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Indicate by check mark whether the registrant:
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Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
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Indicate by check mark whether the registrant
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The aggregate market value of the voting
and non-voting common equity held by non-affiliates of the registrant as of June 30, 2018 was $19,966,655.
As of March 20, 2019, 7,623,227 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 2019 Annual Meeting of Stockholders scheduled
to be held on May 10, 2019 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” or “continue,” 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.
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
Item 1. Business
Overview
AudioEye is a marketplace
leader providing digital accessibility technology solutions for our clients’ customers through our Ally Platform products.
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 of users
.
We believe that, when implemented our solutions offer
businesses 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 population of individuals with disabilities throughout
the world. In addition, our solutions help organizations comply with internationally accepted Web Content Accessibility Guidelines
(“WCAG”) as well as U.S., 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, Content Management System (“CMS”) platform providers and operators
through the delivery of managed services combined with the implementation of our solutions. 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, retail/ecommerce, food services, automotive,
transportation, hospitality, media, and education. Government agencies, both at the federal level and state and local levels have
also integrated our software in their digital platforms.
AudioEye customers
fall into one of two distinct sales channels: direct and indirect. In the direct channel, AudioEye sales personnel engage directly
with the customer. In the indirect channel, AudioEye engages with customers, who are referred to as Indirect Channel Partners,
who provide a website hosting platform for their end-user customers, and who serve as an authorized reseller of the AudioEye solution
to their customers. Indirect channel sales have been a key factor in the acceleration of the AudioEye sales and marketing strategy.
By working with strategically identified resellers, these partners provide a unique opportunity allowing AudioEye to onboard more
end-user customers in a shorter period of time. By working with providers of the proprietary content management systems, AudioEye
leverages economies of scale to deliver the AudioEye solution in a cost-effective and highly efficient way. In middle and lower
markets, this strategy has helped make accessibility accessible to industries that would otherwise neglect the important issue
of digital inclusion, altogether. We believe that there is significant opportunity for us to increase revenues by delivering our
solutions through this indirect channel and therefore will continue to invest capital and resources in expanding our strategic
partner business.
Industry Background
Millions of Internet
users are impacted by disabilities that prevent them from accessing and using digital content on an equivalent basis. 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, they may exclude potential users and customers. These sites also may not comply with U.S.
and foreign laws addressing equal access and digital inclusion.
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 in order 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 plug-ins or software to be installed on the
user’s computer. Many of these solutions are tailored to 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 in which the code was designed and developed, including the
level to which the website adheres to best practices and standards.
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 six issued patents in the United States and we have received
notice of allowance from the U.S. Patent and Trademark Office for a seventh patent; we have four published/pending patent
applications, one pending patent application and one patent application being prepared for filing with the Patent Cooperation
Treaty (“PCT”) (internationally).
We have a trademark
portfolio comprised of one allowed trademark application, two published trademark applications, and six trademark registrations.
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.
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 Ally Platform product suite, we provide cloud-based, enterprise-grade technology solutions, as well as managed services
to fully implement our solution and position our clients’ sites to more fully conform with web accessibility best practices.
Our technology and professional service offerings may be purchased through a subscription service for either a one-year or multi-year
term. Functionally, the business is organized into Executive, Sales, Marketing, Engineering (which includes intellectual property
development), Implementation, Quality Assurance, and Customer Experience. Intellectual property development is tasked with the
development of new leading-edge intellectual property.
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, developers, and operators, federal,
state and local governments, educational institutions, e-learning and e-commerce websites, kiosk companies, 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 customers, 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 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 and fully-managed 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.
Product Service Offerings
AudioEye uses proprietary
technology and development tools to offer advanced web accessibility fully-managed solutions that offer significant savings in
time and money relative to traditional solutions. Our compliance solutions focus on rapid remediation of common 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.
We offer a diversified
portfolio of service offerings that are broken into two broad business categories: subscription to our web accessibility technology
platform and managed services.
Our web accessibility
technology platform (The AudioEye Ally Platform) consists of the Digital Accessibility Platform and Ally Managed Service, which
are offered as an Internet Cloud SaaS subscription service. AudioEye offers two distinct Web Accessibility solution offerings:
Digital Accessibility Platform and Ally Managed Service.
The AudioEye Digital Accessibility Platform empowers web developers to
improve their websites using the most current, innovative, and industry-leading tools. The Digital Accessibility Platform is primarily
a self-service solution for clients who want to own the accessibility process from beginning to end and puts the power of accessibility
issue tracking, auditing and remediation in the hands of developers. This improves the usability and accessibility of their web
infrastructures. For organizations that are developing web accessibility, this robust site evaluation tool provides detailed information
to help developers and designers fully understand the identified issues as well as the different WCAG 2.1 best practices that
may be implemented in order to improve their website through changes implemented at the source. WCAG 2.1 covers a wide range of
recommendations for making Web content more accessible. Following these guidelines will make content more accessible to a wider
range of people with disabilities, including accommodations for blindness and low vision, deafness and hearing loss, limited movement,
speech disabilities, photosensitivity, and combinations of these, and some accommodation for learning disabilities and cognitive
limitations.
