could adversely affect our business,
operating results and financial condition. In addition, we could face claims for product liability, tort, or breach of warranty.
The performance of our products and services could have unforeseen or unknown adverse effects on the networks over which they
are delivered as well as on third-party applications and services that utilize our products and services, which could result in
legal claims against us, harming our business. Furthermore, we expect to provide implementation, consulting, and other technical
services in connection with the implementation and ongoing maintenance of our products and services, which typically involves
working with sophisticated software, computing systems, and communications systems. We expect that our contracts with customers
will contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit,
regardless of its merit, is costly and may divert our management’s attention and adversely affect the market’s perception
of us and our products and services. In addition, if our business liability insurance coverage proves inadequate or future coverage
is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
Malfunctions of third-party communications
infrastructure, hardware and software expose us to a variety of risks we cannot control, and those risks could result in harm
to our business.
Our business depends
upon the capacity, reliability and security of the infrastructure owned by third parties over which our product offerings are
deployed. We have no control over the operation, quality or maintenance of a significant portion of that infrastructure or over
whether those third parties will upgrade or improve their equipment. We do depend on these companies to maintain the operational
integrity of our integrated connections. If one or more of these companies is unable or unwilling to supply or expand its levels
of service in the future, our operations could be adversely impacted. System interruptions or increases in response time could
result in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users.
In addition, users depend on real-time communications; outages caused by increased traffic could result in delays and system failures.
These types of occurrences could cause users to perceive that our products and services do not function properly and could therefore
adversely affect our ability to attract and retain strategic partners and customers.
Security breaches, computer viruses,
and computer hacking attacks could harm our business, financial condition, results of operations, or reputation.
Security breaches,
computer malware and computer hacking attacks have become more prevalent in our industry. Any security breach caused by hacking,
which involves efforts to gain unauthorized access to information or systems, or to cause intentional malfunctions or loss or
corruption of data, software, hardware or other computer equipment, or the inadvertent transmission of computer viruses could
adversely affect our business, financial condition, results of operations or reputation.
Our corporate systems,
third-party systems and security measures may be breached due to the actions of outside parties, employee error, malfeasance,
a combination of these, or otherwise, and, as a result, an unauthorized party may obtain access to our data or any third-party
data we may possess. Any such security breach could require us to comply with various breach notification laws and may expose
us to litigation, remediation and investigation costs, increased costs for security measures, loss of revenue, damage to our reputation,
and potential liability.
System failure or interruption or
our failure to meet increasing demands on our systems could harm our business.
The success of our
product and service offerings depends on the uninterrupted operation of various systems, secure data centers, and other computer
and communication networks that we use or establish. To the extent the number of users of networks utilizing our future products
and services suddenly increases, the technology platform and hosting services which will be required to accommodate a higher volume
of traffic may result in slower response times, service interruptions or delays or system failures. The deployment of our products,
services, systems and operations will also be vulnerable to damage or interruption from:
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power loss, transmission cable cuts and other telecommunications
failures;
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damage or interruption caused by fire, earthquake and other
natural disasters;
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computer viruses or software defects; and
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physical or electronic break-ins, sabotage, intentional acts
of vandalism, terrorist attacks and other events beyond our control.
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System interruptions
or failures and increases or delays in response time could result in a loss of potential or existing users and, if sustained or
repeated, could reduce the appeal of our products and services to users. These types of occurrences could cause users to perceive
that our products and services do not function properly and could therefore adversely affect our ability to attract and retain
strategic partners and customers.
Our ability to sell our solutions
will be dependent on the quality of our technical support and our failure to deliver high-quality technical support services could
have a material adverse effect on our sales and results of operations.
If we do not effectively
assist our customers in deploying our products and services, succeed in helping our customers quickly resolve post-deployment
issues and provide effective ongoing support, or if potential customers perceive that we may not be able to successfully deliver
the foregoing, our ability to sell our products and services would be adversely affected, and our reputation with customers and
potential customers could be harmed. As a result, our failure to deliver and maintain high-quality technical support services
to our customers could result in customers choosing to use our competitors’ products or services in the future.
Growth of internal operations and
business may strain our financial resources.
We may need to significantly
expand the scope of our operating and financial systems in order to build our business. Our growth rate may place a significant
strain on our financial resources for several reasons, including, but not limited to, the following:
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the need for continued development of our financial and information
management systems;
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the need to manage relationships with future resellers, distributors
and strategic partners;
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the need to hire and retain skilled management, technical and
other personnel necessary to support and manage our business; and
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the need to train and manage our employee base.
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The addition of products
and services and the attention they demand may also strain our management resources.
We do not expect to pay any dividends
for the foreseeable future, which will affect the extent to which our investors realize any future gains on their investment.
We do not anticipate
that we will pay any dividends to holders of our convertible preferred and common stock in the foreseeable future. Accordingly,
investors must rely on the ability to convert preferred stock to common stock and on sales of their common stock after price appreciation,
which may never occur, as the only way to realize any future gains on their investment.
We will need to recruit and retain
additional qualified personnel to successfully grow our business.
Our future success
will depend in part on our ability to attract and retain qualified operations, marketing and sales personnel as well as technical
personnel. Inability to attract and retain such personnel could adversely affect our business. Competition for technical, sales,
marketing and executive personnel is intense, particularly in the technology and Internet sectors. We cannot assure you that we
will be able to attract or retain such personnel.
If we fail to establish and
maintain effective internal control over financial reporting and effective disclosure controls and procedures, we may not be able
to report financial results accurately or on a timely basis, or to detect fraud, which could have a material adverse effect on
our business and stock price.
In connection with
this annual report, our management carried out an evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded
that, primarily due to material weaknesses in our internal control over financial reporting as described in this annual report,
our disclosure controls and procedures were not effective as of December 31, 2019 in accordance with generally accepted accounting
principles.
Our management had
identified, and disclosed in last year’s annual report, control deficiencies in our financial reporting process that, as
of December 31, 2018, constituted material weaknesses in our internal control over financial reporting. These material weaknesses
related to the segregation of duties and the lack of formal policies that provide for multiple levels of supervision and reviews.
Our failure to establish
and maintain the required internal control over financial reporting, and to establish and maintain effective disclosure controls
and procedures, or any failure of those controls or procedures once established, could adversely impact our public disclosures
regarding our business, financial condition or results of operations. Upon review of the required internal control over financial
reporting, our management and/or our auditors have in the past and may in the future identify material weaknesses and/or significant
deficiencies that need to be addressed. Any actual or perceived weaknesses or conditions that need to be addressed in our internal
control over financial reporting and disclosure of management's assessment of the Company’s internal control over financial
reporting or disclosure of our independent registered public accounting firm's attestation to or report on management's assessment
of our internal control over financial reporting, or our failure to obtain such an attestation or report, could adversely impact
the price of and our ability to list our common stock and may lead to stockholder claims and regulatory action against us. Failure
to remediate our current material weaknesses or to maintain effective internal controls in the future could also result in a material
misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and that
could cause us to restate our financial statements for a prior period, cause investors to lose confidence in our financial statements
and/or limit our ability to raise capital.
Additionally, any
such failure may also negatively impact our operating results and financial condition, impair our ability to timely file our periodic
and other reports with the SEC, consume a significant amount of management's time, and cause us to incur substantial additional
costs relating to the implementation of remedial measures.
Risks Related to the Market for Our
Common Stock
Although our shares of common stock
are now listed on the NASDAQ Capital Market, we currently have a limited trading volume, which results in higher price volatility
for, and reduced liquidity of, our common stock.
Although
our shares of common stock are now listed on the NASDAQ Capital Market under the symbol “AEYE,” trading volume in
our common stock has been limited and an active trading market for our shares of common stock may never develop or be maintained.
The absence of an active trading market increases price volatility and reduces the liquidity of our common stock. As long as this
condition continues, the sale of a significant number of shares of common stock at any particular time could be difficult to achieve
at the market prices prevailing immediately before such shares are offered.
If we cannot continue to satisfy
the continuing listing criteria of the NASDAQ Capital Market, the exchange may subsequently delist our common stock.
The NASDAQ Capital
Market requires us to meet certain financial, public float, bid price and liquidity standards on an ongoing basis in order to
continue the listing of our common stock. Generally, we must maintain a minimum amount of stockholders’ equity and a minimum
number of holders of our securities, as well as meet certain disclosure and corporate governance requirements. If we fail to meet
any of the continuing listing requirements, our common stock may be subject to delisting. If our common stock is delisted and
we are not able to list our common stock on another national securities exchange, we expect our securities would be quoted on
an over-the-counter market. If this were to occur, our stockholders could face significant material adverse consequences, including
limited availability of market quotations for our common stock and reduced liquidity for the trading of our securities. In addition,
we could experience a decreased ability to issue additional securities and obtain additional financing in the future.
The market price for our common
stock may fluctuate significantly, which could result in substantial losses by our investors.
The market price of
our common stock may fluctuate significantly in response to numerous factors, some of which are beyond our control, such as:
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the outcomes of potential future patent litigation;
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our ability to monetize our future patents;
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changes in our industry;
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announcements of technological innovations, new products or
product enhancements by us or others;
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announcements by us of significant strategic partnerships, out-licensing,
in-licensing, joint ventures, acquisitions or capital commitments;
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changes in earnings estimates or recommendations by security
analysts, if our common stock is covered by analysts;
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investors’ general perception of us;
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future issuances of common stock;
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investors’ future resales of our securities under our
currently effective Registration Statement on Form S-1;
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the addition or departure of key personnel;
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general market conditions, including the volatility of market
prices for shares of technology companies, generally, and other factors, including factors unrelated to our operating performance;
and
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the other factors described in this “Risk Factors”
section.
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These factors and
any corresponding price fluctuations may materially and adversely affect the market price of our common stock and result in substantial
losses by our investors.
Further, the stock
market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations
in the past. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause
a decline in the value of our common stock.
Price volatility of
our common stock might be worse if the trading volume of our common stock is low. In the past, following periods of market volatility,
stockholders have often instituted securities class action litigation. We have previously been the target of securities litigation
and may in the future be subject to additional securities litigation, which could result in substantial costs to us and divert
resources and attention of management from our business, even if we are successful in any such litigation. Future sales of our
common stock could also reduce the market price of such stock.
Moreover, the liquidity
of our common stock is limited, not only in terms of the number of shares that can be bought and sold at a given price, but by
delays in the timing of transactions and reduction in security analysts’ and the media’s coverage of us, if any. These
factors may result in lower prices for our common stock than might otherwise be obtained and could also result in a larger spread
between the bid and ask prices for our common stock. In addition, without a large float, our common stock is less liquid than
the stock of companies with broader public ownership and, as a result, the trading price of our common stock may be more volatile.
In the absence of an active public trading market, an investor may be unable to liquidate its investment in our common stock.
Trading of a relatively small volume of our common stock may have a greater impact on the trading price of our stock than would
be the case if our public float were larger. We cannot predict the prices at which our common stock will trade in the future.
