Item 1. Financial Statements
The financial information set forth below
with respect to the financial statements as of September 30, 2016 and 2015 and for the three and nine month periods ended September
30, 2016 and 2015 is unaudited. This financial information, in the opinion of our management, includes all adjustments consisting
of normal recurring entries necessary for the fair presentation of such data. The results of operations for the three and nine
month periods ended September 30, 2016 are not necessarily indicative of results to be expected for any subsequent period. Our
fiscal year end is December 31.
AUDIOEYE, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,494,513
|
|
|
$
|
1,687,257
|
|
Accounts receivable, net
|
|
|
20,499
|
|
|
|
22,741
|
|
Marketable securities, held in related party
|
|
|
3,600
|
|
|
|
3,600
|
|
Non-marketable securities, held in related party
|
|
|
50,000
|
|
|
|
50,000
|
|
Prepaid expenses and other current assets
|
|
|
57,828
|
|
|
|
41,388
|
|
Total current assets
|
|
|
1,626,440
|
|
|
|
1,804,986
|
|
|
|
|
|
|
|
|
|
|
Intangible assets, net
|
|
|
2,454,162
|
|
|
|
2,840,856
|
|
Goodwill
|
|
|
700,528
|
|
|
|
700,528
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
4,781,130
|
|
|
$
|
5,346,370
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
267,377
|
|
|
$
|
213,620
|
|
Notes and loans payable, current
|
|
|
24,000
|
|
|
|
24,000
|
|
Related party payables
|
|
|
14,744
|
|
|
|
153,474
|
|
Derivative liabilities
|
|
|
3,648,243
|
|
|
|
439,361
|
|
Deferred revenue
|
|
|
414,082
|
|
|
|
60,790
|
|
Total current liabilities
|
|
|
4,368,446
|
|
|
|
891,245
|
|
|
|
|
|
|
|
|
|
|
Long term liabilities:
|
|
|
|
|
|
|
|
|
Convertible notes and loans payable, net
|
|
|
5,800
|
|
|
|
1,923,499
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
4,374,246
|
|
|
|
2,814,744
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.00001 par value, 10,000,000 shares authorized, 160,000 and 175,000 issued and outstanding as of September 30, 2016 and December 31, 2015, respectively
|
|
|
2
|
|
|
|
2
|
|
Common stock, $0.00001 par value, 250,000,000 shares authorized, 107,458,430 and 81,717,154 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively
|
|
|
1,074
|
|
|
|
817
|
|
Treasury stock
|
|
|
(623,000
|
)
|
|
|
(623,000
|
)
|
Additional paid-in capital
|
|
|
33,997,819
|
|
|
|
27,393,238
|
|
Accumulated deficit
|
|
|
(32,969,011
|
)
|
|
|
(24,239,431
|
)
|
Total stockholders' equity
|
|
|
406,884
|
|
|
|
2,531,626
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
$
|
4,781,130
|
|
|
$
|
5,346,370
|
|
See Notes to Unaudited Consolidated Financial Statements
AUDIOEYE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
|
|
Three months ended September 30,
|
|
|
Nine months ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
282,676
|
|
|
$
|
108,685
|
|
|
$
|
594,237
|
|
|
$
|
314,146
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
|
311,519
|
|
|
|
321,755
|
|
|
|
904,091
|
|
|
|
1,178,388
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Loss
|
|
|
(28,843
|
)
|
|
|
(213,070
|
)
|
|
|
(309,854
|
)
|
|
|
(864,242
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
192,881
|
|
|
|
171,594
|
|
|
|
510,448
|
|
|
|
747,990
|
|
Research and development
|
|
|
85,192
|
|
|
|
92,857
|
|
|
|
255,805
|
|
|
|
293,877
|
|
General and administrative
|
|
|
602,041
|
|
|
|
(27,278
|
)
|
|
|
1,894,964
|
|
|
|
4,161,269
|
|
Amortization and depreciation
|
|
|
150,328
|
|
|
|
128,381
|
|
|
|
428,701
|
|
|
|
396,269
|
|
Total operating expenses
|
|
|
1,030,442
|
|
|
|
365,554
|
|
|
|
3,089,918
|
|
|
|
5,599,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(1,059,285
|
)
|
|
|
(578,624
|
)
|
|
|
(3,399,772
|
)
|
|
|
(6,463,647
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain (loss) on derivative liabilities
|
|
|
351,055
|
|
|
|
-
|
|
|
|
(2,990,096
|
)
|
|
|
-
|
|
Unrealized gain on marketable securities
|
|
|
900
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Loss on settlement of debt
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,664,281
|
)
|
|
|
-
|
|
Other income
|
|
|
-
|
|
|
|
-
|
|
|
|
750
|
|
|
|
-
|
|
Interest income (expense)
|
|
|
266
|
|
|
|
81
|
|
|
|
(676,181
|
)
|
|
|
3,345
|
|
Total other income (expense)
|
|
|
352,221
|
|
|
|
81
|
|
|
|
(5,329,808
|
)
|
|
|
3,345
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(707,064
|
)
|
|
|
(578,543
|
)
|
|
|
(8,729,580
|
)
|
|
|
(6,460,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock dividend
|
|
|
(20,000
|
)
|
|
|
-
|
|
|
|
(60,000
|
)
|
|
|
(594,641
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss available to common stockholders
|
|
$
|
(727,064
|
)
|
|
$
|
(578,543
|
)
|
|
$
|
(8,789,580
|
)
|
|
$
|
(7,054,943
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share-basic and diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.09
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding-basic and diluted
|
|
|
107,382,344
|
|
|
|
81,800,488
|
|
|
|
95,840,596
|
|
|
|
80,007,507
|
|
See Notes to Unaudited Consolidated Financial Statements
AUDIOEYE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-controlling
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
Interest/
|
|
|
|
|
|
|
|
|
|
Common stock
|
|
|
Preferred stock
|
|
|
Paid in
|
|
|
Treasury
|
|
|
Accumulated
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Stock
|
|
|
Deficit
|
|
|
Total
|
|
Balance, December 31, 2015
|
|
|
81,717,154
|
|
|
$
|
817
|
|
|
|
175,000
|
|
|
$
|
2
|
|
|
$
|
27,393,238
|
|
|
$
|
(623,000
|
)
|
|
$
|
(24,239,431
|
)
|
|
$
|
2,531,626
|
|
Common stock issued for services
|
|
|
291,666
|
|
|
|
3
|
|
|
|
-
|
|
|
|
-
|
|
|
|
47,455
|
|
|
|
-
|
|
|
|
-
|
|
|
|
47,458
|
|
Common stock issued in settlement of convertible
notes and accrued interest
|
|
|
12,834,800
|
|
|
|
128
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,077,995
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,078,123
|
|
Common stock and warrants issued for cash, net
of placement costs of $60,918
|
|
|
11,714,285
|
|
|
|
117
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,578,965
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,579,082
|
|
Common stock issued upon conversion of preferred
stock
|
|
|
900,525
|
|
|
|
9
|
|
|
|
(15,000
|
)
|
|
|
-
|
|
|
|
(9
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Fair value of warrants issued in settlement of
convertible debt and accrued interest
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,205,959
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,205,959
|
|
Reclassify fair value of liability warrants issued
in connection with sale of common stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(218,786
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(218,786
|
)
|
Warrants and Options issued for services
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
913,002
|
|
|
|
-
|
|
|
|
-
|
|
|
|
913,002
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(8,729,580
|
)
|
|
|
(8,729,580
|
)
|
Balance, September 30, 2016
|
|
|
107,458,430
|
|
|
$
|
1,074
|
|
|
|
160,000
|
|
|
$
|
2
|
|
|
$
|
33,997,819
|
|
|
$
|
(623,000
|
)
|
|
$
|
(32,969,011
|
)
|
|
$
|
406,884
|
|
See Notes to Unaudited Consolidated Financial Statements