For organizations looking
to offload the accessibility process, the Ally Managed Service allows AudioEye Accessibility Engineers and AT Usability Testers
to do the vast majority of the heavy lifting in order to achieve accessibility and compliance for our clients. This unique offering
leverages a balance of system and engineer generated remediation techniques to programmatically fix website problems that inhibit
full access to our customers’ electronic information technologies. By providing our customers with full access to the Digital
Accessibility Platform and working with them on a long-term basis to provide automated and manual testing in order to allow them
to fully understand the issues of accessibility and how to develop with web accessibility in mind, AudioEye is able to reduce the
burden on IT resources, leaving only limited work for finite client resources. In conjunction with the implementation of the AudioEye
JavaScript, AudioEye makes available the option to publish the Ally Toolbar, which includes the Help Desk and Certification Statement.
The Help Desk provides support for end-users who have issues accessing content, while the Certification Statement outlines our
client’s commitment to providing an accessible and usable website experience for individuals with disabilities. As part of
the Ally Managed Service, AudioEye makes available detailed reporting that provide the client with the results of web accessibility
remediation efforts.
As an additional revenue
source, AudioEye provides Managed Services that support the SaaS model infrastructure. When clients adopt the Digital Accessibility
Platform as a self-service tool, AudioEye markets and sells managed services that include the following: Product Support, Accessibility
Training from accessibility engineers and subject matter experts, Manual Assistive Technology Usability Testing, and other ad hoc
services such as Video Transcription & Captioning, PDF Accessibility Solutions, Audio Description Authoring, Accessibility
Help Desk, and more. These same services are also provided to customers adopting the Ally Managed Service solution and go beyond
the inherent managed services that are part of the implementation of website remediation, the provision of the Ally Toolbar, and,
ultimately, the certification of our clients’ websites and web applications.
Customers
Our potential customer
base includes a broad range of private and public sector customers, including, in particular:
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Corporate enterprises;
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Educational institutions;
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Federal, state, and local governments and agencies;
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Not-for-profit organizations; and
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End-user customers of the CMS website hosting providers.
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If we are unable to
establish, maintain or replace our relationships with customers and develop a diversified customer base, our revenues may fluctuate,
and our growth may be limited. The Company had one major customer (including their affiliates) which generated approximately 11.8%
of its revenue in the fiscal year ended December 31, 2018. The Company had two major customers (including their respective
affiliates) which generated approximately 18.0% and 10.4%, respectively, of its revenue in the fiscal year ended December 31, 2017.
Corporate Enterprises
Our management believes
that corporate enterprises and the CMS platform providers are both markets for the Company’s products and services. Management
believes that the AudioEye Ally Managed Service product 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.
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 their implementation of those techniques, such as those outlined within the globally recognized WCAG.
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 direct 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 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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Automotive;
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Food Services; and
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SaaS Providers.
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Marketing and Sales
In addition to direct
sales with industry specialization and geographical diversification, we use strategic business partnerships and development referral
partners, who maintain a long-standing successful track record in securing introductions with C-level executives and key stakeholders
that directly influence the buying decision of our technology and services. As a proven means of breaking down barriers to entry
and shortening sales cycles, these strategic relationships contribute to the success of our sales operation. Conveying the return
on investment of our technology to our prospective clients is critical as a differentiator in our space. 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.
The Company also attends
selected accessibility and industry trade conferences, maintains memberships with key, industry-specific organizations, serves
as subject matter experts 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
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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 for 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.
This is where we come
in. AudioEye makes websites accessible. In fact, we are proud to be the web accessibility company that
revolutionized
the
way businesses and organizations achieve and maintain a sustainable path to digital inclusion. Our solution identifies and remediates
accessibility issues with both automated
and
manual testing and engineering and provides continuous 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.
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 tools include:
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Automated Testing Tools.