Sales or the availability for sale of a substantial number
of shares of our common stock may cause the price of our common stock to decline and adversely affect our ability to raise capital.
If our stockholders
sell substantial amounts of our common stock in the public market, including pursuant to our currently effective Registration
Statement on Form S-1, such sales or the anticipation of such sales could cause the market price of our common stock to fall.
Such circumstances, whether or not sales have occurred or are occurring, also could make more difficult our ability to raise additional
financing through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or
appropriate.
When we issue additional shares of common stock in the
future, including shares of common stock upon conversion of our Series A Convertible Preferred Stock or in future financings,
it will result in the dilution of our existing stockholders and may also result in a reduction in the market price of our common
stock.
Our Certificate of
Incorporation authorizes the issuance of up to 50,000,000 shares of common stock with a $0.00001 par value per share and 10,000,000
shares of preferred stock with a $0.00001 par value per share, of which, as of December 31, 2019, 8,876,553 shares of common stock
and 105,000 shares of Series A Convertible Preferred Stock were issued and outstanding. Such shares of Series A Convertible
Preferred Stock, based upon the applicable conversion rate as of December 31, 2019, were at such time convertible into an aggregate
of approximately 295,380 shares of common stock. As of December 31, 2019, we also had outstanding warrants and options to purchase
an aggregate of 1,389,751 shares of our common stock and unvested, or vested but not yet settled, restricted stock units covering
an aggregate of 428,919 shares of common stock. The exercise of such options and warrants and the vesting or vesting and settlement
of such restricted stock units would further increase the number of our outstanding shares of common stock.
From time to time,
we may adopt new equity compensation plans or increase the number of shares available for issuance in connection with our existing
equity compensation plans. Our board of directors may also choose to issue some or all of our available shares to provide additional
financing or acquire businesses in the future.
The issuance of any
shares upon conversion of any preferred stock, including our Series A Convertible Preferred Stock, under our equity compensation
plans, for acquisition, licensing or financing efforts, upon exercise of warrants and options, or upon settlement of restricted
stock units will dilute the interests of our holders of common stock and cause a reduction in the proportionate ownership and
voting power of all then current stockholders. Any such issuances may also result in a reduction in the market price of our common
stock.
The interests of our controlling
stockholders may not coincide with yours and such controlling stockholders may make decisions with which you may disagree.
As of March 13, 2020, four of our stockholders,
one of whom is our Executive Chairman and two others of whom are directors, beneficially owned in the aggregate over 50% of the
voting power of our outstanding shares of common stock and Series A Preferred Stock on an as-converted basis. As a result, these
stockholders may be able to influence the outcome of matters requiring stockholder approval, including the election of directors
and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change
in control of our company and make some future transactions more difficult or impossible without the support of our controlling
stockholders. The interests of our controlling stockholders may not coincide with our interests or the interests of other stockholders.
If securities or industry analysts
do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could
decline.
The trading market
for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or
our business. We currently have new research coverage by securities and industry analysts. If one or more of the analysts who
covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely
decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock
could decrease, which could cause our stock price and trading volume to decline.
We are subject to financial reporting
and other requirements that place significant demands on our resources.
We are subject to
reporting and other obligations under the Securities Exchange Act of 1934, as amended, including the requirements of Section 404
of the Sarbanes-Oxley Act of 2002. Section 404 requires us to conduct an annual management assessment of the effectiveness of
our internal control over financial reporting. These reporting and other obligations place significant demands on our management,
administrative, operational, internal audit and accounting resources. Any failure to maintain effective internal controls could
have a material adverse effect on our business, operating results and stock price. Moreover, effective internal control is necessary
for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial reports or prevent fraud,
we may not be able to manage our business as effectively as we would if an effective control environment existed, and our business
and reputation with investors may be harmed. We may also face claims by our investors, which could harm our business and financial
condition.
Risks Relating to Our Charter Documents
and Capital Structure
We are close to being controlled
by a small number of “insider” stockholders, which could determine corporate and stockholder action on significant
matters.
As of March 13, 2020, our directors and
executive officers beneficially owned an aggregate of 4,494,964 of our outstanding shares of common stock and 71,407 shares of
our outstanding shares of Series A Convertible Preferred Stock, which represents approximately 49% of the aggregate voting power
of our outstanding shares of common stock and Series A Preferred Stock on an as-converted basis. Through their collective ownership
of our outstanding stock, such holders, if they were to act together, would be close to controlling the voting of our shares at
all meetings of stockholders and, because the common stock does not have cumulative voting rights, to determining the outcome
of the election of all of our directors and determining corporate and stockholder action on other matters. The beneficial holdings
of our directors and executive officers as a group represent approximately 50% of our shares of common stock on a fully diluted
basis.
Provisions of our Certificate of
Incorporation and bylaws could discourage potential acquisition proposals and could deter or prevent a change in control.
Some provisions in
our Certificate of Incorporation and bylaws, as well as statutes, may have the effect of delaying, deterring or preventing a change
in control. These provisions, including those providing for the possible issuance of shares of our preferred stock, which may
be divided into series and with the preferences, limitations and relative rights to be determined by our board of directors, and
the right of the board of directors to amend the bylaws, may make it more difficult for other persons, without the approval of
our board of directors, to make a tender offer or otherwise acquire a substantial number of shares of our common stock or to launch
other takeover attempts that a stockholder might consider to be in his or her best interest. These provisions could limit the
price that some investors might be willing to pay in the future for shares of our common stock.
Delaware law may delay or prevent
takeover attempts by third parties and therefore inhibit our stockholders from realizing a premium on their stock.
We are subject to
the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. These provisions prevent any stockholder
who owns 15% or more of our outstanding shares of common stock from engaging in certain business combinations with us for a period
of three years following the time that the stockholder acquired such stock ownership unless certain approvals were or are obtained
from our board of directors or from the holders of 66 2/3% of our outstanding shares of common stock (excluding the shares of
our common stock owned by the 15% or more stockholder). Our board of directors can use these and other provisions to discourage,
delay or prevent a change in the control of our company or a change in our management. Any delay or prevention of a change of
control transaction or a change in our board of directors or management could deter potential acquirers or prevent the completion
of a transaction in which our stockholders could receive a substantial premium over the then current market price of our shares.
These provisions could also limit the price that investors might be willing to pay for shares of our common stock.
Failure to manage growth effectively
could adversely affect our business, results of operations and financial condition.
The success of our
future operating activities will depend upon our ability to expand our support system to meet the demands of our growing business.
Any failure by our management to effectively anticipate, implement, and manage changes required to sustain our growth would have
a material adverse effect on our business, financial condition, and results of operations. We cannot assure you that we will be
able to successfully operate acquired businesses (if any), become profitable in the future, or effectively manage any other change.
The elimination of the monetary
liability of our directors under Delaware law and the existence of indemnification rights held by our directors, officers and
employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees.
Our Certificate of
Incorporation contains specific provisions that eliminate the liability of our directors for monetary damages to our company and
stockholders and requires indemnification of our directors and officers to the extent provided by Delaware law. Our Bylaws also
contain provisions that require the indemnification of our directors, officers and employees. We may also have contractual indemnification
obligations under our employment agreements with our officers. The foregoing limitation of liability and indemnification obligations
could result in our company incurring substantial expenditures to cover the cost of settlement or damage awards against directors
and officers, which we may be unable to recoup. These provisions and resultant costs may also discourage our company from bringing
a lawsuit against directors and officers for breaches of their fiduciary duties and may similarly discourage the filing of derivative
litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit
our company and our stockholders.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
The Company’s
principal executive offices are located at 5210 E. Williams Circle, Suite 750, Tucson, Arizona 85711, consisting of approximately
5,151 square feet as of March 13, 2020 in a facility that is leased under an agreement that expires on October 31, 2022.
The Company also leases
offices in Scottsdale, Arizona; Atlanta, Georgia; and New York, New York.
We believe our current
premises are suitable and adequate for our operations. We believe that suitable additional or substitute space will be available
as needed to accommodate changes in our operations and location needs.
Item 3. Legal Proceedings
For a description
of any material legal proceedings, see the section titled “Litigation” included in Note 10 – “Commitments
and Contingencies” in the notes to the consolidated financial statements, which is incorporated by reference herein.
Item 4. Mine
Safety Disclosures
Not applicable.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 1 — ORGANIZATION
AudioEye, Inc. (“we”,
“our”, the “Company”) was incorporated on May 20, 2005 in the state of Delaware. The Company has
developed patented, Internet content publication and distribution software that enables conversion of any media into accessible
formats and allows for real time distribution to end users on any Internet connected device. The Company’s focus is to create
more comprehensive access to Internet, print, broadcast and other media to all people regardless of their network connection,
device, location, or disabilities.
The Company is focused on developing innovations
in the field of networked and device embedded audio technology. Our intellectual property is primarily comprised of trade secrets,
trademarks, issued, published and pending patent applications, copyrights and technological innovation. We have a patent portfolio
comprised of eight issued patents in the United States. We also have two pending patent applications and two international patent
applications filed via the Patent Cooperation Treaty (“PCT”) and the European Patent Office. The patents have been
extended and cover a period from 2002 through 2026.
Our common stock is listed on The NASDAQ
Capital Market under the symbol “AEYE” since September 4, 2018. Prior to September 4, 2018, our common stock was listed
on the OTCQB and the OTC Bulletin Board since April 15, 2013 under the same symbol.
In August 2018, the Company sold 1,000,000
shares of its common stock at $6.25 per share for net proceeds of $5,609,215, after costs and expenses of $640,785 (the “Private
Placement”). At the closing of the Private Placement, the Company entered into a registration rights agreement (the “Registration
Rights Agreement”) with the investors pursuant to which the Company agreed to register the Shares for resale. On September
4, 2018, the Company filed a registration statement on Form S-1 covering the resale or other disposition of the securities subject
to the Registration Rights Agreement.
On August 1, 2018, the Company amended
its Articles of Incorporation to implement a reverse stock split in the ratio of 1 share for every 25 shares of common stock and
to reduce the number of authorized common stock from 250,000,000 to 50,000,000. As a result, 186,994,384 shares of the Company’s common
stock were exchanged for 7,479,775 shares of the Company's common stock. These financial statements have been retroactively restated
to reflect the reverse stock split. (See Note 11)
NOTE 2 — GOING CONCERN AND MANAGEMENT’S
LIQUIDITY PLANS
As of December 31, 2019, the Company had
cash and cash equivalents of $1,972,160 and a working capital deficit of $(1,118,567). In addition, the Company used actual
net cash in operations of $5,615,841 during the year ended December 31, 2019. The Company has incurred net losses since inception.