AUDIOEYE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
|
|
Nine months ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(8,729,580
|
)
|
|
$
|
(6,460,302
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
428,701
|
|
|
|
396,269
|
|
Amortization of debt discounts
|
|
|
600,301
|
|
|
|
-
|
|
Option, warrant and PSU expense
|
|
|
913,002
|
|
|
|
1,200,459
|
|
Stock issued or issuable for services
|
|
|
47,458
|
|
|
|
679,972
|
|
Loss on change in derivative liabilities
|
|
|
2,990,096
|
|
|
|
-
|
|
Loss on settlement of debt
|
|
|
1,664,281
|
|
|
|
-
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
2,242
|
|
|
|
212,662
|
|
Related party receivable
|
|
|
-
|
|
|
|
(44,250
|
)
|
Other current assets
|
|
|
(16,440
|
)
|
|
|
11,650
|
|
Accounts payable and accruals
|
|
|
173,558
|
|
|
|
(517,743
|
)
|
Billing in excess of costs
|
|
|
-
|
|
|
|
(57,012
|
)
|
Deferred revenue
|
|
|
353,292
|
|
|
|
-
|
|
Related party payables
|
|
|
(138,730
|
)
|
|
|
(226,483
|
)
|
Net cash (used in) operating activities
|
|
|
(1,711,819
|
)
|
|
|
(4,804,778
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Cash (paid for) intellectual property
|
|
|
(42,007
|
)
|
|
|
(88,156
|
)
|
Net cash (used in) investing activities
|
|
|
(42,007
|
)
|
|
|
(88,156
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Issuance of common stock and warrants for cash
|
|
|
1,579,082
|
|
|
|
325,000
|
|
Collection of stock subscription receivable
|
|
|
-
|
|
|
|
1,175,000
|
|
Issuance of preferred stock for cash
|
|
|
-
|
|
|
|
1,750,000
|
|
Proceeds from exercise of options and warrants
|
|
|
-
|
|
|
|
43,943
|
|
Repayments of notes payable
|
|
|
(18,000
|
)
|
|
|
(22,000
|
)
|
Net cash provided by financing activities
|
|
|
1,561,082
|
|
|
|
3,271,943
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash
|
|
|
(192,744
|
)
|
|
|
(1,620,991
|
)
|
Cash-beginning of period
|
|
|
1,687,257
|
|
|
|
1,672,901
|
|
Cash-end of period
|
|
$
|
1,494,513
|
|
|
$
|
51,910
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
-
|
|
|
$
|
307
|
|
Income taxes paid
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
Deemed dividend beneficial conversion feature on convertible preferred stock
|
|
$
|
-
|
|
|
$
|
594,641
|
|
Common stock issued in settlement of convertible notes payable and accrued interest
|
|
|
1,078,123
|
|
|
|
-
|
|
Fair value of warrants issued in settlement of convertible notes payable and accrued interest
|
|
|
3,205,959
|
|
|
|
-
|
|
Reclass fair value of liability warrants from equity to liability upon issuance
|
|
|
218,786
|
|
|
|
-
|
|
Common stock issued upon conversion of preferred stock
|
|
|
9
|
|
|
|
-
|
|
See Notes to Unaudited Consolidated Financial Statements
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
NOTE 1: ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited interim financial
statements of AudioEye, Inc. and its wholly-owned subsidiary (collectively, the “Company”) have been prepared
in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities
and Exchange Commission, and should be read in conjunction with the audited financial statements and notes thereto contained in
the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2016.
In the opinion of management, all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations
for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily
indicative of the results to be expected for the full year. Notes to the financial statements that would substantially duplicate
the disclosures contained in the audited financial statements for the year ended December 31, 2015 as reported in the Company’s
Annual Report on Form 10-K have been omitted.
Corporate Information and Background
AudioEye, Inc. was formed as a Delaware
corporation on May 20, 2005. The Company focuses on providing its customers with the most complete and inclusive web accessibility
solution available. The Company’s suite of technologies allows its customers to provide their site visitors with an enhanced
web experience. When implemented, the Company believes its solutions offer businesses the opportunity to reach more customers,
improve brand image, and build additional brand loyalty. In addition, the Company’s solutions provide organizations with
the ability to comply with internationally accepted web content accessibility guidelines (WCAG) as well as United States, Canadian
and United Kingdom accessibility laws.
Reclassification
Certain prior year amounts have been reclassified
to conform to the current year presentation.
Revenue Recognition
Revenue is recognized when all applicable
recognition criteria have been met, which generally include (a) persuasive evidence of an existing arrangement; (b) fixed
or determinable price; (c) delivery has occurred or service has been rendered; and (d) collectability of the sales price
is reasonably assured. For software and technology development contracts the Company recognizes revenues on a percentage of completion
method based upon several factors including but not limited to (a) estimate of total hours and milestones to complete; (b) total
hours completed; (c) delivery of services rendered; (d) change in estimates; and (e) collectability of the contract.
The Company had one major customer including
their affiliates which generated approximately 55% of its revenue in the three months ended September 30, 2016.
The Company had four major customers including
their affiliates which generated approximately 43% (21%, 16%, 15% and 11%) of its revenue in the nine months ended September 30,
2016.
At September 30, 2016, the Company had
three customers representing 24%, 17% and 15% of the outstanding accounts receivable.
Certain Software as a Service (SaaS) and
website hosting contracts are prepared and invoiced on an annual basis. Any funds received for hosting services not provided yet
are held in deferred revenue, and are recorded as revenue when earned.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
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 and the valuation allowance related to deferred tax assets. Actual
results may differ from these estimates.
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, the
fair value of the award is measured on the grant date and for non-employees, the fair value of the award is generally re-measured
on vesting dates and interim financial reporting dates until the service period is complete. 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.
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 hedge relationships and the types of relationships designated
are based on the exposures hedged. At September 30, 2016 and December 31, 2015, the Company did not have any derivative instruments
that were designated as hedges.
On October 9, 2015, the Company issued
convertible promissory notes representing $2,500,000 in aggregate principal together with warrants exercisable for up to 25,000,000
shares of Common Stock. The warrants have a strike price of $0.10 and term of 5 years. In addition on May 9, 2016, in connection
with the sale of the Company’s common stock, the Company issued warrants exercisable for up to 1,312,000 shares of Common
Stock. The warrants have a strike price of $0.25 and a term of 5 years.