These tools are insufficient and not 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 next to nothing to assist businesses in understanding true access barriers and may even provide misleading evidence (e.g. false positives) that further waste 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). Further, and most importantly, these solutions do nothing to fix anything. At the very best, they 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. 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 Ally 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 see through their façade and/or gain very little 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 they are not combined with a cloud-based tool with a full suite of comparable 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-deployed remediations, nor do they pair their solution with the full breadth of services offered through the AudioEye Ally 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 combination of technology and specialized managed service
. Our management believes that AudioEye, unlike any other company in the marketplace, has addressed the problem of Web Accessibility, holistically, and has uniquely positioned itself to provide a combination of leading-edge technology and high-quality specialized managed service. Our one-of-a-kind, combined solution empowers our clients to provide the highest level of access and usability across their digital infrastructure, while reducing burden on finite IT resources, which leads 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 and enabling a tangible and non-trivial return on investment – a true competitive advantage. This return on investment is derived from opening access to the approximately 15% of the population with a disability or physical limitation. This has allowed our clients to reach more customers, improve brand image, and build additional brand loyalty from their customers in a competitive manner.
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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 Ally Platform products
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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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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 are actively pursuing the expansion of this portfolio to include
a broad range of pertinent and novel concepts that AudioEye has employed (or is in the process of employing) for our growing client
list. 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 broadcasting 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
We have a portfolio
comprised of six approved patents in the United States, and we have received a notice of allowance from the U.S. Patent and Trademark
Office for a seventh patent. We also have several additional patents that are either pending or are being prepared for filing.
The patents have been
extended and cover a period from 2002 through 2026. We have six issued patents and six registered trademarks with the U.S. Patent
and Trademark Office.
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 2019.
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.
Employees
As of March 5, 2019,
we had 65 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 "People First" cultural value we aspire to every day. 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.
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 $5,019,874
for the year ended December 31, 2018. As of December 31, 2018, we have an accumulated deficit of $42,143,101. 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 requires substantial
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 5, 2019,
our cash available was $4,537,086. 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: 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.
Current economic and credit conditions
could adversely affect our plan of operations.
Our ability to secure
additional financing and satisfy our financial obligations under indebtedness outstanding from time to time will depend upon our
future operating performance, which is subject to the prevailing general economic and credit market conditions, including interest
rate levels and the availability of credit generally, and financial, business and other factors, many of which are beyond our control.
The prolonged continuation or worsening of current credit market conditions would have a material adverse effect on our ability
to secure financing on favorable terms, if at all.
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, which 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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·
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computer viruses or software defects; and
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·
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physical or electronic break-ins, sabotage, intentional acts of vandalism, terrorist attacks and other events beyond our control.
|
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, 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 and our annual report on Form 10-K for the year ended December 31, 2017, 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 and Financial Officer has 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, 2017
or 2018.
In addition, our management
has identified, and we have disclosed in this 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,
which relate to the segregation of duties and the lack of formal policies that provide for multiple levels of supervision and reviews,
also existed at December 31, 2017. Management has evaluated, and continues to evaluate, avenues for mitigating our internal controls
weaknesses, but mitigating controls to completely mitigate internal control weaknesses have been deemed to be impractical and prohibitively
costly, due to the size of our organization at the current time and limited capital resources. Management expects to continue to
use reasonable care in following and seeking improvements to effective internal control processes that have been and continue to
be in use at the Company. Our management also determined that our internal control over financial reporting was ineffective as
of December 31 in each of 2012 through 2016.
Failure to establish
and maintain the required internal control over financial reporting or related procedures, 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 public accounting firm's attestation to or report on management's assessment of our
internal control over financial reporting 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 periods 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.
Offers or availability for sale of
a substantial number of shares of our common stock may cause the price of our common stock to decline.
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, it could create a circumstance commonly referred to as an “overhang,” in anticipation of which the market
price of our common stock could fall. The existence of an overhang, 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 additional shares of common stock upon conversion of Series A Convertible Preferred Stock,
it will result in the dilution of our existing stockholders.
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 7,579,995 shares of common stock were issued and outstanding
as of December 31, 2018 and 105,000 shares of Series A Convertible Preferred Stock were issued and outstanding as of December
31, 2018. Upon any conversion of the Series A Convertible Preferred Stock, based upon the applicable conversion rate as of December
31, 2018, approximately 283,407 shares of common stock, resulting in dilution to our existing holders of common stock. From time
to time we may increase the number of shares available for issuance in connection with our equity compensation plans. Our board
of directors may fix and determine the designations, rights, preferences or other variations of each class or series within each
class of preferred stock and may choose to issue some or all of such shares to provide additional financing or acquire more businesses
in the future.
Moreover, as of December
31, 2018, we had outstanding warrants and options to purchase an aggregate of 2,779,704 shares of our common stock, and outstanding
restricted stock units covering an aggregate of 222,514 shares of common stock. The exercise of such options and warrants and the
settlement of such restricted stock units would further increase the number of our outstanding shares of common stock and dilute
the interests of our holders of common stock. The issuance of any shares for acquisition, licensing or financing efforts, upon
conversion of any preferred stock, upon exercise of warrants and options, or upon settlement of restricted stock units may result
in a reduction of the market price of our common stock. If we issue any such additional shares, such issuance will cause a reduction
in the proportionate ownership and voting power of all then current stockholders.