These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
On August 14, 2019, the Company entered
into a Loan Agreement (the “Loan Agreement”) with Sero Capital LLC, a shareholder who owns more than 10% of the outstanding
shares of common stock of the Company. The Loan Agreement provides the Company with an unsecured credit facility under which the
Company may borrow up to the aggregate principal amount of $2,000,000. Any advances under the Loan Agreement will bear interest
at a per annum rate of 10% (subject to increase in the event of a default), which is payable monthly and may, at the Company’s
option, be paid either in cash or by the issuance of shares of the Company’s common stock. The term of the Loan Agreement
extends through August 14, 2020, subject to earlier termination as provided in the Loan Agreement. The Company’s obligations
under the Loan Agreement are subject to acceleration upon the occurrence of an event of default (as defined in the Loan Agreement).
The Company may prepay its obligations under the Loan Agreement without penalty, but subject to certain limitations regarding
the number, timing and dollar amounts of prepayments. The Loan Agreement provides for certain customary covenants, representations
and events of default. No amounts have been drawn under the Loan Agreement as of December 31, 2019.
In consideration of the Loan Agreement,
the Company issued to Sero Capital LLC a common stock warrant to acquire up to a total of 146,667 shares of the Company’s
common stock at an exercise price of $6.00 per share, which exercise price may be paid in cash or, at the election of the holder,
in a cashless, or “net,” exercise transaction. The warrant expires one year from the date of issuance.
The estimated fair value of the Sero Capital
LLC warrant was $219,335 at date of issuance. The Company valued the warrants using the Black-Scholes pricing model and the following
assumptions: contractual term of 1 year, a risk-free interest rate of 1.86%, a dividend yield of 0%, and volatility of 75.9%.
The deferred costs attributed to the value of the warrants of $219,335 is amortized ratably over the term of the credit facility
as interest expense. As of December 31, 2019, the unamortized balance was $137,084 and included as debt issuance costs in current
assets on the consolidated balance sheet.
The Company expects that cash used in
operations will decrease significantly over the next several quarters as the Company executes its business plan. In the event
that the Company is not able to fully achieve its plan, the Company may need to raise additional funds through equity or debt
financing. If the Company is unsuccessful in raising additional financing, it will need to reduce costs and operations in the
future.
Accordingly, the accompanying financial
statements have been prepared in conformity with U.S. GAAP, which contemplates continuation of the Company as a going concern
and the realization of assets and satisfaction of liabilities in the normal course of business. The carrying amounts of assets
and liabilities presented in the financial statements do not necessarily purport to represent realizable or settlement values.
The financial statements do not include any adjustment that might result from the outcome of this uncertainty
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 3 — SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
This summary of significant accounting
policies is presented to assist in understanding the Company’s financial statements. These accounting policies conform to
accounting principles, generally accepted in the United States of America, and have been consistently applied in the preparation
of the financial statements. The Company has a fiscal year ending on December 31. Certain prior period amounts have been
reclassified to conform to current period classification.
Principles of Consolidation
The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiary, Empire Technologies, LLC (“Empire”). All significant
inter-company accounts and transactions have been eliminated. During the years ended December 31, 2019 and 2018, Empire had no
activity. Empire had no assets or liabilities as of December 31, 2019 and 2018.
Revenue Recognition
Revenue is recognized when delivery of
the promised goods or services is transferred to its customers, in an amount that reflects the consideration that the Company
expects to be entitled to in exchange for those goods or services.
We determine revenue recognition through the following five
steps:
|
·
|
Identify the contract with the customer;
|
|
·
|
Identify the performance obligations in the contract;
|
|
·
|
Determine the transaction price;
|
|
·
|
Allocate the transaction price to the performance obligations in the contract; and
|
|
·
|
Recognize revenue when, or as, the performance obligations are satisfied.
|
Certain Software as a Service (“SaaS”)
invoices are prepared on an annual basis. Any funds received for services not provided yet are held in deferred revenue and are
recorded as revenue when earned. Subscription revenue is recognized on a ratable basis over the contractual subscription term
of the arrangement beginning on the date that our service is made available to the customer. Payments received in advance of services
being rendered are recorded as deferred revenue. Any funds received for services not provided yet are held in deferred revenue
and are recorded as revenue when earned. We generate substantially all our revenue from subscription services, which are comprised
of subscription fees from customer accounts on the Managed Platform.
The following table presents our revenues
disaggregated by type of good or service and sales channel:
|
|
Year ended
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Subscription revenue and support – Enterprise
|
|
$
|
7,251,819
|
|
|
$
|
4,315,168
|
|
Subscription revenue and support – Vertical Partners
|
|
|
3,513,334
|
|
|
|
1,345,259
|
|
Total revenues
|
|
$
|
10,765,153
|
|
|
$
|
5,660,427
|
|
In
accordance with Accounting Standard ASU 2014-09 Revenue from Contracts with Customers and all subsequent amendments to
the ASU (collectively, “ASC 606”),
the Company records accounts receivable for amounts invoiced to customers for which service has been rendered and for amounts
invoiced and are in deferred revenue but for which the Company has an unconditional right to consideration as provided under the
contractual arrangement.
The table below compares the deferred revenue balance as of
December 31, 2019 versus December 31, 2018:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Deferred revenue
|
|
$
|
5,526,002
|
|
|
$
|
3,028,787
|
|
As of December 31, 2019, $5,372,767 was
classified as short term and is expected to be recognized over the next twelve months. The remaining $153,235 is long-term deferred
revenue to be recognized thereafter.
At December 31, 2019, the Company had one
customer representing approximately 40% of the outstanding accounts receivable. At December 31, 2018, the Company had one customer
representing 22% of the outstanding accounts receivable.
The Company had one major customer (including
such customer’s affiliates) which accounted for approximately 10% of its revenues in the year ended December 31, 2019.
The Company had one major customer including
their affiliates which generated approximately 11.8% of its revenue in the year ended December 31, 2018.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Effective January 1, 2018, the Company
adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements
in Topic 605, Revenue Recognition, and most industry-specific revenue recognition guidance throughout the Industry Topics of the
Accounting Standards Codification. The updated guidance states that an entity should recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in exchange for those goods or services. The guidance also provides for additional disclosures with respect to revenues and cash
flows arising from contracts with customers. The Company adopted the standard using the modified retrospective approach effective
January 1, 2018.
The Company applied Topic 606 using the
following practical expedients:
|
·
|
The measurement of the transaction price excludes all taxes assessed by a governmental authority
that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the Company from a
customer;
|
|
·
|
The new revenue guidance has been applied to portfolios of contracts with similar characteristics;
|
|
·
|
The modified retrospective approach has been applied only to contracts that are not completed
contracts at the date of initial adoption;
|
|
·
|
The value of unsatisfied performance obligations for contracts with an original expected
length of one year or less has not been disclosed; and
|
|
·
|
the costs of obtaining contracts with customers are expensed when the amortization period
would have been one year or less.
|
The most significant impact of the standard
relates to capitalizing costs to acquire contracts, which have historically been expensed as incurred. As of December 31,
2017, the Company’s sales commission plans have included multiple payments, including initial payments in the period a customer
contract is obtained and deferred payments over the life of the contract as future payments are collected from the customers.
Under the standard, only the initial payment is subject to capitalization as the deferred payments require a substantive performance
condition of the employee. These initial commission payments are now capitalized in the period a customer contract is obtained
and payment is received; and will be amortized consistent with the transfer of the goods or services to the customer over the
expected period of benefit. The expected period of benefit is the contract term, except when the commission payment is expected
to provide economic benefit to the Company for a period longer than the contract term, such as for new customer or incremental
sales where renewals are expected, and renewal commissions are not commensurate with initial commissions. Such commissions are
amortized over the greater of contract term or technological obsolescence period when the underlying contracted products are technology-based,
such as for the SaaS-based platforms, or the expected customer relationship period when the underlying contracted products are
not technology-based, such as for patient experience survey products. Upon adoption of Topic 606, the Company reclassified $80,153
from equity previously expensed commissions to deferred costs effective January 1, 2018. See Note 6 below for a summary of activity
in the deferred costs account during the year ended December 31, 2019.
Effects of adoption of ASU 2014-09 are
as follows:
|
|
At January 1, 2018:
|
|
|
|
|
|
|
Prior to adoption of
ASU 2014-09
|
|
|
Subsequent to
adoption of ASU
2014-09
|
|
|
Change
|
|
Accumulated deficit
|
|
$
|
(39,425,900
|
)
|
|
$
|
(39,345,747
|
)
|
|
$
|
(80,153
|
)
|
Deferred commission costs
|
|
$
|
-
|
|
|
$
|
80,153
|
|
|
$
|
80,153
|
|
Cost of Revenue
Cost of revenue consists primarily of
employee-related costs, including payroll, benefits and stock-based compensation expense for our technology operations and customer
experience teams, fees paid to our managed hosting providers and other third-party service providers, amortization of capitalized
software development costs and acquired technology, and allocated overhead costs.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Use of Estimates
The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include the fair value of the Company’s stock, stock-based compensation,
fair values relating to derivative liabilities, debt discounts, allowance for doubtful accounts, impairment of long-lived assets
and goodwill and the valuation allowance related to deferred tax assets . Actual results may differ from these estimates.
Capitalization of Software Development
Costs
In accordance with ASC 350-40, the Company
capitalizes certain computer software and software development costs incurred in connection with developing or obtaining computer
software for internal use when both the preliminary project stage is completed, and it is probable that the software will be used
as intended. Capitalized software costs include only (i) external direct costs of materials and services utilized in developing
or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software
project and (iii) any interest costs incurred while developing internal-use computer software. Capitalized software costs are
included in intangible assets on our balance sheet and amortized on a straight-line basis when placed into service over the estimated
useful lives of the software (see Note 5).
Research and Technology Expenses
Research and technology expenses are expensed
in the period costs are incurred. For the years ended December 31, 2019 and 2018, research and technology expenses totaled
$701,054 and $194,429 respectively.
Cash and Cash Equivalents
The Company considers cash in savings
accounts to be cash equivalents. The Company considers any short-term, highly liquid investments with maturities of three months
or less as cash and cash equivalents.
Investments in Equity Securities
The Company has elected the fair value
option under ASC 825 for its investments in marketable equity securities. Investments in marketable securities are measured at
fair value through earnings and consist of common stock holdings of publicly traded companies. These equity securities are marked
to market at the end of each reporting period based on the closing price of the security at each balance sheet date. Changes in
fair value are recorded as unrealized gains or losses in the consolidated statements of operations in accordance with ASC 321.
From time to time, the Company invests
in the securities of other entities where there exists no active market for the securities held. These strategic investments may
consist of non-controlling equity investments in privately held companies. These investments without readily determinable fair
values for which the Company does not have the ability to exercise significant influence are accounted for using the measurement
alternative. Under the measurement alternative, the non-marketable securities are carried at cost less any impairments, plus or
minus adjustments resulting from observable price changes in orderly transactions for identical or similar investments of the
same issuer. Fair value is not estimated for non-marketable equity securities if there are no identified events or changes in
circumstances that may have an effect on the fair value of the investment.