In accordance with ASC 815, these outstanding
warrants are deemed to contain embedded 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 Sheets. The change
in the value of the liability is recorded as “unrealized gain (loss) on derivative liability” on the Consolidated Statements
of Operations. This is a non-cash income (expense) item and is adjusted in the “operating activities” of the Consolidated
Statements of Cash Flow. At September 30, 2016 and December 31, 2015, the derivative liability was stated at $3,648,243 and $439,361,
respectively. The change in fair value of $2,990,096 was driven by the increased value of the Company’s common stock in the
period and recorded as the “Loss on change in derivative liability” in the Consolidated Statements of Operations for
the nine months ended September 30, 2016. As the warrants are exercised or expire, the derivative liability will be adjusted on
the balance sheet and an adjustment will be reflected in stockholders equity under additional paid-in capital.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
Fair Value Measurements
Fair value is an estimate of the exit price,
representing the amount that would be received to, sell 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.
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.
In October and November 2015, the Company
issued warrants with an exercise price of $0.10 in connection with a convertible debt instruments. The five year warrants also
contain a provision that the warrant exercise price will automatically be adjusted for any common stock equity issuances at less
than $0.10 per share. The Company determined that the warrants were not afforded equity classification because the warrants are
not considered to be indexed to the Company’s own stock due to the anti-dilution provision. Accordingly, the warrants are
treated as a derivative liability and are carried at fair value.
The Company estimated the fair value of
these derivative warrants at initial issuance and again at each balance sheet date. The changes in fair value are recognized in
earnings in the Consolidated Statements of Operations under the caption “unrealized gain/(loss) – derivative liability”
until such time as the derivative warrants are exercised or expire. The Company used the Black-Scholes Option Pricing model to
estimate the fair value of the dates of issuance, the price of the Company stock ranged $0.031 to $0.058, volatility was estimated
to be 102%, the risk free rate ranged 1.14% to 1.75% and the remaining term was 5 years.
In April and May 2016, the Company issued
warrants with an exercise price of $0.25 in connection with the sale of Common Stock. The five year warrants also contain a provision
that the warrant exercise price will automatically be adjusted for any common stock equity issuances at less than $0.25 per share.
The Company determined that the warrants were not afforded equity classification because the warrants are not considered to be
indexed to the Company’s own stock due to the anti-dilution provision. Accordingly, the warrants are treated as a derivative
liability and are carried at fair value.
The Company estimated the fair value of
these derivative warrants at initial issuance and again at each balance sheet date. The changes in fair value are recognized in
earnings in the Consolidated Statements of Operations under the caption “unrealized gain/(loss) – derivative liability”
until such time as the derivative warrants are exercised or expire. The Company used the Black-Scholes Option Pricing model to
estimate the fair value of the dates of issuance, the price of the Company stock ranged $0.169 to $0.195, volatility was estimated
to be from 169% to 178%, the risk free rate ranged 1.22% to 1.35% and the remaining term was 5 years. The estimated initial fair
value of these warrants of $218,786 was reclassified from equity to liability at the date of issuance.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
At September 30, 2016, the price of the
Company stock was 0.149, volatility was estimated to be 170.52%, the risk free rate of 1.14% and the remaining term ranged from
4.02 to 4.56 years. As of September 30, 2016, the fair value of the warrants was determined to be $3,648,243, resulting in an unrealized
gain (loss) on the change in the fair value of this derivative liability of $351,055 and $(2,990,096) for the three and nine months
ended September 30, 2016, respectively.
The following are the Company’s assets
and liabilities, measured at fair value on a recurring basis, as of September 30, 2016 and December 31, 2015:
|
|
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Hierarchy
|
Assets
|
|
|
|
|
|
|
Marketable securities, September 30, 2016
|
|
$
|
3,600
|
|
|
Level 1
|
Marketable securities, December 31, 2015
|
|
$
|
3,600
|
|
|
Level 1
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Derivative Liability , September 30, 2016
|
|
$
|
3,648,243
|
|
|
Level 3
|
Derivative Liability , December 31, 2015
|
|
$
|
439,361
|
|
|
Level 3
|
Recent Accounting Pronouncements
There are various 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.
NOTE 2: MANAGEMENT LIQUIDITY PLANS
As of September 30, 2016, the Company had
cash of $1,494,513 and working capital deficit of $2,742,006, principally due to the inclusion of non-cash derivative liability
recorded in current liabilities. Excluding the derivative liability, the Company’s working capital would have been $906,237.
In addition, the Company used actual net cash in operations of $1,711,819 during the nine months ended September 30, 2016. The
Company has incurred net losses since inception. These conditions raise substantial doubt about the Company’s ability to
continue as a going concern.
In
May 2016, the Company sold shares of common stock and warrants for net proceeds, after commissions and other costs, of approximately
$1,579,082. It is anticipated that the proceeds from the sale of its common stock and warrants will provide the Company with
cash sufficient to fund operations through May 2017.
The Company expects that cash used in operations
will decrease significantly over the next several years 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
September 30, 2016 (Unaudited)
NOTE 3: RELATED PARTY TRANSACTIONS
Dr. Carr Bettis, Executive Chairman and Chairman of Board
of Directors
As of September 30, 2016 and December 31,
2015, the Company owed Dr. Bettis $5,992 and $72,944 in accrued salary, respectively. In addition, AudioEye sub-leases an
office for the Company’s CEO Todd Bankofier from Verus Analytics, Inc, a company in which Dr. Bettis has a controlling interest
in. The sub-lease amount is $500 per month totaling $1,500 and $4,500 in three and nine months ended September 30, 2016.
Sean Bradley, President, Chief Technology Officer, and Secretary
As of September 30, 2016 and December 31,
2015, the Company owed Sean Bradley $8,752 and $6,250 in accrued salary, respectively.
David Moradi, a Material Shareholder, on a fully diluted
basis
As of December 31, 2015 the Company owed
David Moradi $70,000 in principal and $4,280 in accrued interest. During the nine months ended September 30, 2016, Mr. Moradi
was paid in full. As of September 30, 2016, Mr. Moradi is no longer considered a material shareholder.
In summary, as of September 30, 2016 and
December 31, 2015 the total balances of related party payables were $14,744 and $153,474, respectively.
NOTE 4: INTANGIBLE ASSETS
For the nine months ended September 30,
2016 and 2015, the Company invested in Patents in the amounts of $42,007 and $88,156 respectively.
Prior to December 31, 2015, patents,
technology and other intangibles with contractual terms were 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.
Software development costs are amortized over their estimated
useful life of three years.
Prior to any impairment adjustment, intangible assets consisted
of the following:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Patents
|
|
$
|
3,697,076
|
|
|
$
|
3,655,069
|
|
Capitalized software development
|
|
|
621,567
|
|
|
|
621,567
|
|
Accumulated amortization
|
|
|
(1,864,481
|
)
|
|
|
(1,435,780
|
)
|
Intangible assets, net
|
|
$
|
2,454,162
|
|
|
$
|
2,840,856
|
|
Amortization expense for patents totaled
$94,209 and $281,064 for the three and nine months ended September 30, 2016, respectively; and $87,395 and $268,940 for the three
and nine months ended September 30, 2015, respectively. Amortization expense for software development totaled $56,119 and $147,637
for the three and nine months ended September 30, 2016, respectively; and $40,427 and $126,677 for the three and nine months ended
September 30, 2015, respectively.