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 5, 2019,
three of our stockholders, one of whom is our Executive Chairman, beneficially owned in the aggregate over 50% of our common stock.
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 controls 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 5, 2019,
our directors, executive officers and certain other beneficial owners of our common stock, beneficially owned an aggregate of 5,686,225
shares of common stock which is approximately 74.59% of our outstanding 7,623,227 shares of common stock. Through their collective
ownership of our outstanding common 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, would determine
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 26.89% 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 5, 2019 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 current and expected operations. We believe that suitable additional or substitute space
will be available as needed to accommodate changes in our operations.
Item 3. Legal Proceedings
For a description of
our material legal proceedings, see the section titled “Litigation” included in Note 11 – “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, 2018 AND 2017
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. The Company owns a unique patent portfolio comprised of six issued
patents in the United States, a notice of allowance from the U.S. Patent and Trademark Office for a seventh patent, and two U.S.
patents pending with additional patents being drafted for filing with the U.S. Patent and Trademark Office and internationally.
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 — MANAGEMENT’S LIQUIDITY
PLANS
As of December 31, 2018, the Company had
cash of $5,741,549 and working capital of $3,370,983. In addition, the Company used actual net cash in operations of $1,643,854
during the year ended December 31, 2018.
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. In connection
with the October 9, 2015 Note and Warrant Purchase Agreement, the Company has received proceeds from issuance of convertible notes
payable of $100,000 in September 2018 and $124,975 in October 2018 (see Note 8). It is anticipated that the Company has cash sufficient
to fund operations for the next twelve months.
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, 2018 and 2017, Empire had no activity. Empire
had no assets or liabilities as of December 31, 2018 and 2017.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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:
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Identify the contract with the customer;
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Identify the performance obligations in the contract;
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Determine the transaction price;
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Allocate the transaction price to the performance obligations in the contract; and
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Recognize revenue when, or as, the performance obligations are satisfied.
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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 Ally Platform.
The following table presents our revenues
disaggregated by type of good or service and sales channel:
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Year ended December 31,
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2018
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2017
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Subscription revenue and support – Direct
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$
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4,315,168
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$
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2,543,947
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Subscription revenue and support – Indirect (Strategic partners)
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1,345,259
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195,492
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Total revenues
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$
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5,660,427
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$
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2,739,439
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There were significant changes in contract
liabilities balances during the year ended December 31, 2018. The table below summarizes the activity within the deferred revenue
accounts, during the year ended December 31, 2018:
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December 31,
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Cash
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Revenue
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|
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December 31,
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|
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2017
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received
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recognized
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2018
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Deferred revenue
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$
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1,233,754
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$
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5,969,417
|
|
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$
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4,174,384
|
|
|
$
|
3,028,787
|
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As of December 31, 2018, $2,626,712 was
classified as short term and is expected to be recognized over the next twelve months. The remaining $402,075 is long-term deferred
revenue to be recognized thereafter.
At December 31, 2018, the Company had one
customer representing 22% of the outstanding accounts receivable. At December 31, 2017, the Company had five customers representing
18%, 14%, 14%, 13% and 10% (an aggregate of approximately 69%) of the outstanding accounts receivable.
The Company had
one major customer including their affiliates which generated approximately 11.8% of its revenue in the year ended December 31,
2018.
The Company had
two major customers including their affiliates which generated approximately 28.4% (18.0% and 10.4%) of its revenue in the year
ended December 31, 2017.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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, 2018.
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, 2018 AND 2017
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.
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 year ended December 31, 2018 and 2017, research and technology expenses totaled
$194,429 and $181,303 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. There were no cash equivalents as of December 31, 2018 and 2017.
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 statement 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, 2018 and 2017, the Company incurred $-0- and $3,202 as bad debt expense.
There was an allowance for doubtful accounts of $-0- as of December 31, 2018 and 2017.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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, 2018 and 2017 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, 2018 and 2017, 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, 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.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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 and convertible debentures
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 year ended December 31, 2018 and 2017 are as follows:
|
|
2018
|
|
|
2017
|
|
Preferred stock on a converted basis
|
|
|
283,407
|
|
|
|
284,360
|
|
Options to purchase common stock
|
|
|
997,989
|
|
|
|
1,003,836
|
|
Warrants to purchase common stock
|
|
|
1,781,715
|
|
|
|
1,919,906
|
|
Restricted stock units
|
|
|
222,514
|
|
|
|
156,340
|
|
Totals
|
|
|
3,285,625
|
|
|
|
3,364,442
|
|
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, 2018 and 2017, 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, 2018 AND 2017
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 shareholders 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
of
ASU 2014-09
|
|
|
Subsequent to
adoption of ASU
2014-09
|
|
|
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, account and notes receivable, accounts 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 to 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, 2018 AND 2017
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 and April
2017, the Company issued warrants with an exercise price of $2.50 in connection with 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 $2.50 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 as of the dates of issuance, the price of the Company stock ranged $0.775 to $4.675, volatility was estimated
to be 102% to 172%, the risk-free rate ranged 1.14% to 1.79% and the remaining term was 5 years.