Allowance for Doubtful Accounts
The Company establishes an allowance for
bad debts through a review of several factors including historical collection experience, current aging status of the customer
accounts, and financial condition of the Company’s customers. The Company does not generally require collateral for its
accounts receivable. During the years ended December 31, 2019 and 2018, the Company incurred $-0- as bad debt expense. There was
an allowance for doubtful accounts of $63,210 and $-0- as of December 31, 2019 and 2018, respectively.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Property and Equipment
Property and equipment are carried at
the cost of acquisition or construction and depreciated over the estimated useful lives of the assets. Costs associated with repairs
and maintenance are expensed as incurred. Costs associated with improvements which extend the life, increase the capacity or improve
the efficiency of the Company’s property and equipment are capitalized and depreciated over the remaining life of the related
asset. Gains and losses on dispositions of equipment are reflected in operations. Depreciation is provided using the straight-line
method over the estimated useful lives of the assets, which are 5 to 7 years.
Goodwill, Intangible Assets, and
Long-Lived Assets
Goodwill is carried at cost and is not
amortized. The Company tests goodwill for impairment on an annual basis at the end of each fiscal year, relying on a number of
factors including operating results, business plans, economic projections, anticipated future cash flows and marketplace data.
Company management uses its judgment in assessing whether goodwill has become impaired between annual impairment tests according
to specifications set forth in ASC 350. The Company completed an evaluation of goodwill at December 31, 2019 and 2018 and
determined that there was no impairment.
The fair value of the Company’s
reporting unit is dependent upon the Company’s estimate of future cash flows and other factors. The Company’s estimates
of future cash flows include assumptions concerning future operating performance and economic conditions and may differ from actual
future cash flows. Estimated future cash flows are adjusted by an appropriate discount rate derived from the Company’s market
capitalization plus a suitable control premium at date of the evaluation.
The financial and credit market volatility
directly impacts the Company’s fair value measurement through the Company’s weighted average cost of capital that
the Company uses to determine its discount rate and through the Company’s stock price that the Company uses to determine
its market capitalization. Therefore, changes in the stock price may also affect the amount of impairment recorded.
The Company recognizes an acquired intangible
asset apart from goodwill whenever the intangible asset arises from contractual or other legal rights, or when it can be separated
or divided from the acquired entity and sold, transferred, licensed, rented or exchanged, either individually or in combination
with a related contract, asset or liability. Such intangibles are amortized over their useful lives. Impairment losses are recognized
if the carrying amount of an intangible asset subject to amortization is not recoverable from expected future cash flows and its
carrying amount exceeds its fair value.
The Company reviews its long-lived assets,
including property and equipment, identifiable intangibles, and goodwill annually or whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be fully recoverable. To determine recoverability of its long-lived assets,
the Company evaluates the probability that future undiscounted net cash flows will be less than the carrying amount of the assets.
Impairment of Long-Lived Assets
The Company’s long-lived assets,
including intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the historical-cost
carrying value of an asset may no longer be appropriate. The Company assesses recoverability of the asset by comparing the undiscounted
future net cash flows expected to result from the asset to its carrying value. If the carrying value exceeds the undiscounted
future net cash flows of the asset, an impairment loss is measured and recognized. An impairment loss is measured as the difference
between the net book value and the fair value of the long-lived asset. Long-lived assets were evaluated for impairment and no
impairment losses were incurred during the years ended December 31, 2019 and 2018, respectively.
Stock Based Compensation
The Company measures the cost of services
received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors and
non-employees (effective January 1, 2019), the fair value of the award is measured on the grant date. The fair value amount is
then recognized over the period during which services are required to be provided in exchange for the award, usually the vesting
period. Stock-based compensation expense is recorded by the Company in the same expense classifications in the consolidated statements
of operations, as if such amounts were paid in cash.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Income Taxes
Deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to temporary differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases. These assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse.
The Company has net operating loss carryforwards
available to reduce future taxable income. Future tax benefits for these net operating loss carryforwards are recognized to the
extent that realization of these benefits is considered more likely than not. To the extent that the Company will not realize
a future tax benefit, a valuation allowance is established.
Earnings (loss) per Share
Basic earnings (loss) per share is calculated
by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s
common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could
occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect
of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and
the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental
shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included
in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock is computed using the
if-converted method, which assumes conversion at the beginning of the year.
Potentially dilutive securities excluded
from the computation of basic and diluted net earnings (loss) per share for the years ended December 31, 2019 and 2018 are as
follows:
|
|
2019
|
|
|
2018
|
|
Preferred stock on a converted basis
|
|
|
295,380
|
|
|
|
283,407
|
|
Options to purchase common stock
|
|
|
965,043
|
|
|
|
997,989
|
|
Warrants to purchase common stock
|
|
|
424,708
|
|
|
|
1,781,715
|
|
Restricted stock units
|
|
|
428,919
|
|
|
|
222,514
|
|
Totals
|
|
|
2,114,050
|
|
|
|
3,285,625
|
|
Derivative Instrument Liability
The Company accounts for derivative instruments
in accordance with ASC 815, which establishes accounting and reporting standards for derivative instruments and hedging activities,
including certain derivative instruments embedded in other financial instruments or contracts and requires recognition of all
derivatives on the balance sheet at fair value, regardless of hedging relationship designation. Accounting for changes in fair
value of the derivative instruments depends on whether the derivatives qualify as hedging relationships and the types of relationships
designated are based on the exposures hedged. At December 31, 2019 and 2018, the Company did not have any derivative instruments
that were designated as hedges.
In 2017 and prior and in accordance with
ASC 815, certain warrants with anti-dilutive provisions were deemed to be derivatives. The value of the derivative instrument
will fluctuate with the price of the Company’s common stock and is recorded as a current liability on the Company’s
Consolidated Balance Sheet. The change in the value of the liability is recorded as “unrealized gain (loss) on derivative
liability” on the Consolidated Statements of Operations.
Effective January 1, 2018, the Company
adopted ASU No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging
(Topic 815). The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments
(or embedded features) with down round features.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
When determining whether certain financial
instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification
when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure
requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion
option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round
feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share
(EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated
as a dividend and as a reduction of income available to common stockholders in basic EPS. Convertible instruments with embedded
conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion
features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260).
The amendments in Part II of this Update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are
presented as pending content in the Codification, to a scope exception.
On January 1, 2018, the Company adopted
ASU 2017-11 by electing the modified retrospective method to the outstanding financial instruments with a down round feature by
means of a cumulative-effect adjustment to the statement of financial position as of the beginning of the fiscal year. Accordingly,
the Company reclassified the fair value of the reset provisions embedded in previously issued warrants from liability to equity
(accumulated deficit) in aggregate of $2,984,010.
Effects of adoption of ASU 2017-11 modified
retrospective are as follows:
|
|
At January
1, 2018:
|
|
|
|
|
|
|
Prior to adoption
|
|
|
Subsequent
to
adoption
|
|
|
Change
|
|
Derivative liabilities
|
|
$
|
2,984,010
|
|
|
$
|
-
|
|
|
$
|
(2,984,010
|
)
|
Additional paid in capital
|
|
|
40,120,293
|
|
|
|
40,881,783
|
|
|
|
761,490
|
|
Accumulated deficit
|
|
$
|
(39,425,900
|
)
|
|
$
|
(37,203,380
|
)
|
|
$
|
2,222,520
|
|
Financial Instruments
The carrying amount of the Company’s
financial instruments, consisting of cash equivalents, short-term investments, accounts receivable and notes payable, short-term
borrowings and certain other liabilities, approximate their fair value due to their relatively short maturities.
Fair Value Measurements
Fair value is an estimate of the exit
price, representing the amount that would be received upon the sale of an asset or paid to transfer a liability in an orderly
transaction between market participants (i.e., the exit price at the measurement date). Fair value measurements are not adjusted
for transaction cost. Fair value measurement under generally accepted accounting principles provides for use of a fair value hierarchy
that prioritizes inputs to valuation techniques used to measure fair value into three levels:
Level 1: Unadjusted quoted prices in active
markets for identical assets or liabilities.
Level 2: Inputs other than quoted market
prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions
market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent
of the Company.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Level 3: Unobservable inputs reflect the
assumptions that the Company develops based on available information about what market participants would use in valuing the asset
or liability.
An asset or liability’s level within
the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Availability
of observable inputs can vary and is affected by a variety of factors. The Company uses judgment in determining fair value of
assets and liabilities and Level 3 assets and liabilities involve greater judgment than Level 1 and Level 2 assets or liabilities.
On August 14, 2019, the Company entered
into a Loan Agreement (the “Loan Agreement”) with Sero Capital LLC, a shareholder who owns more than 10% of the outstanding
shares of common stock of the Company. The Loan Agreement provides the Company with an unsecured credit facility under which the
Company may borrow up to the aggregate principal amount of $2,000,000.
In consideration of the Loan Agreement,
the Company issued to Sero Capital LLC a common stock warrant to acquire up to a total of 146,667 shares of the Company’s
common stock at an exercise price of $6.00 per share, which exercise price may be paid in cash or, at the election of the holder,
in a cashless, or “net,” exercise transaction. The warrant expires one year from the date of issuance.
The estimated fair value of the Sero Capital
LLC warrant was $219,335 at date of issuance and $150,562 at December 31, 2019. The Company valued the warrants using the Black-Scholes
pricing model and the following assumptions: contractual term of 1 year, a risk-free interest rate of 1.86%, a dividend yield
of 0%, and volatility of 75.9%. The deferred costs attributed to the value of the warrants of $219,335 are amortized ratably over
the term of the credit facility as interest expense. The warrants are classified as a liability instrument since the holder has
the option to require the Company to repurchase the warrants when certain events occur that are considered outside of the control
of the Company.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
The following are the Company’s
assets and liabilities, measured at fair value on a recurring basis, as of December 31, 2019 and 2018:
|
|
|
|
|
Fair Value
|
|
|
|
Fair Value
|
|
|
Hierarchy
|
|
Assets
|
|
|
|
|
|
|
|
|
Marketable securities, December 31, 2019
|
|
$
|
-
|
|
|
|
Level
1
|
|
Marketable securities, December 31, 2018
|
|
$
|
510
|
|
|
|
Level
1
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Warrant liability, December 31, 2019
|
|
$
|
120,416
|
|
|
|
Level
3
|
|
Warrant liability, December 31, 2018
|
|
$
|
-
|
|
|
|
Level
3
|
|
Recent Accounting Pronouncements
In February 2016, the Financial Accounting
Standards Board (“FASB”) established ASC Topic 842, Leases (Topic 842), by issuing ASU No. 2016-02, which requires
lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. Topic 842 was subsequently
amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements
to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements. The new standard establishes a right-of-use (ROU) model that
requires a lessee to recognize a ROU asset and lease liability on the balance sheet. Leases will be classified as finance or operating,
with classification affecting the pattern and classification of expense recognition in the statement of operations. The Company
adopted the new standard using the modified-retrospective method on January 1, 2019 and thus did not adjust comparative periods.