Total amortization expense totaled $428,701
and $395,617 for the nine months ended September 30, 2016 and 2015, respectively.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
NOTE 5: NOTES PAYABLE
As of September 30, 2016 and December 31,
2015, the Company has short term and long term notes payable of $24,000 and $5,800, and $24,000 and $1,923,499, respectively as
shown in the table below.
Notes and loans payable
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Short Term
|
|
|
|
|
|
|
|
|
Maryland TEDCO
|
|
$
|
24,000
|
|
|
$
|
24,000
|
|
Total
|
|
$
|
24,000
|
|
|
$
|
24,000
|
|
Long Term
|
|
|
|
|
|
|
|
|
Convertible Secured Note (net of unamortized discounts of $600,301 in 2015)
|
|
|
-
|
|
|
|
1,899,699
|
|
Maryland TEDCO
|
|
$
|
5,800
|
|
|
$
|
23,800
|
|
Total
|
|
$
|
5,800
|
|
|
$
|
1,923,499
|
|
As of December 31, 2012, the Company
had an outstanding loan to a third party in the amount of $74,900, which was originally issued during 2006 as part of an Investment
Agreement. The loan was unsecured and bore interest at 25% per year for four years. The Company had accrued interest of $74,900,
which was included in accounts payable and accrued expenses on the consolidated balance sheets. The note was in default until
October 24, 2011, at which time the Company entered into a Termination and Release Agreement (“Release”) with
the third party. The terms of the Release, among other things, terminated the Investment Agreement between the parties, and
required the Company to issue a Promissory Note to the third-party in the combined amount of principal and accrued interest to
date, for a total principal amount of $149,800. The note is interest free, and is payable in monthly installments of $2,000
beginning November 1, 2011. As of September 30, 2016 and December 31, 2015, the principal amount owing was
$29,800 and $47,800, respectively, of which $24,000 and $24,000, respectively, has been recorded as the current portion of the
note, and $5,800 and $23,800, respectively, as the long-term portion of the note. The Company has paid $18,000 for the nine months
ended September 30, 2016.
On October 9, 2015 (the “Initial
Closing Date”), AudioEye, Inc. (the “Company”) entered into a Note and Warrant Purchase Agreement (the “Purchase
Agreement”) with certain investors (the “Investors”) for the issuance and sale of convertible promissory notes
in an aggregate principal amount of up to $3,750,000 (the “Notes”) and warrants (the “Warrants”) to purchase
up to an aggregate of 37,500,000 shares of common stock of the Company (the “Common Stock”) (the “Transaction”).
Notes representing up to $2,500,000 in aggregate principal, and Warrants exercisable for up to 25,000,000 shares of Common Stock
in the aggregate, may be issued and sold at one or more closings during the 30-day period immediately following the Initial Closing
Date. The maximum of $2,500,000 in aggregate principal was sold as of November 8, 2015. In addition, upon the election of any Investor
within the three-year period immediately following the Initial Closing Date, any Investor may purchase an additional Note in the
principal amount equal to 50% of the principal amount of the Notes purchased by such Investor at previous closings (the “Option
Principal Amount”) and an additional Warrant with an aggregate exercise price equal to such Investor’s Option Principal
Amount.
The Notes mature three years from the date
of issuance (the “Maturity Date”) and, until the Notes are repaid or converted into shares of the Company’s equity
securities (“Equity Securities”), accrue payable-in-kind interest at the rate of 10% per annum. As described in the
Purchase Agreement, as amended (see below), if the Company sold 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 (the “Equity Financing”), all of the unpaid
principal on the Notes 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. The
Notes, if not converted, shall be due and payable in full on the Maturity Date.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
The Notes contained customary events of
default provisions. In connection with the issuance of the Notes, on October 9, 2015, the Company entered into a Security Agreement
with the Investors (the “Security Agreement”) pursuant to which the Company granted a security interest in all of its
assets to the Investors as collateral for the Company’s obligations under the Notes. As noted below, on April 18, 2016, the
parties agreed to remove the security interest feature from the form of convertible promissory note that may be issued in the future
under the Original Agreement.
The Warrants are exercisable at $0.10 per
share and expire 60 months following the date of issuance. The Warrants are subject to anti-dilution protection, subject to certain
customary exceptions.
During 2015, the Company issued notes under
this offering totaling $2,500,000. The fair value of the warrants issued in connection with the notes was determined to be $627,293
and was recognized as a discount to the debt being amortized to interest expense over the life of the loans. During three and nine
months ended September 30, 2016, aggregate amortization (and write-off) of $-0- and $600,301 was recognized against the discount.
In connection with the transaction, the
Company also entered into amendments to certain agreements. On April 18, 2016, the Company entered into a First Amendment to Note
and Warrant Purchase Agreement (the “Purchase Agreement Amendment”) and an Omnibus Amendment to Secured Promissory
Notes (the “Note Amendment”), which collectively amend that certain Note and Warrant Purchase Agreement dated as of
October 9, 2015 (the “Original Agreement”) and the convertible promissory notes previously issued thereunder to, among
other things (i) remove the right of Anthion Partners II, LLC (together with its affiliates, “Anthion”) to designate
a member of the Board of Directors of the Company; (ii) amend the convertible promissory notes issued thereunder to provide that
if a change of control of the Company occurs prior to the maturity date or an equity financing (as defined therein), the convertible
promissory note shall be repaid in an amount equal to the product of (a) 1.4 and (b) the outstanding principal amount and all accrued
and unpaid interest thereunder; (iii) reduce the conversion threshold in the definition of “qualified financing” under
the convertible promissory notes from $2,000,000 to $1,000,000; (iv) remove the security interest feature from the form of convertible
promissory note that may be issued in the future under the Original Agreement, as amended, and (v) provide for optional conversion
into warrants containing “blocker” provisions (“Special Warrants”) instead of shares upon an equity financing.
The Company also made certain amendments to outstanding warrants to add similar “blocker” provisions.
On April 18, 2016, the Company issued an
aggregate of 12,834,800 shares of its common stock to the Note holders other than Anthion, and 18,353,310 warrants to acquire its
common stock to Anthion in lieu of common stock. Collectively the common stock and warrants issued were in full settlement of $2,500,000
convertible notes and accrued interest of $119,801. The warrants issued to Anthion are exercisable at $0.001 per share for five
years from the date of issuance.
At the date of conversion, the Company
determined that the conversion price of $0.84 per share did not exceed the fair value of Common Stock at note inception, therefore
there was no beneficial conversion feature upon conversion of $1,025,000 of convertible notes and accrued interest. However, the
Company determined that the estimated fair value of the 18,353,310 warrants of $3,205,959 exceeded the settlement of $1,541,678
of convertible notes and accrued interest and accordingly recorded a loss of settlement of debt of $1,664,281 for the nine months
ended September 30, 2016. The Company used the Black-Scholes Option Pricing model to estimate the fair value of the warrants at
the date of conversion using the following assumptions: the price of the Company stock of $0.175, volatility was estimated to be
178%, the risk free rate of 1.24% and the remaining term was 5 years.
NOTE 6: STOCKHOLDERS’ EQUITY
As of September 30, 2016 and December 31,
2015, the Company had 107,458,430 and 81,717,154 shares of common stock issued and outstanding, respectively, and the Company had
160,000 and 175,000 shares of Series A Convertible Preferred Stock, respectively, issued at $10 per share, paying a 5% cumulative
annual dividend and convertible at 0.1754 per share of common stock.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
In April 2016, the Company issued an aggregate
83,336 shares of its common stock in payment for consulting services at a fair value of $14,292.