In 2016 and 2017, the Company issued warrants
with an exercise price of $6.25 in connection with the sale of the Company’s 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 $6.25
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 and as of the dates of issuance, the price of the Company stock ranged $3.80 to $4.875, volatility was
estimated to be from 169% to 178%, the risk-free rate ranged 1.22% to 1.87% and the remaining term was 5 years. The estimated initial
fair value of these warrants of $6,062 during 2017 was reclassified from equity to liability at the date of issuance.
On May 2, 2017, a warrant holder exercised
a warrant to acquire 40,000 shares of the Company’s common stock under a cashless provision. The Company used the Black-Scholes
Option Pricing model to estimate the fair value and as of the date of exercise, the price of the Company stock was $5.00, volatility
was estimated at 171%, the risk-free rate of 1.45% and the remaining term was 3.4 years. The estimated fair value of the warrant
of $184,569 was reclassified from liability to equity at the date of exercise.
In October and November 2017, the Company
offered, as an inducement to exercise, to reduce the exercise price of previously issued warrants from $2.50 per share to $1.75
per share. The Company used the Black-Scholes Option Pricing model to estimate the change in fair value and the dates of exercise,
the price of the Company’s common stock was $3.475 to $3.8725, volatility estimated from 165% to 166%, risk free rate from
1.60% to 1.99% and remaining term from 2.94 to 4.42 years. The estimated fair value of the change in warrant fair value of $13,262
was charged to current period interest expense. The estimated fair value of the warrants at the dates of exercise of $574,342 was
reclassified from liability to equity at the date of exercise(s). In connection with the offering, the exercise price of an aggregate
of 71,680 previously issued warrants with anti-dilutive provisions were reset from $6.25 to $1.75 per share
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
At December 31, 2017, the price of the
Company stock was $3.8725, volatility was estimated to be 163.9%, the risk-free rate from 1.98% to 2.20% and the remaining term
ranged from 2.77 to 4.03 years. As of December 31, 2017, the fair value of the warrants was determined to be $2,984,010, resulting
in an unrealized loss on the change in the fair value of this derivative liability of $155,027 for the year ended December 31,
2017.
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). See discussion above. The following are the Company’s assets and liabilities, measured at fair value on a recurring
basis, as of December 31, 2018 and 2017:
|
|
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Hierarchy
|
Assets
|
|
|
|
|
|
|
Marketable securities, December 31, 2018
|
|
$
|
510
|
|
|
Level 1
|
Marketable securities, December 31, 2017
|
|
$
|
750
|
|
|
Level 1
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Derivative liabilities, December 31, 2018
|
|
$
|
-
|
|
|
Level 3
|
Derivative liabilities, December 31, 2017
|
|
$
|
2,984,010
|
|
|
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-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 on January 1, 2019.
The new standard provides a number of optional
practical expedients in transition. The Company has elected the ‘package of practical expedients’, which permit it
not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct
costs. The Company does not expect to elect the use-of-hindsight or the practical expedient pertaining to land easements; the latter
is not applicable to the Company.
The new standard will have 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.
The new standard also provides practical
expedients for an entity’s ongoing accounting. The Company will elect the short-term lease recognition exemption for all
leases that qualify. This means, for those leases that qualify, the Company will 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.
Beginning in 2019, the Company expects changes to its disclosed lease recognition policies and practices, as well as to other related
financial statement disclosures due to the adoption of this standard. These revised disclosures will be made in the Company’s
first quarterly report in 2019.
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 guidance is effective for annual reporting periods beginning after December 15, 2018, including
interim periods within that reporting period. Early adoption is permitted. We do not expect the adoption of this standard to have
a material effect on our consolidated financial statements.
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, 2018 AND 2017
NOTE 4 — PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2018 and 2017 is summarized
as follows:
|
|
2018
|
|
|
2017
|
|
Computer equipment
|
|
$
|
62,170
|
|
|
$
|
63,517
|
|
Equipment under capital lease
|
|
|
95,506
|
|
|
|
-
|
|
Furniture and fixtures
|
|
|
4,968
|
|
|
|
3,128
|
|
Total
|
|
|
162,644
|
|
|
|
66,645
|
|
Less accumulated depreciation
|
|
|
(54,637
|
)
|
|
|
(31,651
|
)
|
Property and equipment, net
|
|
$
|
108,007
|
|
|
$
|
34,994
|
|
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 $95,506, less accumulated depreciation of $16,117 as of December 31, 2018 and
$0, less accumulated depreciation of $0 as of December 31, 2017, respectively.