The new standard provides a number of
optional practical expedients in transition. The Company has elected the ‘package of practical expedients’, which
permits it not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial
direct costs. The Company did not elect the use-of-hindsight or the practical expedient pertaining to land easements; the latter
is not applicable to the Company.
The new standard had a material effect
on the Company’s financial statements. The most significant effects of adoption relate to (1) the recognition of new ROU
assets and lease liabilities on its balance sheet for real estate operating leases; and (2) providing significant new disclosures
about its leasing activities.
As of January 1, 2019, the Company recognized
additional operating lease liabilities of $568,268 based on the present value of the remaining minimum rental payments under current
leasing standards for existing operating leases. The Company recognized corresponding ROU assets of $557,212. In February 2019,
the Company entered into a new lease in Marietta, Georgia, which resulted in ROU assets of an incremental $483,565 being recognized
on the balance sheet upon lease commencement in June 2019.
The
new standard also provides practical expedients for an entity’s
ongoing accounting. The Company elected the short-term lease recognition exemption for all leases that qualify. This means, for
those leases that qualify, that the Company does not recognize ROU assets or lease liabilities, and this includes not recognizing
ROU assets or lease liabilities for existing short-term leases of those assets in transition. The Company changed its disclosed
lease recognition policies and practices, as well as to other related financial statement disclosures due to the adoption of this
standard. See Note 7.
In June 2018, the FASB issued ASU 2018-07,
regarding ASC Topic 718 Compensation - Stock Compensation, which largely aligns the accounting for share-based compensation
for non-employees with employees. The Company implemented this effective January 1, 2019 and no material impact was recognized.
There are various other updates recently
issued, most of which represented technical corrections to the accounting literature or application to specific industries and
are not expected to a have a material impact on the Company's financial position, results of operations or cash flows.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 4 — PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2019 and 2018 is
summarized as follows:
|
|
2019
|
|
|
2018
|
|
Computer equipment
|
|
$
|
64,194
|
|
|
$
|
62,170
|
|
Equipment under capital lease
|
|
|
156,858
|
|
|
|
95,506
|
|
Furniture and fixtures
|
|
|
58,883
|
|
|
|
4,968
|
|
Total
|
|
|
279,935
|
|
|
|
162,644
|
|
Less accumulated depreciation
|
|
|
(123,764
|
)
|
|
|
(54,637
|
)
|
Property and equipment, net
|
|
$
|
156,171
|
|
|
$
|
108,007
|
|
Property and equipment are stated at cost
and depreciated using the straight-line method over their estimated useful life of 3 years. When retired or otherwise disposed,
the related carrying value and accumulated depreciation are removed from the respective accounts and the net difference less any
amount realized from disposition, is reflected in earnings.
Included in net property are assets under
capital leases of $156,858, less accumulated depreciation of $59,777 as of December 31, 2019 and $95,506, less accumulated depreciation
of $16,117 as of December 31, 2018, respectively.
The Company spent $55,939 in purchases
and leased $61,352 of equipment during the year ended December 31, 2019 and spent $10,893 in purchases and leased $95,506 during
the year ended December 31, 2018. Depreciation expense was $69,127 and $33,386 for the years ended December 31, 2019 and 2018,
respectively.
NOTE 5 — INTANGIBLE ASSETS
For the years ended December 31, 2019
and 2018, the Company invested in software development costs in the amounts of $307,207 and $404,890 respectively and acquired
a domain name in 2018 in the amount of $10,000.
Patents, technology and other intangibles
with contractual terms are generally amortized over their estimated useful lives of ten years. When certain events or changes
in operating conditions occur, an impairment assessment is performed and lives of intangible assets with determinable lives may
be adjusted. Due to the Company’s history of operating losses, intangible assets were evaluated for impairment and no impairment
losses were incurred during the years ended December 31, 2019 and 2018, respectively.
Software development costs are amortized over their estimated
useful life of three years.
Intangible assets as of December 31 consisted of the following:
|
|
2019
|
|
|
2018
|
|
Patents
|
|
$
|
3,697,709
|
|
|
$
|
3,697,709
|
|
Capitalized software development
|
|
|
1,717,466
|
|
|
|
1,410,259
|
|
Domain name
|
|
|
10,000
|
|
|
|
10,000
|
|
Accumulated amortization
|
|
|
(3,709,958
|
)
|
|
|
(3,056,564
|
)
|
Intangible assets, net
|
|
$
|
1,715,217
|
|
|
$
|
2,061,404
|
|
Amortization expense for patents totaled
$374,631 and $374,632 for the years ended December 31, 2019 and 2018, respectively. Amortization expense for software development
totaled $278,763 and $143,317 for the years ended December 31, 2019 and 2018, respectively.
Total amortization expense totaled $653,394
and $517,949 for the years ended December 31, 2019 and 2018, respectively.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 6 — DEFERRED COSTS
Effective January 1, 2018, the Company
capitalizes initial and renewal sales commission payments in the period a customer contract is obtained, and payment is received;
and is amortized consistent with the transfer of the goods or services to the customer over the expected period of benefit, which
we have deemed to be the contract term.
Such commissions are amortized over the
greater of contract term or technological obsolescence period when the underlying contracted products are technology-based, such
as for the SaaS-based platforms, or the expected customer relationship period when the underlying contracted products are not
technology-based, such as for patient experience survey products. The table below summarizes the activity within the deferred
commission costs account, during the year ended December 31, 2019:
|
|
January 1,
|
|
|
Commission
|
|
|
Commission
|
|
|
December 31,
|
|
|
|
2019
|
|
|
Costs Deferred
|
|
|
Amortized
|
|
|
2019
|
|
Deferred costs, short term
|
|
$
|
176,006
|
|
|
$
|
247,144
|
|
|
$
|
(240,486
|
)
|
|
$
|
182,664
|
|
Deferred costs, long term
|
|
|
93,790
|
|
|
|
51,142
|
|
|
|
-
|
|
|
|
144,932
|
|
Deferred commission costs
|
|
$
|
269,796
|
|
|
$
|
298,286
|
|
|
$
|
(240,486
|
)
|
|
$
|
327,596
|
|
During the year ended December 31, 2019,
the Company deferred an aggregate $298,286 commissions paid. Amortization of deferred costs for the year ended December 31, 2019
was $240,486.
NOTE 7 — LEASE LIABILITIES AND RIGHT OF USE ASSETS
Finance Leases
Finance leases as of December 31 consist of:
|
|
2019
|
|
|
2018
|
|
Finance equipment lease dated April 5, 2018
|
|
$
|
7,683
|
|
|
$
|
13,056
|
|
Finance equipment lease dated May 8, 2018
|
|
|
9,060
|
|
|
|
14,525
|
|
Finance equipment lease dated June 27, 2018
|
|
|
13,408
|
|
|
|
21,701
|
|
Finance equipment lease dated September 18, 2018
|
|
|
9,890
|
|
|
|
15,368
|
|
Finance equipment lease dated September 28, 2018
|
|
|
11,108
|
|
|
|
16,672
|
|
Finance equipment lease dated February 20, 2019
|
|
|
14,090
|
|
|
|
-
|
|
Finance equipment lease dated June 4, 2019
|
|
|
17,674
|
|
|
|
-
|
|
Finance equipment lease dated September 30, 2019
|
|
|
21,100
|
|
|
|
-
|
|
Total finance lease liabilities
|
|
|
104,013
|
|
|
|
81,322
|
|
Less current portion
|
|
|
(52,449
|
)
|
|
|
(30,172
|
)
|
Long term portion
|
|
$
|
51,564
|
|
|
$
|
51,150
|
|
During the year ended December 31, 2019,
the Company entered into three finance leases for computer equipment for a three-year term. The Company recognized these arrangements
as finance leases based on the determination that the leases exceeded 75% of the economic life of the underlying assets.
The Company initially recorded the equipment and finance leases liability at the estimated present value of the minimum lease
payments of $61,352, collectively. During the year ended December 31, 2018, the Company entered into five finance leases for computer
equipment for a three-year term and initially recorded the equipment and the finance leases liability at the estimated present
value of the minimum lease payments of $95,506.
The leases include base monthly payments
in aggregate of $4,761, due on the contract monthly anniversary of each calendar month. At the expiration of the lease,
the Company is required to return all leased equipment to the lessor with right of repurchase at fair value. The Company has made
payments in the amount of $47,044 during the year ended December 31, 2019. The effective interest rate of the finance leases is
estimated at 6.00% based on the implicit rate in the lease agreements.
The following summarizes the right to
use assets under finance leases included in property and equipment as of December 31:
|
|
2019
|
|
|
2018
|
|
Classes of property
|
|
|
|
|
|
|
|
|
Computer equipment
|
|
$
|
156,858
|
|
|
$
|
95,506
|
|
Less: accumulated depreciation
|
|
|
(59,777
|
)
|
|
|
(16,117
|
)
|
|
|
$
|
97,081
|
|
|
$
|
79,389
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
The following summarizes total future minimum lease payments
at December 31, 2019:
Period ending December 31,
|
|
|
|
2020
|
|
$
|
57,126
|
|
2021
|
|
|
43,375
|
|
2022
|
|
|
10,083
|
|
Total minimum lease payments
|
|
|
110,584
|
|
Amount representing interest
|
|
|
(6,571
|
)
|
Present value of minimum lease payments
|
|
|
104,013
|
|
Current portion of finance lease obligations
|
|
|
52,449
|
|
Finance lease obligations, less current portion
|
|
$
|
51,564
|
|
Operating Leases
The Company’s principal offices
are located at 5210 E. Williams Circle, Suite 750, Tucson, Arizona 85711, consisting of approximately 5,151 square feet as of
December 31, 2019. The Company’s principal office originally consisted of approximately 2,362 square feet. On December 21,
2017, effective February 1, 2018, the Company amended its existing lease to expand its principal office to approximately 4,248
square feet and to extend the expiration date to September 30, 2021. Beginning February 1, 2018, the basic rent increased to $9,598
per month. On October 2, 2018, effective December 1, 2018, the Company further amended its existing lease to expand its principal
office to approximately 5,151 square feet. In accordance with the amended lease, rent increased to $11,810 on January 1, 2019,
escalating over time to $12,977 at the end of the lease, which was further extended to October 31, 2022.
The Company also had offices in Atlanta,
Georgia located at 3901 Roswell Road, Suite 134, leased for an aggregate of $3,937 per month as of December 31, 2017 under a lease
that expired on September 30, 2019 and was not renewed. On December 29, 2017, effective February 1, 2018, the Company amended
its existing lease to expand its Atlanta office from approximately 2,739 square feet to approximately 3,831 square feet. Beginning
February 1, 2018, the basic rent increased by $1,500 through the remainder of the lease term. In February 2019, the Company entered
into a lease for new offices in Marietta, Georgia located at 450 Franklin Gateway, Marietta, Georgia consisting of approximately
9,662 square feet. The new lease commenced on June 1, 2019, with move-in on June 15, 2019.