In April 2016, the Company issued an aggregate
of 12,834,800 shares of its common stock to Note holders in settlement of $1,025,000 in convertible notes and accrued interest
(Note 5).
In May 2016, the Company sold an aggregate of 11,714,285 shares
of common stock of the Company and 1,312,000 warrants to purchase the Company’s common stock to accredited investors for
net proceeds of $1,579,082. The warrants have a term of five years, an exercise price of $0.25 per share and are subject
to anti-dilution protection, as defined.
In May 2016, the Company issued 900,525
shares of its common stock upon conversion of 15,000 shares of Series A Convertible Preferred Stock and accrued dividends.
In July 2016, the Company issued an aggregate
124,998 shares of its common stock in payment for consulting services at a fair value of $20,666.
In August 2016, the Company issued an aggregate
41,666 shares of its common stock in payment for consulting services at a fair value of $6,208.
In September 2016, the Company issued an
aggregate 41,666 shares of its common stock in payment for consulting services at a fair value of $6,292.
Registration rights
Under the purchase agreement, the Company
has agreed to use its reasonable best efforts to prepare and file with the SEC registration statement within 60 days of the initial
closing date, covering the resale by the investors of any common stock previously issued to the investors, and any common stock
into which any convertible promissory notes previously issued to the investors are convertible and any common stock for which the
warrants or any warrants previously issued to the investors are exercisable. The Company filed a registration statement on September
30, 2016.
NOTE 7: OPTIONS
As of September 30, 2016 and December 31,
2015, the Company has outstanding options to purchase 25,005,504 and 14,759,914 shares of common stock, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intrinsic
|
|
|
|
|
|
|
|
|
|
Wtd Avg.
|
|
|
|
|
|
Value
|
|
|
|
Number of
|
|
|
Wtd Avg.
|
|
|
Remaining
|
|
|
|
|
|
of Exercisable
|
|
|
|
Options
|
|
|
Exercise Price
|
|
|
Term
|
|
|
Exercisable
|
|
|
Options
|
|
Outstanding at December 31, 2015
|
|
|
14,759,914
|
|
|
$
|
0.30
|
|
|
|
3.61
|
|
|
|
8,374,294
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
10,756,090
|
|
|
|
0.08
|
|
|
|
4.86
|
|
|
|
|
|
|
|
—
|
|
Forfeited/Expired
|
|
|
(510,500
|
)
|
|
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2016
|
|
|
25,005,504
|
|
|
$
|
0.20
|
|
|
|
3.52
|
|
|
|
13,177,211
|
|
|
$
|
417,857
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
On January 15, 2016, the Company granted
performance options to acquire shares of the Company’s common stock in aggregate of 6,500,000 to key board member and officers
at an exercise price of $0.038 per share for five years. Vesting shall only occur if the closing share price of the Company’s
common stock on each of the 20 trading days before and including the end of any performance period is not less than $0.20 per share
(market condition). Of the granted options, 5,500,000 include performance conditions (as defined) with both conditions (market
and performance) to be met before vesting. All determinations of whether performance goals have been achieved, the number of vested
performance options earned by the grantee, and all other matters related to the award of performance options shall be made by the
compensation committee of the Company’s board of directors in its sole discretion.
The estimated fair values of the options
with performance and market conditions were determined using a Monte Carlo pricing model. Significant assumptions used in the valuation
include expected term of 5 years, expected volatility of 162%, risk free interest rate of 1.46%, and expected dividend yield of
0%.
Nonperformance option grants during the
nine months ended September 30, 2016 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation
include expected term of 1.5 to 3.5 years, expected volatility of 102.00% to 174.99%, risk free interest rate of 0.87% to 1.73%,
and expected dividend yield of 0%.
On April 15, 2016, the Company issued 49,715
options, which vest immediately, have an exercise price of $0.179, and expire on April 15, 2019. The value on the grant date of
the options was $6,250.
On May 12, 2016, the Company issued 100,000
options, which vest 50% after one year and 4.17% every month thereafter, have an exercise price of $0.177, and expire on May 12,
2021. The value on the grant date of the options was $16,694.
On May 12, 2016, the Company issued an
aggregate of 3,400,000 options, which vest 50% immediately and 50% vesting quarterly over 12 months, have an exercise price of
$0.177, and expire on May 12, 2021. The value on the grant date of the options was $559,603.
On July 15, 2016, the Company issued 56,375
options, which vest immediately, have an exercise price of $0.156, and expire on July 15, 2019. The value on the grant date of
the options was $6,250.
For the three and nine months ended September 30,
2016 and 2015, total stock compensation expense related to the options totaled $166,111 and $706,230 and $(119,224) and $709,311,
respectively.
NOTE 8: WARRANTS
Below is a table summarizing the Company’s outstanding
warrants as of September 30, 2016 and December 31, 2015:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intrinsic
|
|
|
|
|
|
|
|
|
|
Wtd Avg.
|
|
|
|
|
|
Value
|
|
|
|
Number of
|
|
|
Wtd Avg.
|
|
|
Remaining
|
|
|
|
|
|
of Exercisable
|
|
|
|
Warrants
|
|
|
Exercise Price
|
|
|
Term
|
|
|
Exercisable
|
|
|
Warrants
|
|
Outstanding at December 31, 2015
|
|
|
42,526,609
|
|
|
$
|
0.22
|
|
|
|
4.15
|
|
|
|
41,297,920
|
|
|
$
|
1,167
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
21,961,513
|
|
|
|
0.02
|
|
|
|
4.66
|
|
|
|
|
|
|
|
-
|
|
Expired
|
|
|
(393,081
|
)
|
|
|
0.42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2016
|
|
|
64,095,041
|
|
|
|
0.15
|
|
|
|
3.73
|
|
|
|
63,907,541
|
|
|
$
|
4,059,950
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
NOTE 8: WARRANTS
The warrant grants during the nine months
ended September 30, 2016 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation include
expected term of 1.5 to 2.5 years, expected volatility of 166.74% to 178.98%, risk free interest rate of 0.71% to 1.08%, and expected
dividend yield of 0%.
During the nine months ended September
30, 2016, the Company issued an aggregate of 1,575,954 warrants to purchase shares of the Company’s common stock with an
exercise prices of $0.038 to $0.179 per share vested immediately for services. The fair value on the grant date of the warrants
was $150,500.
In April 2016, the Company issued an aggregate
of 18,353,310 warrants to acquire its common stock in settlement of $1,541,678 convertible notes and accrued interest. The warrants
issued to Anthion are exercisable at $0.001 per share for five years from the date of issuance.
The Company determined that the estimated
fair value of the 18,353,311 warrants of $3,205,959 exceeded the settlement of $1,541,678 of convertible notes and accrued interest
and accordingly recorded a loss of settlement of debt of $1,664,281 for the nine months ended September 30, 2016. The Company used
the Black-Scholes Option Pricing model to estimate the fair value of the warrants at settlement with the following assumptions:
the price of the Company stock of $0.175, volatility was estimated to be 178%, the risk free rate of 1.24% and the remaining term
was 5 years.