The Company spent $10,893 in purchases
and leased $95,506 of equipment during the year ended December 31, 2018 and $41,167 in purchases of equipment during the year ended
December 31, 2017. Depreciation expense was $33,386 and $6,173 for the year ended December 31, 2018 and 2017.
NOTE 5 — INTANGIBLE ASSETS
For the year ended December 31, 2018 and
2017, the Company invested in software development costs in the amounts of $404,890 and $383,802 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, 2018 and 2017, respectively.
Software development costs are amortized over their estimated
useful life of three years.
Intangible assets consisted of the following:
|
|
2018
|
|
|
2017
|
|
Patents
|
|
$
|
3,697,709
|
|
|
$
|
3,697,709
|
|
Capitalized software development
|
|
|
1,410,259
|
|
|
|
1,005,369
|
|
Domain name
|
|
|
10,000
|
|
|
|
-
|
|
Accumulated amortization
|
|
|
(3,056,564
|
)
|
|
|
(2,538,615
|
)
|
Intangible assets, net
|
|
$
|
2,061,404
|
|
|
$
|
2,164,463
|
|
Amortization expense for patents totaled
$374,632 and $379,158 for the year ended December 31, 2018 and 2017, respectively. Amortization expense for software development
totaled $143,317 and $153,430 for the years ended December 31, 2018 and 2017, respectively.
Total amortization expense totaled $517,949
and $532,588 for the year ended December 31, 2018 and 2017, respectively.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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, 2018:
|
|
January 1,
|
|
|
Commission
|
|
|
Commission
|
|
|
December 31,
|
|
|
|
2018
|
|
|
Costs Deferred
|
|
|
Amortized
|
|
|
2018
|
|
Deferred costs, short term
|
|
$
|
80,153
|
|
|
$
|
199,236
|
|
|
$
|
(103,383
|
)
|
|
$
|
176,006
|
|
Deferred costs, long term
|
|
|
-
|
|
|
|
93,790
|
|
|
|
-
|
|
|
|
93,790
|
|
Deferred commission costs
|
|
$
|
80,153
|
|
|
$
|
293,026
|
|
|
$
|
(103,383
|
)
|
|
$
|
269,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the year ended December 31, 2018,
the Company deferred an aggregate $293,026 commissions paid and reclassified from equity $80,153 previously paid and expensed commissions.
Amortization of deferred costs for the year ended December 31, 2018 was $103,383.
NOTE 7 — CAPITAL LEASES
|
|
2018
|
|
|
2017
|
|
Capital equipment lease dated April 5, 2018
|
|
$
|
13,056
|
|
|
$
|
-
|
|
Capital equipment lease dated May 8, 2018
|
|
|
14,525
|
|
|
|
-
|
|
Capital equipment lease dated June 27, 2018
|
|
|
21,701
|
|
|
|
-
|
|
Capital equipment lease dated September 18, 2018
|
|
|
15,368
|
|
|
|
-
|
|
Capital equipment lease dated September 28, 2018
|
|
|
16,672
|
|
|
|
|
|
Total capital leases payable
|
|
|
81,322
|
|
|
|
-
|
|
Less current portion
|
|
|
(30,172
|
)
|
|
|
-
|
|
Long term portion
|
|
$
|
51,150
|
|
|
$
|
-
|
|
During the year ended December 31, 2018,
the Company entered into five capital leases for computer equipment for a three-year term. The Company recognized these arrangements
as capital leases based on the determination the leases exceeded 75% of the economic life of the underlying assets. The Company
initially recorded the equipment and the capitalized lease liability at the estimated present value of the minimum lease payments
of $95,506.
The leases include base monthly payments
in aggregate of $2,894, 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 $14,184 during the year ended December 31, 2018. The effective interest rate of the capitalized lease is estimated
at 6.00% based on the implicit rate in the lease agreements.