Beginning in 2017, the Company leased
office space in New York for $300 per month, which was increased to $850 per month in October 2018 through May 31, 2019. Beginning
in June 2019, the Company moved to larger office space in New York, leased for $4,482 per month, for a term of 12 months ending
May 31, 2020. Beginning November 1, 2015, we subleased an office in Scottsdale, Arizona from a company controlled by our Executive
Chairman for $3,578 per month, which continues on a month to month basis as of December 31, 2019. These New York and Scottsdale
properties were considered short-term leases and therefore were not measured under Topic 842.
The Company has made operating lease payments
in the amount of $230,882 during the fiscal year ended December 31, 2019. Rent expense charged to operations, which differs from
rent paid due to rent credits and to increasing amounts of base rent, is calculated by allocating total rental payments on a straight-line
basis over the term of the lease. Operating lease liabilities at December 31, 2019 and January 1, 2019 consist of:
|
|
December 31,
|
|
|
January 1,
|
|
|
|
2019
|
|
|
2019
|
|
Tucson Arizona office lease
|
|
$
|
402,015
|
|
|
$
|
518,309
|
|
Marietta Georgia office lease
|
|
|
462,425
|
|
|
|
-
|
|
Atlanta Georgia office lease
|
|
|
-
|
|
|
|
49,959
|
|
Total operating lease liabilities
|
|
|
864,440
|
|
|
|
568,268
|
|
Less current portion
|
|
|
(209,009
|
)
|
|
|
(166,252
|
)
|
Long term portion
|
|
$
|
655,431
|
|
|
$
|
402,016
|
|
As of January 1, 2019, the Company adopted
the provisions of ASC Topic 842 using the modified retrospective method. In adopting ASC Topic 842, Leases (Topic 842),
the Company elected the ‘package of practical expedients’, which permitted it not to reassess under the new standard
its prior conclusions about lease identification, lease classification and initial direct costs. The Company did not elect the
use-of-hindsight or the practical expedient pertaining to land easements; the latter is not applicable to the Company. In addition,
the Company elected not to apply ASC Topic 842 to arrangements with lease terms of 12 month or less. Effective January 1, 2019,
the Company initially recognized operating lease liabilities of $568,268 based on the present value of the remaining minimum rental
payments under current leasing standards for existing operating leases. The discount rate utilized in such present value calculation
was 6% based on an estimate of the Company’s incremental borrowing rate. At such time, the Company also recognized corresponding
right-of-use (ROU) assets of $557,212 and eliminated the prior period deferred rent of $11,056.
During the fiscal year ended December
31, 2019, the Company entered into an operating lease for new office space in Marietta, Georgia, for a five-year term. The
Company measured and recorded a right of use asset and corresponding operating lease liability of $483,565 at the lease commencement
date in June 2019.
The following summarizes total future minimum operating lease
payments at December 31, 2019:
Period ending December 31,
|
|
|
|
2020
|
|
$
|
255,222
|
|
2021
|
|
|
261,773
|
|
2022
|
|
|
256,970
|
|
2023
|
|
|
118,166
|
|
2024
|
|
|
80,637
|
|
Total minimum lease payments
|
|
|
972,768
|
|
Less: present value discount
|
|
|
(108,328
|
)
|
Present value of minimum lease payments
|
|
|
864,440
|
|
Current portion of operating lease obligations
|
|
|
209,009
|
|
Operating lease obligations, less current portion
|
|
$
|
655,431
|
|
As of December 31, 2019, the weighted average discount rate
for these leases is 6% and the weighted average remaining term is 46 months.
The following summarizes lease expenses for the fiscal year
ended December 31, 2019:
Finance lease expenses:
|
|
|
|
|
Depreciation/amortization expense
|
|
$
|
43,660
|
|
Interest on lease liabilities
|
|
|
6,571
|
|
Finance lease expense
|
|
|
50,231
|
|
Operating lease expense
|
|
|
257,635
|
|
Short-term lease expense
|
|
|
78,560
|
|
Total lease expenses
|
|
$
|
386,426
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 8 — CONVERTIBLE NOTES PAYABLE
In connection with the October 9, 2015
Note and Warrant Purchase Agreement, in September 2018 and October 2018, the Company issued convertible promissory notes in aggregate
principal amount of $224,975 (the “Notes”) and warrants (the “Warrants”) to purchase 89,990 shares of
common stock of the Company. $50,000 of the principal was in connection with an entity that a member of the Company’s board
of directors is deemed a beneficial owner (see Note 9). Subject to the agreement, any investor in the October 9, 2015 Purchase
Agreement within the three-year period immediately following the initial closing date, may purchase an additional note in the
principal amount equal to 50% of the principal amount of the initial note purchased by such investor at previous closings and
an additional warrant equal to the principal amount of such additional note divided by the exercise price of the additional warrant.
The Notes bore interest at 10% and matured
on the earlier of October 9, 2018 or after the occurrence of an event of default (as defined in the Note). In the event of any
conversion, all interest was converted into equity and shall not be payable in cash.
Under the terms of the October 9, 2015
Note and Warrant Purchase Agreement, if the Company sells equity securities in a single transaction or series of related transactions
for cash of at least $1,000,000 (excluding the conversion of the Notes and excluding the shares of common stock to be issued upon
exercise of the warrants) on or before the maturity date, all of the unpaid principal on the Note plus accrued interest shall
be automatically converted at the closing of the equity financing into a number of shares of the same class or series of equity
securities as are issued and sold by the Company in such equity financing (or a class or series of equity securities identical
in all respects to and ranking pari passu with the class or series of equity securities issued and sold in such equity financing)
as is determined by dividing (i) the principal and accrued and unpaid interest amount of the Notes by (ii) 60% of the price per
share at which such equity securities are issued and sold in such equity financing.
On October 2, 2018, the Company’s
board of directors approved to convert the debt, upon maturity, at $3.75 per share, which is 60% of the price per share at which
equity was sold in August 2018 and will be treated as debt extinguishment at conversion. On October 29, 2018, the Company issued
an aggregate of 60,182 shares of its common stock in settlement of the outstanding notes and accrued interest of $225,687 (principal
plus accrued interest). In connection with the settlement, the Company incurred a loss on settlement of debt of $267,812, calculated
as the difference between the fair value of the shares of common stock issued less the value of convertible debt settled.
The Warrants are exercisable at $2.50
per share and expire 5 years following the date of issuance. The Warrants are subject to anti-dilution protection, subject to
certain customary exceptions.
In accordance with Accounting Standards
Codification subtopic 470-20, the Company estimated relative fair value of the issued warrants, determined to be $175,617 as a
credit to additional paid in capital. The Company amortized $175,617 of the debt discount to current period operations as interest
expense for the year ended December 31, 2018.
NOTE 9 — RELATED PARTY TRANSACTIONS
On August 14, 2019, the Company entered
into a Loan Agreement (the “Loan Agreement”) with Sero Capital LLC, a stockholder who owns more than 10% of the outstanding
shares of common stock of the Company. The beneficial owner of Sero Capital LLC is David Moradi, who became a director of the
Company on November 8, 2019. The Loan Agreement provides the Company with an unsecured credit facility under which the Company
may borrow up to the aggregate principal amount of $2,000,000. Any advances under the Loan Agreement will bear interest at a per
annum rate of 10% (subject to increase in the event of a default), which is payable monthly and may, at the Company’s option,
be paid either in cash or by the issuance of shares of the Company’s common stock. The term of the Loan Agreement extends
through August 14, 2020, subject to earlier termination as provided in the Loan Agreement. The Company’s obligations under
the Loan Agreement are subject to acceleration upon the occurrence of an event of default (as defined in the Loan Agreement).
The Company may prepay its obligations under the Loan Agreement without penalty, but subject to certain limitations regarding
the number, timing and dollar amounts of prepayments. The Loan Agreement provides for certain customary covenants, representations
and events of default. No amounts have been drawn under the Loan Agreement as of December 31, 2019.
In consideration of the Loan Agreement,
the Company issued to Sero Capital LLC a common stock warrant to acquire up to a total of 146,667 shares of the Company’s
common stock at an exercise price of $6.00 per share, which exercise price may be paid in cash or, at the election of the holder,
in a cashless, or “net,” exercise transaction. The warrant expires one year from the date of issuance.
Sero Capital LLC, beneficially owned by
David Moradi who became a director of the Company on November 8, 2019, was paid $70,000 in consulting fees through December 31,
2019.
On September 26, 2018, the Company issued
a $50,000 convertible note payable and warrants to acquire 20,000 shares of the Company’s common stock with a term of five
years, an exercise price of $2.50 per share to an entity that Alexandre Zyngier, a member of the Company’s board of directors
is deemed a beneficial owner. On October 29, 2018, the Company issued 13,384 shares of the Company’s common stock in settlement
of this outstanding convertible note for $50,000 and accrued interest.
As of December 31, 2019 and 2018,
the total balances of related party payable were $0 and $14,467, respectively.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
NOTE 10 — COMMITMENTS AND CONTINGENCIES
Litigation
On January 23, 2017, the court granted
preliminary approval of the settlement pursuant to the terms set forth in the Stipulation of Settlement, provisionally certified
a settlement class of shareholders, and directed plaintiffs' counsel to provide notice to that class. The Court held a Settlement
Hearing May 8, 2017 to consider any objections to the Settlement that might be raised by settlement class members, to consider
plaintiffs’ counsel's application for an award of fees and costs, and to determine whether the Order and Final Judgment
as provided under the Stipulation of Settlement should be entered, dismissing the case with prejudice. On May 8, 2017, this Court
granted final approval to the settlement of the securities class action brought by Lead Plaintiffs, individually and on behalf
of all others similarly situated. On February 9, 2018, the Court authorized distribution of the Net Settlement Fund and approved
the proposed modified plan of allocation.
On May 16, 2016, a stockholder derivative
complaint entitled LiPoChing, Derivatively and on Behalf of AudioEye, Inc., v. Bradley, et al., was filed in the United States
District Court for the District of Arizona. As a derivative complaint, the plaintiff-stockholder purported to act on behalf of
the Company against the Named Individuals. The Company was named as a nominal defendant. The complaint asserted causes of action
including breach of fiduciary duty and others, arising from the Company’s restatement of its financial results for the first
three quarters of 2014. The complaint sought, among other relief, compensatory damages, restitution and attorneys’ fees.
In October 2016, the Company and Named Defendants filed a motion to dismiss. In response, the Plaintiff voluntarily dismissed
the complaint without prejudice. Plaintiff’s counsel subsequently submitted a demand to the Company’s Board of Directors,
to investigate the circumstances surrounding restatement of its financial results for the first three quarters of 2014. On June
22, 2018, the matter was resolved to the parties’ satisfaction. The resolution of the matter did not have a material adverse
effect on our financial position or results of operations.