In May 2016, the Company issued 1,312,000
warrants with an exercise price of $0.25 in connection with the sale of Common Stock. The five year warrants also contain a provision
that the warrant exercise price will automatically be adjusted for any common stock equity issuances at less than $0.25 per share.
For the three and nine months ended September 30,
2016 and 2015, the Company has incurred warrant-based expense of $58,599 and $206,772 and $20,962 and $491,148, respectively.
NOTE 9: COMMITMENTS AND CONTINGENCIES
Litigation
In April 2015, two shareholder class
action lawsuits were filed against the Company and former officers Nathaniel Bradley and Edward O’Donnell in the U.S. District
Court for the District of Arizona. The plaintiffs allege various causes of action against the defendants arising from our announcement
that our previously issued financial results for the first three quarters of 2014 and the guidance for the fourth quarter of 2014
and the full year of 2014 could no longer be relied upon. The complaints sought among other relief, compensatory damages
and plaintiff’s counsel’s fees and experts’ fees. The Court appointed a lead plaintiff and lead counsel,
and consolidated the actions. A consolidated amended complaint was filed under the caption
In re AudioEye, Inc. Sec. Litigation.
The Company and individual defendants filed a motion to dismiss.
On July 25, 2016, in connection with a
voluntary mediation, the parties reached an agreement in principle to settle the consolidated actions. The settlement agreement
is subject to definitive documentation, shareholder notice, and court approval. The terms of the agreement include a settlement
payment to the class of $1,525,000 from the Company’s insurer, with no admission of liability by any party. In 2015, the
Company paid a deductible under its D&O insurance policy in the amount of $100,000 regarding this matter.
On May 16, 2016, a shareholder 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-shareholder purports to act
on behalf of the Company against certain of the Company's current and former officers and directors (the “
Named
Individuals
”).
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016 (Unaudited)
The Company is named as a nominal defendant.
The complaint asserts 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 seeks, among other relief, compensatory damages, restitution
and attorneys’ fees. No discovery has occurred. In October 2016, the Company and Named Defendants filed a motion to dismiss,
which remains pending. While the Company believes that its legal defense costs may be reimbursed by the Company’s insurance
carrier, no reasonable estimate of the outcome of the litigation, the related legal fees, or the impact on the financial results
of the Company can be made as of the date of this statement.
On July 26, 2016, a shareholder 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 asserts 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-shareholder
purports to act on behalf of the Company against certain of the Company's current and former officers and directors (the “
Named
Individuals
”). The Company is named as a nominal defendant. The Company understands that the Named Individuals intend
to vigorously defend the lawsuit. While the Company believes that its legal defense costs may be reimbursed by the Company’s
insurance carrier, no reasonable estimate of the outcome of the litigation, the related legal fees, or the impact on the financial
results of the Company can be made as of the date of this statement.
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 10: SUBSEQUENT EVENTS
Employee options/warrants
On October 15, 2016, the Company granted
61,599 options to Sean Bradley as compensation for services rendered. The options are exercisable at $0.125 for three years, vesting
immediately. The exercise price was determined using the 10-day average closing price beginning with the closing price on October
1, 2016.
Common stock
In October 2015, the Company issued 41,666
shares of its common stock for consulting services rendered valued at $4,292.
Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
The following Management’s Discussion
and Analysis of Financial Condition and Results of Operations or MD&A, should be read in conjunction with our consolidated
financial statements and related notes in Part I, Item 1 of this report.
As used in this quarterly report, the
terms “we,” “us,” “our” and similar references refer to AudioEye, Inc. and our wholly-owned
subsidiary, unless otherwise indicated.
Cautionary Note Regarding Forward-Looking Statements
Any statements in this Quarterly Report
on Form 10-Q about our expectations, beliefs, plans, objectives, prospects, financial condition, assumptions or future events
or performance are not historical facts and are “forward-looking statements” as that term is defined under the federal
securities laws. These statements are often, but not always, made through the use of words or phrases such as “believe”,
“anticipate”, “should”, “intend”, “plan”, “will”, “expects”,
“estimates”, “projects”, “positioned”, “strategy”, “outlook” and similar
words. You should read the statements that contain these types of words carefully. Such forward-looking statements are subject
to a number of risks, uncertainties and other factors that could cause actual results to differ materially from what is expressed
or implied in such forward-looking statements. There may be events in the future that we are not able to predict accurately or
over which we have no control. Potential risks and uncertainties include, but are not limited to, those discussed in “Part I, Item
1A. Risk Factors” in our Annual Report filed on Form 10-K for the year ended December 31, 2015. We urge you not
to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We do not undertake
any obligation to release publicly any revisions to such forward-looking statements to reflect events or uncertainties after the
date hereof or to reflect the occurrence of unanticipated events.
Overview
AudioEye is a marketplace leader providing
web accessibility solutions for our clients’ customers through our
Ally Platform Products.
Our technology advances
accessibility with patented technology solutions that reduce barriers, expand access for individuals with disabilities, and enhance
the user experience for a broader audience of users
.
When implemented, we believe that our solutions offer businesses the
opportunity to reach more customers, improve brand image, and build additional brand loyalty. In addition, our solutions
help organizations comply with internationally accepted Web Content Accessibility Guidelines (WCAG) as well as US, Canadian, Australian,
and United Kingdom accessibility laws.
We generate revenues through the sale of
subscriptions of our software as a service (SaaS) technology platform, called the AudioEye Ally Platform, to website owners, publishers,
developers, and operators and through the delivery of managed services combined with the implementation of the AudioEye solution.
Our solutions have been adopted by some of the largest and most influential companies in the world. Our customers span disparate
industries and target market verticals, which encompass (but are not limited to) the following categories: human resources, finance,
transportation, media, and education. Government agencies have also integrated our software in their digital platforms.
The AudioEye Solution
AudioEye uses proprietary technology and
development tools to offer web accessibility solutions that offer significant savings in time and money relative to traditional
solutions. Our compliance solutions focus on rapid remediation of the most important accessibility issues, followed by in-depth
analysis identifying and addressing a more comprehensive compliance program. Our technology was built to not only provide users
with a cloud-based assistive toolset that gets embedded and made freely available to users within our client websites, but to also
improve the code in a way that optimizes the user experience for users of existing third-party assistive technologies, such as
screen readers.
Intellectual Property
Our technology development was initiated
at the University of Arizona Science & Technology Park in Tucson, Arizona. In 2006, we received technology development
venture funding from the Maryland Technology Development Corporation (TEDCO), which contributed to the development of our platform
strategy. Beginning in 2009, we engaged in a multi-year technology development program with the Eller College of Management’s
Department of Management Information Systems at the University of Arizona. In connection with our proprietary technology,
our company has been issued a number of U.S. patents in two distinct patent families. Today, an experienced team of in-house
engineers, designers, and developers in our Atlanta, GA, and Tucson, AZ, offices develop the Company’s technology &
software and are actively engaged in the expansion of the AudioEye IP Portfolio.
Our patented technology was a 2013 Edison
Gold Award winner for innovation in the category of “Quality of Life.”
Our intellectual property is primarily
comprised of trade secrets, trademarks, issued and pending patents, copyrights and technological innovation. We have a patent portfolio
comprised of six patents issued in the United States, we have received a notice of allowance from the U.S. Patent and Trademark
Office for a seventh patent, and we have several additional patents that are either pending or are being prepared for filing in
the United States and internationally.