The following summarizes the assets under
capital leases:
|
|
2018
|
|
|
2017
|
|
Classes of property
|
|
|
|
|
|
|
|
|
Computer equipment
|
|
$
|
95,506
|
|
|
$
|
-
|
|
Less: accumulated depreciation
|
|
|
(16,117
|
)
|
|
|
-
|
|
|
|
$
|
79,389
|
|
|
$
|
-
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
The following summarizes total future minimum lease payments
at December 31, 2018:
Period ending December 31,
|
|
|
|
|
2019
|
|
$
|
34,729
|
|
2020
|
|
|
34,729
|
|
2021
|
|
|
18,985
|
|
Total minimum lease payments
|
|
|
88,443
|
|
Amount representing interest
|
|
|
7,121
|
|
Present value of minimum lease payments
|
|
|
81,322
|
|
Current portion of capital lease obligations
|
|
|
30,172
|
|
Capital lease obligation, less current portion
|
|
$
|
51,150
|
|
NOTE 8 — CONVERTIBLE NOTES PAYABLE
2017
:
On April 11, 2017, the Company issued a
convertible promissory note in the principal amount of $50,000 (the “Note”) and warrant (the “Warrant”)
to purchase 20,000 shares of common stock of the Company. The Note and Warrant were issued in connection with an election granted
under our October 9, 2015 Note and Warrant Purchase Agreement (the “October 2015 Purchase Agreement”) whereby any investor
in the October 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 with an aggregate exercise price equal to such investor’s the principal amount
of such additional note.
The Note bears interest at 10% and matures
the earlier of October 9, 2018 or after the occurrence an event of default (as defined in the Note). In the event of any conversion,
all interest shall be also converted into equity and shall not be payable in cash.
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 Note
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 Note by (ii) 60% of the price per share at which such equity securities are issued and sold in such equity financing.
The Warrant is exercisable at $2.50 per
share and expires 5 years following the date of issuance. The Warrant is subject to anti-dilution protection, subject to certain
customary exceptions.
The estimated fair value of the issued
warrant of $89,944 was charged as a debt discount up to the net proceeds of the note ($50,000) and the excess ($39,944) recorded
as current period interest expense. The Company amortized $50,000 of the debt discount to current period operations as interest
expense for the year ended December 31, 2017.
On November 30, 2017, the Company issued
31,450 shares of the Company’s in full settlement of the promissory note and accrued interest of $2,836. In connection with
the settlement, the Company incurred a $15,724 loss on settlement of debt.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
On October 11, 2017, the “Company
entered into a Second Amendment to the Note and Warrant Purchase Agreement (the “Purchase Agreement Amendment”) and
an Omnibus Amendment to Common Stock Warrants (the “Warrant Amendment”), which collectively amend that certain Note
and Warrant Purchase Agreement dated as of October 9, 2015 (the “Original Agreement”) and the warrants previously issued
thereunder (the “Warrants”) to, among other things; (i) for the period from the Closing Date until November 8, 2017
(the “Discount Period”), provide parties to the Original Agreement the option to purchase additional notes (in an amount
of up to 50% of their respective original investment as provided in the Original Agreement) that will immediately convert to shares
of common stock of the Company (“Common Stock”) at a price of $1.68 per share along with warrants exercisable for shares
of Common Stock at a price of $1.75 per share if exercised during the Discount Period or $2.50 per share if exercised during the
term of the warrant following the Discount Period; (ii) provide for certain registration rights for shares of Common Stock issued
pursuant to the Original Purchase Agreement, as amended, at any time after 30 days subsequent to the listing of the Common Stock
on a national securities exchange; and (iii) amend the Warrants such that they are exercisable for shares of Common Stock at a
price of $1.75 per share if exercised during the Discount Period or $0.10 per share if exercised during the term of the warrant
following the Discount Period.
The Company recognized a charge of $13,262
to current period interest for change in fair value due to the warrant modifications using the Black-Scholes pricing model and
the following assumptions: contractual terms of 5 years, a risk-free interest rate of 1.60% to 1.99%, a dividend yield of 0%, and
volatility of 165.18% to 166.12%.
In November 2017, the Company issued convertible
promissory notes in aggregate of $812,500 and 325,000 warrants to acquire the Company’s common stock at $1.75 per share for
five years under the above described terms. The notes were immediately converted into 483,631 shares of the Company’s common
stock at a conversion rate of $1.68 per share. Of the issued 325,000 warrants, 30,000 warrants were exercised for net proceeds
of $52,500.
In accordance with ASC 470-20, the Company
recognized the value attributable to the warrants and the conversion feature in the aggregate amount of $812,500 to additional
paid in capital and a discount against the November 2017 notes. The Company valued the warrants in accordance with ASC 470-20 using
the Black-Scholes pricing model and the following assumptions: contractual terms of 5 years, a risk-free interest rate of 1.83%
to 2.01%, a dividend yield of 0%, and volatility of 165.45% to 166.12%. Due to the immediate conversion feature, the debt discount
attributed to the value of the warrants and conversion feature in aggregate of $812,500 was charged to current period as interest
expense.
2018:
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 10). 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.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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
Issuance of convertible notes payable
In 2017, the Company issued an aggregate
of $762,500 in convertible notes payable and warrants to acquire 305,000 shares of the Company’s common stock with a term
of five years, an exercise price of $1.75 per share to David Moradi. Upon issuance, the convertible notes immediately and automatically
convert into the Company’s common stock at a conversion rate of $1.68 per share.