On July 26, 2016, a stockholder derivative
complaint entitled Denese M. Hebert, derivatively on Behalf of Nominal Defendant AudioEye, Inc., v. Bradley, et al., was filed
in the State of Arizona Superior Court for Pima County. The complaint generally asserted causes of action related to the Company’s
restatement of its financial statements for the first three fiscal quarters of 2014. As a derivative complaint, the plaintiff-stockholder
purported to act on behalf of the Company against the Named Individuals. The Company was named as a nominal defendant. The defendants
filed a motion to dismiss, which the Court granted on May 8, 2017, while also denying Plaintiff’s request for leave to amend
the complaint. As in the above matter, after this matter was dismissed Plaintiff’s counsel subsequently submitted a demand
to the Company’s Board of Directors, to investigate the circumstances surrounding restatement of its financial results for
the first three quarters of 2014. On June 22, 2018, the matter was resolved to the parties’ satisfaction. The resolution
of the matter did not have a material adverse effect on our financial position or results of operations.
We may become involved in various other
routine disputes and allegations incidental to our business operations. While it is not possible to determine the ultimate disposition
of these matters, our management believes that the resolution of any such matters, should they arise, is not likely to have a
material adverse effect on our financial position or results of operations.
NOTE 11 — STOCKHOLDERS’ EQUITY AND STOCK-BASED
COMPENSATION
On August 1, 2018, the Company amended
its Certificate of Incorporation to implement a reverse stock split in the ratio of 1 share for every 25 shares of common stock
and to reduce the number of authorized common stock from 250,000,000 to 50,000,000. No fractional shares were issued from such
aggregation of common stock, upon the reverse split; any fractional share was rounded up and converted to the nearest whole share
of common stock. As a result, 186,994,384 shares of the Company’s common stock were exchanged for 7,479,775 shares
of the Company's common stock resulting in the transfer of $1,795 from common stock to additional paid in capital. These amendments
were approved and filed of record by the Delaware Secretary of State and effective on August 1, 2018. FINRA declared
the Company’s 1-for-25 reverse stock split market effective as of August 8, 2018. These financial statements have been retroactively
restated to reflect the reverse stock split.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Preferred Stock
As of December 31, 2019, and 2018, the
Company had 105,000 shares of Series A Convertible Preferred Stock (the “Preferred Stock”), issued at $10 per share,
paying a 5% cumulative annual dividend and convertible for common stock at a price of $4.385 per share. For the fiscal year ended
December 31, 2019, preferred stockholders earned, but were not paid, $52,500 in annual dividends, or equivalent to 11,973 shares
of common stock based on a conversion price of $4.385 per share. As of December 31, 2019, and December 31, 2018, cumulative and
unpaid dividends were $245,240 and $192,740, respectively, or equivalent to 55,927 and 43,954 shares of common stock, respectively,
based on a conversion price of $4.385 per share.
On any matter presented to the stockholders
of the Company, holders of Preferred Stock are entitled to cast the number of votes equal to the number of shares of common stock
into which the shares of Preferred Stock are convertible as of the record date to vote on such matter. As long as any shares of
Preferred Stock are outstanding, the Company has certain restrictions on share repurchases or amendments to the Certificate of
Incorporation in a manner that adversely affects any rights of the preferred stockholders.
In addition, the preferred stockholders
have a liquidation preference for purposes of which the Preferred Stock would be valued at $10 per share plus accrued cumulative
annual dividend. At December 31, 2019 and December 31, 2018, the total liquidation preference was valued at $1,295,240 and $1,242,740,
respectively. In the event of any liquidity event, holders of each share of Preferred Stock shall be entitled to be paid the liquidation
preference out of the assets of the Company legally available before any sums shall be paid to holders of common stock.
Common Stock
As of December 31, 2019, and December 31,
2018, the Company had 8,876,553 and 7,579,995 shares, respectively, of common stock issued and outstanding.
In the fiscal year ended December 31, 2019, the Company issued
21,932 shares of its common stock upon the exercise of options, for aggregate proceeds of $24,898. During the same period, the
Company issued 1,252,319 shares of its common stock, upon the exercise of outstanding warrants to purchase an aggregate of 1,252,319
shares of common stock, for aggregate proceeds of $2,231,744. Additionally, the Company issued an aggregate of 11,083 shares of
its common stock upon the net exercise of 15,596 outstanding options, and issued an aggregate of 11,224 shares of its common stock
upon the net exercise of outstanding warrants.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Options
As of December 31, 2019 and 2018,
the Company had outstanding options to purchase 965,043 and 997,989 shares of common stock, respectively.
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Intrinsic
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
Value
|
|
|
|
Number of
|
|
|
Average
|
|
|
Remaining
|
|
|
|
|
|
of
|
|
|
|
Options
|
|
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Exercise Price
|
|
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Term
|
|
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Exercisable
|
|
|
Options
|
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Outstanding at December 31, 2017
|
|
|
1,003,836
|
|
|
$
|
4.69
|
|
|
|
2.64
|
|
|
|
891,087
|
|
|
$
|
1,356,188
|
|
Granted
|
|
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73,440
|
|
|
|
6.32
|
|
|
|
5.00
|
|
|
|
|
|
|
|
-
|
|
Exercised
|
|
|
(32,173
|
)
|
|
|
2.15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited/Expired
|
|
|
(47,114
|
)
|
|
|
9.31
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Outstanding at December 31, 2018
|
|
|
997,989
|
|
|
$
|
4.67
|
|
|
|
2.14
|
|
|
|
925,545
|
|
|
$
|
4,705,220
|
|
Granted
|
|
|
189,599
|
|
|
|
6.54
|
|
|
|
9.25
|
|
|
|
|
|
|
|
-
|
|
Exercised
|
|
|
(37,528
|
)
|
|
|
1.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited/Expired
|
|
|
(185,017
|
)
|
|
|
11.83
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Outstanding at December 31, 2019
|
|
|
965,043
|
|
|
$
|
3.70
|
|
|
|
3.01
|
|
|
|
759,631
|
|
|
$
|
1,666,266
|
|
On February 7, 2019, the Company granted
an aggregate of 28,700 incentive stock options to certain employees hired June 4, 2018. The options to purchase shares of common
stock are exercisable at $10.55 per share, have a term of five years, and vest as to 50% of the options at the vesting commencement
date, which is generally one year from the date of hire (vesting commencement dates range from June 4, 2019 through January 25,
2020), and vest as to the remaining 50% of the options in eight equal quarterly installments commencing on the first day of each
calendar quarter following the vesting commencement date and installments continuing on the first day of each of the seven calendar
quarters thereafter. All vesting is subject to the employee’s continued service through the vesting date. The exercise price
was determined using the closing price of the Company’s common stock on February 7, 2019. The Black-Scholes value on the
grant date of the options was $258,392.
On June 3, 2019, the Company granted an
aggregate of 93,734 nonqualified stock options to certain employees hired after February 7, 2019, and longer-tenured employees
for performance in 2018. The options to purchase shares of common stock are exercisable at $6.53 per share, have a term of ten
years, and vest in approximately equal annual installments on the first three anniversaries of the grant date. All vesting is
subject to the employee’s continued service through the vesting date. The exercise price was determined using the closing
price of the Company’s common stock on June 3, 2019. The Black-Scholes value on the grant date of the options was $571,471.
On December 6, 2019, the Company granted
an aggregate of 67,960 nonqualified stock options to certain employees hired after June 3, 2019, and longer-tenured employees
for performance in 2019. The options to purchase shares of common stock are exercisable at $4.85 per share, have a term of ten
years, and vest in approximately equal annual installments on the first three anniversaries of the grant date. All vesting is
subject to the employee’s continued service through the vesting date. The exercise price was determined using the closing
price of the Company’s common stock on December 6, 2019. The Black-Scholes value on the grant date of the options was $268,068.
Option grants during the fiscal year ended
December 31, 2019 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation include expected
term of 3.25 to 6.00 years, expected volatility of 139.40% to 156.23%, risk free interest rate of 1.67% to 2.48%, and expected
dividend yield of 0%.
On March 9, 2018, the Company granted
an aggregate of 60,390 options to employees as compensation for services rendered. The options are exercisable at $6.45 per share
for five years with (i) 37,890 options vesting 50% over the first year on the first day of each month beginning January 1, 2018
through December 1, 2018, 25% vesting over the year on the first day of each month from January 1, 2019 through December 1, 2019
and 25% vesting over the year on the first day of each month beginning January 1, 2020 through December 1, 2020; (ii) 12,500 options
vesting 50% on January 1, 2018, 50% vesting over the year on each month beginning on January 1, 2019 for 24 months; and (iii)
10,000 options fully vesting on January 1, 2018.
The exercise price was determined using
the 10-day average closing price beginning with the closing price on January 9, 2018. The value on the grant date of the options
was $298,914.
On April 12, 2018, the Company granted
6,000 options to purchase the Company’s common stock for services rendered at an exercise price of $6.20 per share for five
years with 2,000 options vesting immediately and 1,000 options vesting every 90 days thereafter. The exercise price was determined
using the 10-day average closing price beginning with the closing price on March 12, 2018. The value on the grant date of the
options was $29,694.
On May 31, 2018, the Company granted an
aggregate of 7,050 options to employees as compensation for services rendered. The options are exercisable at $5.30 per share
for five years with 50% of options vesting upon one-year employee anniversary and 50% vesting at a rate of 1/24 per month thereafter.
The exercise price was determined using the 10-day average closing price beginning with the closing price on May 16, 2018. The
value on the grant date of the options was $33,130.
Option grants during the year ended December
31, 2018 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation include expected term
of 2.50 to 3.50 years, expected volatility of 160.87% to 163.85%, risk free interest rate of 2.45% to 2.65%, and expected dividend
yield of 0%.
For the fiscal years ended December 31,
2019 and December 31, 2018, total stock compensation expense related to options totaled $320,868 and $342,384, respectively. As
of December 31, 2019, the outstanding unamortized stock compensation expense related to options was $741,909 (which will be recognized
through December 2022).