Our current patented invention relates
to 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. It involves the creation of audio files
for each section within a website, and then assigning a hierarchy and navigation system in line with the website design.
To implement the system, a script is installed across the pages of the website and, when loaded, it plays an audible
tone upon a user’s visit indicating that the website is enhanced with our proprietary technology. Upon hearing the
tone, a user presses a key on the keyboard to enter the audible website. Audible narration is played through the user’s
computer, reading text and describing non-text information, such as images. The narration includes menus for navigating the
site which have a hierarchy in line that of the original website. Users navigate the website menus and move from webpage to
webpage by making keystrokes or using a mouse.
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.
Our Annual Report filed on Form 10-K for the year ended
December 31, 2015 provides additional information about our business and operations.
Results of Operations
Our consolidated audited financial statements
are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles
(“GAAP”). The discussion of the results of our operations compares the three and nine months ended September 30, 2016
with the three and nine months ended September 30, 2015 and are not necessarily indicative of the results which may be expected
for any subsequent period. Our prospects should be considered in light of the risks, expenses and difficulties encountered
by companies in similar positions. We may not be successful in addressing these risks and difficulties.
Comparative for the Three Months ended September 30,
2016 and September 30, 2015
Results of Operations
|
|
Three Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Revenue
|
|
|
282,676
|
|
|
$
|
108,685
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
311,519
|
|
|
|
321,755
|
|
Gross loss
|
|
|
(28,843
|
)
|
|
|
(213,070
|
)
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Selling & marketing
|
|
|
192,881
|
|
|
|
171,594
|
|
Research & development
|
|
|
85,192
|
|
|
|
92,857
|
|
General and administrative expenses
|
|
|
602,041
|
|
|
|
(27,278
|
)
|
Amortization & depreciation
|
|
|
150,328
|
|
|
|
128,381
|
|
Total operating expenses
|
|
|
(1,030,442
|
)
|
|
|
(365,554
|
)
|
Operating loss
|
|
|
(1,059,285
|
)
|
|
|
(578,624
|
)
|
|
|
|
|
|
|
|
|
|
Unrealized gain on derivative liabilities
|
|
|
351,055
|
|
|
|
-
|
|
Unrealized gain on marketable securities
|
|
|
900
|
|
|
|
-
|
|
Interest income/(expense)
|
|
|
266
|
|
|
|
81
|
|
|
|
|
|
|
|
|
|
|
Net (loss)
|
|
|
(707,064
|
)
|
|
|
(578,543
|
)
|
Deemed dividend on Series A Convertible preferred stock
|
|
|
(20,000
|
)
|
|
|
(-
|
)
|
Net loss attributable to common stockholders
|
|
$
|
(727,064
|
)
|
|
$
|
(578,543
|
)
|
Net loss per common share – basic and diluted
|
|
|
(0.01
|
)
|
|
|
(0.01
|
)
|
Weighted average common shares outstanding – basic and diluted
|
|
|
107,382,344
|
|
|
|
81,800,488
|
|
Revenue
For the three months ended September 30,
2016 and 2015, revenue was $282,676 and $108,685, respectively, consisting primarily of revenues from various levels of licensing,
website design and maintenance. Revenues increased due to a change of marketing focus.
Cost of Sales
For the three months ended September 30,
2016 and 2015, cost of sales was $311,519 and $321,755, respectively, consisting primarily of sub-contracting to outside sources,
direct labor and direct technology costs.
Gross Loss
An increase in our implementation costs
resulted in a gross loss of $28,843 and $213,070 during the three months ended September 30, 2016 and 2015, respectively. Gross
loss decreased as a result of lower implementation costs as compared to the same period in 2015.
Selling and Marketing Expenses
Selling and marketing expenses were $192,881
and $171,594 for the three months ended September 30, 2016 and 2015, respectively. The increase resulted from the higher
sales activity in 2016 as compared to 2015.
Research and Development Expenses
Research and development expenses were
$85,192 and $92,857 for three months ended September 30, 2016 and 2015, respectively. Research and development expenses decreased
from period to period and reflect continued developments of our product.
General and Administrative Expenses
General and administrative expenses were
$602,041 and $(27,278) for the three months ended September 30, 2016 and 2015, respectively. In 2015, we recaptured stock option
and warrant expense incurred in prior periods due to the forfeitures of unvested awards due to from staff reductions. Stock based
compensation for the three months ended September 30, 2016 was $224,710 as compared to $(299,811) for the same period last year.
Amortization and Depreciation
Amortization and depreciation expenses
were $150,328 and $128,381 for the three months ended September 30, 2016 and 2015, respectively. The increase in expense was primarily
related to added patent costs in later 2015 and 2016.
Gain on change in Fair Value of Derivative
Liabilities
In October 2015 and in 2016, we issued
warrants with an embedded reset provisions requiring us to fair value the derivatives each reporting period and mark to market
as a non-cash adjustment to our current period operations. This resulted in a gain of $351,055 on change in fair value of derivative
liabilities for the three months ended September 30, 2016. None were issued as of September 30, 2015.
Interest Income (Expense), net
Interest income (expense), net during the
three months ended September 30, 2016 was $266 compared to $81 three months ended September 30, 2015. Both representing interest
earning with our interest bearing deposit accounts.
Comparative for the Nine Months ended September 30,
2016 and September 30, 2015
Results of Operations
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Revenue
|
|
|
594,237
|
|
|
$
|
314,146
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
904,091
|
|
|
|
1,178,388
|
|
Gross loss
|
|
|
(309,854
|
)
|
|
|
(864,242
|
)
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Selling & marketing
|
|
|
510,448
|
|
|
|
747,990
|
|
Research & development
|
|
|
255,805
|
|
|
|
293,877
|
|
General and administrative expenses
|
|
|
1,894,964
|
|
|
|
4,161,269
|
|
Amortization & depreciation
|
|
|
428,701
|
|
|
|
396,269
|
|
Total operating expenses
|
|
|
(3,089,918
|
)
|
|
|
(5,599,405
|
)
|
Operating loss
|
|
|
(3,399,772
|
)
|
|
|
(6,463,647
|
)
|
|
|
|
|
|
|
|
|
|
Unrealized loss on derivative liabilities
|
|
|
(2,990,096
|
)
|
|
|
-
|
|
Loss on settlement of debt
|
|
|
(1,664,281
|
)
|
|
|
-
|
|
Other income
|
|
|
750
|
|
|
|
-
|
|
Interest income/(expense)
|
|
|
(676,181
|
)
|
|
|
3,345
|
|
|
|
|
|
|
|
|
|
|
Net (loss)
|
|
|
(8,729,580
|
)
|
|
|
(6,460,302
|
)
|
Deemed dividend on Series A Convertible preferred stock
|
|
|
(60,000
|
)
|
|
|
(594,641
|
)
|
Net loss attributable to common stockholders
|
|
$
|
(8,789,580
|
)
|
|
$
|
(7,054,943
|
)
|
Net loss per common share – basic and diluted
|
|
|
(0.09
|
)
|
|
|
(0.09
|
)
|
Weighted average common shares outstanding – basic and diluted
|
|
|
95,840,596
|
|
|
|
80,007,507
|
|
Revenue
For the nine months ended September 30,
2016 and 2015, revenue was $594,237 and $314,146, respectively, consisting primarily of revenues from various levels of licensing,
website design and maintenance. Revenues increased due to a change of marketing focus.
Cost of Sales
For the nine months ended September 30,
2016 and 2015, cost of sales was $904,091 and $1,178,388, respectively, consisting primarily of sub-contracting to outside sources,
direct labor and direct technology costs.
Gross Loss
An increase in our implementation costs
resulted in a gross loss of $309,854 and $864,242 during the nine months ended September 30, 2016 and 2015, respectively. Gross
loss decreased as a result of lower implementation costs as compared to the same period in 2015.
Selling and Marketing Expenses
Selling and marketing expenses were $510,448
and $747,990 for the nine months ended September 30, 2016 and 2015, respectively. The decrease resulted from the reduction
primarily in staffing levels.
Research and Development Expenses
Research and development expenses were
$255,805 and $293,877 for nine months ended September 30, 2016 and 2015, respectively. Research and development expenses declined
from period to period and reflect the material completion of our product.
General and Administrative Expenses
General and administrative expenses were
$1,894,964 and $4,161,269 for the nine months ended September 30, 2016 and 2015, respectively. General and administrative expenses
decreased as a result of employee staff reductions and the associated benefits costs as well as decrease in stock based compensation
year over year.
Amortization and Depreciation
Amortization and depreciation expenses
were $428,701 and $396,269 for the nine months ended September 30, 2016 and 2015, respectively. The increase in expense was primarily
related to added patent costs in later 2015 and 2016.
Loss on change in Fair Value of Derivative
Liabilities
In October 2015 and in 2016, we issued
warrants with an embedded reset provisions requiring us to fair value the derivatives each reporting period and mark to market
as a non-cash adjustment to our current period operations. This resulted in a loss of $2,990,096 on change in fair value of derivative
liabilities for the nine months ended September 30, 2016. None were issued as of September 30, 2015.
Loss on settlement of Debt
In April 2016, we issued common stock warrants
in settlement of convertible debt and accrued interest. As such, we incurred a non-cash loss on debt settlement between the estimated
fair value of the issued warrants and the carrying value of the debt and accrued interest of $1,664,281.
Interest Income (Expense), net
Interest income (expense), net during the
nine months ended September 30, 2016 was $(676,181) compared to $3,345 for the nine months ended September 30, 2015. For 2016,
Interest expense consists of amortization of debt discounts and interest incurred relating to our issued notes payable, as compared
to interest income of $3,264 for the nine months ended September 30, 2016
Contracts in Process/Revenue Recognition
Under current accounting procedures, the
Company only recognizes revenue on new contracts for the actual services delivered in the period under the following criteria:
i) the contract has been signed and delivered to the Company; ii) the services have been performed or delivered; and iii) the client
has been billed for the services delivered. The Company does not record deferred revenues for new contracts until the first payment
for services has been received. The Company only records accounts receivable for the amount of revenue recognized as service is
rendered, even if the client has been billed for the entire contract value. The table below summarizes the amount of contract value
in excess of the revenue recognized of $644,334 and the deferred revenue recognized of $445,082, in the amount of $318,824. This
amount is expected to be recognized in future periods. The Company also receives contracts for service hours but whose total contract
value is uncertain. These “fee for service contracts” are recorded in the table below only if the services have been
delivered and the associated revenue has been recognized.
A summary of our contracts in process is
as follows:
|
|
Contracts in Process
|
|
|
|
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
Revenue
Recognized
|
|
|
Deferred
|
|
|
Contract Amount in
Excess of Deferred
|
|
|
|
Contract
|
|
|
Recognized
|
|
|
9 Months Ended
|
|
|
Revenue
|
|
|
Revenue and
|
|
|
|
Amount
|
|
|
prior to 2016
|
|
|
September 30, 2016
|
|
|
September 30, 2016
|
|
|
Recognized Revenue
|
|
Fixed Contracts
|
|
$
|
1,330,408
|
|
|
$
|
50,097
|
|
|
$
|
516,405
|
|
|
$
|
445,082
|
|
|
$
|
318,824
|
|
Fee for Service Contracts
|
|
|
77,832
|
|
|
|
|
|
|
|
77,832
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,408,240
|
|
|
$
|
50,097
|
|
|
$
|
594,237
|
|
|
$
|
445,082
|
|
|
$
|
318,824
|
|
Liquidity and Capital Resources
Working Capital
|
|
At September 30,
|
|
|
At December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Current Assets
|
|
$
|
1,626,440
|
|
|
$
|
1,804,986
|
|
Current Liabilities
|
|
|
4,368,446
|
|
|
|
891,245
|
|
Working Capital (Deficit)
|
|
$
|
(2,742,006
|
)
|
|
$
|
913,741
|
|
The working capital (deficit)/surplus for
the periods ended September 30, 2016 and December 31, 2015 was $(2,742,006) and $913,741 respectively. The decrease in Working
Capital was primarily due to an increase in our non-cash derivative liability, accounts payable, deferred revenue and decrease
in cash. Adjusting for the non-cash derivative liability, Working Capital would have been $906,237 at September 30, 2016. In addition,
the Company used actual net cash in operations of $1,711,819 during the nine months ended September 30, 2016. The Company
has incurred net losses since inception. These conditions raise substantial doubt about the Company’s ability to continue
as a going concern.
The Company expects that cash used in operations
will decrease significantly over the next several years 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.
Cash Flows
|
|
For the nine months ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Net Cash (Used in) Operating Activities
|
|
$
|
(1,711,819
|
)
|
|
$
|
(4,804,778
|
)
|
Net Cash (Used in) Investing Activities
|
|
|
(42,007
|
)
|
|
|
(88,156
|
)
|
Net Cash Provided by Financing Activities
|
|
|
1,561,082
|
|
|
|
3,271,943
|
|
Decrease in Cash
|
|
$
|
(192,744
|
)
|
|
$
|
(1,620,991
|
)
|
We had cash in the amount of $1,494,513
and $1,687,257 as of September 30, 2016 and December 31, 2015, respectively.
On April 18, 2016 (the “Initial Closing
Date”), the Company entered into a Common Stock and Warrant Purchase Agreement (the “Purchase Agreement”) with
certain investors for the issuance and sale of 11,714,285 shares of common stock of the Company and warrants to purchase up to
an aggregate of 1,312,000 shares of Common Stock, representing up to $1,640,000 of proceeds, in one or more closings within 30
days of the Initial Closing Date (the “Transaction”). The warrants are exercisable at $0.25 per share for five years
from the date of issuance and subject to anti-dilution protection as defined. As of July 23, 2016, the Company had received proceeds,
net of costs, of $1,579,082.
Critical Accounting Policies
The discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance
with the accounting principles generally accepted in the United States. Preparing financial statements requires our management
to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates
and assumptions are affected by our management’s application of accounting policies. We believe that understanding the basis
and nature of the estimates and assumptions involved with the following aspects of our financial statements is critical to an understanding
of our financial statements.
Our critical accounting policies, as described
in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, relate to capitalized legal patent costs,
income taxes, goodwill, intangible assets, share-based payments, revenue recognition, and research and other accounting descriptions.
There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2015.