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019 AND 2018
Warrants
Below is a table summarizing the Company’s
outstanding warrants activity for the two years ended December 31, 2019. The Company had outstanding warrants to purchase 424,708
and 1,781,715 shares of the Company’s common stock as of December 31, 2019 and 2018, respectively:
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|
|
|
|
|
|
Weighted
|
|
|
Intrinsic
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
Value
|
|
|
|
Number of
|
|
|
Average
|
|
|
Remaining
|
|
|
of
|
|
|
|
Warrants
|
|
|
Exercise Price
|
|
|
Term
|
|
|
Warrants
|
|
Outstanding at December 31, 2017
|
|
|
1,919,906
|
|
|
$
|
4.84
|
|
|
|
2.61
|
|
|
$
|
1,656,083
|
|
Granted
|
|
|
303,234
|
|
|
|
5.14
|
|
|
|
2.64
|
|
|
|
—
|
|
Exercised
|
|
|
(137,525
|
)
|
|
|
5.87
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(303,900
|
)
|
|
|
8.43
|
|
|
|
|
|
|
|
—
|
|
Outstanding at December 31, 2018
|
|
|
1,781,715
|
|
|
$
|
4.20
|
|
|
|
2.23
|
|
|
$
|
8,930,058
|
|
Granted
|
|
|
146,667
|
|
|
|
6.00
|
|
|
|
0.62
|
|
|
|
—
|
|
Exercised
|
|
|
(1,279,550
|
)
|
|
|
1.85
|
|
|
|
|
|
|
|
|
|
Forfeited/Expired
|
|
|
(224,124
|
)
|
|
|
5.33
|
|
|
|
|
|
|
|
—
|
|
Outstanding at December 31, 2019
|
|
|
424,708
|
|
|
$
|
5.31
|
|
|
|
0.82
|
|
|
$
|
189,450
|
|
In August 2019, the Company negotiated
with holders of certain warrants to purchase the Company’s common stock with respect to a transaction in which the Company
and the holders agreed to amend certain warrant agreements to provide that from the date of amendment through August 16, 2019,
the exercise price was reduced from $2.50 to $1.63 per share for warrants to purchase an aggregate of 1,194,990 shares and from
$6.25 to $4.07 per share for warrants to purchase an aggregate of 85,719 shares, provided that any exercise during such period
was in full and the exercise price was paid in cash. During the August period, an aggregate of 1,212,136 warrants to purchase
the Company’s common stock were exercised for net proceeds of $2,114,918.
On August 14, 2019, the Company issued
to Sero Capital LLC 146,667 warrants to acquire the Company’s common stock at an exercise price of $6.00 per share for a
term of one year (see Note 9). The estimated fair value of the Sero Capital LLC warrant was $219,335 at date of issuance. The
Company valued the warrants using the Black-Scholes pricing model and the following assumptions: contractual term of 1 year, a
risk-free interest rate of 1.86%, a dividend yield of 0%, and volatility of 75.9%. As of December 31, 2019, the warrants are classified
as a deferred financing costs asset and amortized over a twelve-month term. For the year ended December 31, 2019, the Company
recorded $82,251 of amortization expense. As of December 31, 2019, the Company has $137,084 of debt issuance costs remaining to
be amortized during 2020. A related liability is also on the balance sheet at a fair value of $120,416 using the Black-Scholes
pricing model. Changes in value of the warrant liability flow through our income statement accordingly.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
On April 17, 2018, the Company granted
127,525 warrants to a consultant for services rendered. The warrants were exercisable at $6.25 per share through May 16, 2018.
The fair value of the warrants of $109,207 was charged to current operations.
On August 23, 2018, the Company granted
85,719 warrants in connection with the 2017 sale of the Company’s common stock. The warrants are exercisable at $6.25 through
September 29, 2022.
In September 2018 and October 2018, the
Company issued an aggregate of 89,990 warrants in connection with the issuance of convertible notes payable. The warrants are
exercisable at $2.50 through five years from the date of issuance. The aggregate fair value of the warrants (up to the net note
proceeds) was charged as a debt discount against the convertible notes.
Warrants issued during the year ended
December 31, 2018 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation include expected
term of 0.08 to 5.0 years, expected volatility of 159.77% to 162.35%, risk free interest rate of 1.68% to 2.96%, and expected
dividend yield of 0%.
For the year ended December 31, 2019 and
2018, the Company has incurred warrant-based expense of $0 and $110,600, respectively. There was no outstanding unamortized
stock compensation expense related to warrants as of December 31, 2019.
Restricted Stock Units (“RSU”)
The following table summarizes the restricted
stock activity for the two years ended December 31, 2019:
Total Restricted Shares Issued at December 31, 2017
|
|
|
156,340
|
|
Granted
|
|
|
92,174
|
|
Forfeited/Canceled
|
|
|
(26,000
|
)
|
Total Restricted Shares Issued at December 31, 2018
|
|
|
222,514
|
|
Granted
|
|
|
206,405
|
|
Forfeited/Canceled
|
|
|
-
|
|
Total Restricted Shares Issued at December 31, 2019
|
|
|
428,919
|
|
Vested at December 31, 2019
|
|
|
269,114
|
|
Unvested restricted shares as of December 31, 2019
|
|
|
186,405
|
|
On June 3, 2019, the Company granted 11,280
RSUs to each of Alexandre Zyngier, Ernest Purcell and Anthony Coelho for their continued service on the Board of Directors. Such
RSUs will vest on June 3, 2020, subject to the director’s continuous service through the vesting date. The settlement date
for such RSUs is the earlier of (i) June 3, 2026 or (ii) the date on which the Company undergoes a change of control. The fair
value of the RSUs at grant date was $220,975.
On June 3, 2019, the Company granted 20,000
RSUs for services provided. Such RSUs vest each calendar month at a rate of one-third of 20,000 per month, whereby the RSUs would
vest by September 3, 2019 provided that services are not terminated by the Company or the grantee. The settlement date for such
RSUs is (i) March 15, 2020 or (ii) the date on which the Company undergoes a change of control during the seven-year term of the
award. The fair value of the RSU’s at grant date was $130,600.
On June 3, 2019, the Company granted 80,900
RSUs to Sachin Barot, its Chief Financial Officer, in accordance with his employment agreement. Such RSUs will vest annually over
a three-year period, in installments of (i) 26,967 RSUs on June 3, 2020, (ii) 26,967 RSUs on June 3, 2021 and (iii) 26,966 RSUs
on June 3, 2022, subject to Mr. Barot’s continuous service through the vesting date. The settlement date for such RSUs is
the earlier of (a) promptly after each vesting date or (b) in any event no later than March 15 of the calendar year following
the calendar year in which such vesting occurs. The fair value of the RSUs at grant date was $528,277.
On August 19, 2019, the Company granted
24,105 RSUs to a consultant to the Company in accordance with a consulting agreement. Such RSUs will vest in installments according
to performance conditions establishing certain milestones to be achieved within a timeframe stipulated by the consulting agreement,
and as determined quarterly and certified by the Compensation Committee of the Board of Directors. The settlement date for such
RSUs is the earlier of (a) promptly after each vesting date or (b) in any event no later than March 15 of the calendar year following
the calendar year in which such vesting occurs. The fair value of the RSUs at grant date was $95,697.
On December 6, 2019, the Company granted
11,280 RSUs to each of David Moradi and Jamil Tahir for their service on the Board of Directors. Such RSUs will vest on December
6, 2020, subject to the director’s continuous service through the vesting date. The settlement date for such RSUs is the
earlier of (i) December 6, 2026 or (ii) the date on which the Company undergoes a change of control. The fair value of the RSUs
at grant date was $109,416.
On December 6, 2019, the Company granted
25,000 RSUs to Christopher Meinerz, its Corporate Controller, in accordance with his employment agreement. Such RSUs will vest
annually over a three-year period, in installments of (i) 8,333 RSUs on December 6, 2020, (ii) 8,334 RSUs on December 6, 2021
and (iii) 8,333 RSUs on December 6, 2022, subject to Mr. Meinerz’s continuous service through the vesting date. The settlement
date for such RSUs is the earlier of (a) promptly after each vesting date or (b) in any event no later than March 15 of the calendar
year following the calendar year in which such vesting occurs. The fair value of the RSUs at grant date was $121,250.
On March 27, 2018, the Company granted
38,334 RSUs for services provided. 20,000 of such RSUs began vesting May 1, 2018 and will vest each calendar month at a rate of
1,667 RSUs per month, whereby the RSUs would vest provided that services are not terminated by the Company or the grantee. 18,333
RSU’s vested immediately. The settlement date for such RSUs is (i) April 1, 2025 or (ii) the date on which the Company undergoes
a change of control during the seven-year term of the award. As of December 31, 2018, no RSUs have been settled. The fair value
of the RSU’s at grant date was $247,250.
On December 31, 2018, the Company following
consideration of the report prepared by Farient Advisors LLC granted 11,280 RSUs to each of Alexandre Zyngier, Ernest Purcell
and Anthony Coelho for their continued service on the Board of Directors and 20,000 RSUs to Dr. Carr Bettis for his continued
service as the chair of the Board of Directors (for an aggregate grant of 53,840 RSUs). Such RSUs vest upon the first to occur
of the following: (i) April 30, 2019 provided that the director’s service with the Company has not terminated prior to such
date and (ii) the date of a meeting of the stockholders of the Company at which the director, being willing and available to serve
as a director, is nominated for election but is not reelected by the stockholders. The settlement date for such RSUs is the earlier
of (i) April 30, 2025 or (ii) the date on which the Company undergoes a change of control. The fair value of the RSU’s at
grant date was $460,332.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
For the year ended December 31, 2019 and
2018, the Company has incurred RSU-based expense of $895,540 and $372,537, respectively. The outstanding unamortized stock
compensation expense related to RSUs was $798,898 (which will be recognized through December 2022) as of December 31, 2019.
NOTE 12 — INCOME TAXES
The Company accounts for income taxes
under ASC 740, “Income Taxes”. Temporary differences are differences between the tax basis of assets and liabilities
and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. Under
this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases
of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are
expected to reverse. A valuation allowance is recorded when the ultimate realization of a deferred tax is uncertain. The tax effects
of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented
below:
Deferred tax assets:
|
|
2019
|
|
|
2018
|
|
Net operating loss carry forwards
|
|
$
|
7,757,797
|
|
|
$
|
5,329,518
|
|
Less valuation allowance
|
|
|
(7,757,797
|
)
|
|
|
(5,329,518
|
)
|
Net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
At this time, the Company is unable to
determine if it will be able to benefit from its deferred tax asset. There are limitations on the utilization of net operating
loss carry forwards, including a requirement that losses be offset against future taxable income, if any. In addition, there are
limitations imposed by certain transactions, which are deemed to be ownership changes. Accordingly, a valuation allowance has
been established for the entire deferred tax asset. The approximate net operating loss carry forward was $36,941,892 and $25,378,656
as of December 31, 2019 and 2018, respectively and will start to expire in 2031. The Company’s tax return for the years
2016, 2017 and 2018 are open to IRS inspection.
On December 22, 2017, the Tax Act was
signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate
tax rate decrease from 35% to 21%, effective for tax years beginning after December 31, 2017, and the transition of U.S international
taxation from a worldwide tax system to a territorial system. We use the asset and liability method of accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to reverse.
NOTE 13 — SUBSEQUENT EVENTS
On January 13, 2020, the Company granted
15,000 performance based RSUs to a consultant to the Company. Such RSUs will vest in installments according to performance conditions
establishing certain milestones to be achieved within a specified timeframe.