In 2017, the Company issued an aggregate
of 453,869 shares of the Company’s common stock in settlement of outstanding convertible notes, issued in 2017, for $762,500
to David Moradi.
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, discussed
further in Note 8, issued in 2018, for $50,000 and accrued interest.
Sales of common stock
In 2017, the Company sold to Anthion Partners
II, LLC, an entity under the control of David Moradi, 214,286 shares of the Company’s common stock for net proceeds of $750,000.
In 2017, the Company issued 30,000 shares of the Company’s
common stock in exchange for the exercise of warrants for net proceeds of $52,500 to David Moradi.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
In 2017, the Company issued 729,028 shares
of the Company’s common stock in exchange for the exercise on a cashless basis of 734,133 warrants to David Moradi.
In summary, as of December 31, 2018
and 2017, the total balances of related party payable were $14,467 and $23,535, respectively.
NOTE 10 — COMMITMENTS AND CONTINGENCIES
Operating leases
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 December 31, 2018. The Company’s principal executive office was leased for an aggregate amount of $4,724 per month
through September 1, 2016, $5,474 through September 30, 2017 and an aggregate amount of $6,224 per month as of December 31, 2017.
On December 21, 2017, effective February 1, 2018, the Company amended its existing lease to expand its Arizona office to approximately
4,248 square feet that expires September 30, 2021. As such, beginning February 1, 2018, the basic rent increased to $9,598 on February
1, 2018. On October 2, 2018, effective December 1, 2018, the Company amended further its existing lease to expand its Arizona office
to approximately 5,151 square feet. In accordance with the amended lease, rent increases to $11,810 on January 1, 2019, escalating
to $12,977 at the end of the lease, which was extended to October 31, 2022.
The Company also has offices in Atlanta,
previously located at 1855 Piedmont Road, Suite 200, Marietta, Georgia leased for an aggregate of $2,763 per month. Beginning
September 1, 2016, we re-located offices located at 3901 Roswell Road, Suite 134, leased for an aggregate of $3,937 per month as
of December 31, 2017 and expiring September 30, 2019. On December 29, 2017, effective February 1, 2018, amended its existing lease
to expand its Georgia office to approximately 3,831 square feet. As such, beginning February 1, 2018, the basic rent increases
by $1,500 on February 1, 2018 through remainder of lease term. Subsequent to year end, 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 will commence, depending on substantial completion of the landlord’s development but no later
than June 1, 2019.
In 2018 and 2017, we leased office space
in New York on a month to month basis for $300 per month.
Beginning November 1, 2015, we subleased
an office from a company controlled by our Executive Chairman in Scottsdale, AZ for $3,578 per month as of December 31, 2018.
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. During the years ended December 31, 2018 and 2017, rent expense was $220,407
and $144,030, respectively and as of December 31, 2018 and 2017, net deferred rent payable was $11,057 and $14,450, respectively.
The following is a schedule of future minimum
lease payments for all non-cancelable operating leases for each of the next four years ending December 31 and thereafter:
Year ended December 31,
|
|
|
|
|
2019
|
|
|
195,454
|
|
2020
|
|
|
147,079
|
|
2021
|
|
|
150,386
|
|
2022
|
|
|
142,242
|
|
Total
|
|
$
|
635,161
|
|
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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 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 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 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 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-shareholder
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 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. 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, 2018 AND 2017
Preferred Stock
As of December 31, 2018 and 2017,
the Company had 105,000 and 110,000 shares of Series A Convertible Preferred Stock, respectively, issued at $10 per share, paying
a 5% cumulative annual dividend and convertible for common stock at a price of $4.385 per share, as adjusted for the Company’s
reverse stock split. The Preferred Stock is perpetual. For the year ended December 31, 2018, preferred shareholders earned, but
were not paid $53,740 in annual dividends, or equivalent to 12,256 common shares based on a conversion price of $4.385 per share.
As of December 31, 2018 and 2017, cumulative and unpaid dividends were $192,740 and $146,918, or equivalent to 43,955 and 33,505
common shares based on a conversion price of $4.385 per share, respectively.
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 Stock holders.
In addition, the Preferred stock holders
have a liquidation preference, which Preferred Stock would be valued at $10 per share plus accrued cumulative annual dividend.
At December 31, 2018, the liquidation preference was valued at $1,242,740. In the event of any liquidity event, holders of each
share of Preferred Stock shall be entitled to be paid 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, 2018 and 2017,
the Company had 7,579,995 and 6,467,066 shares of common stock issued and outstanding, respectively.
During the year ended December 31, 2017,
the Company issued 6,667 shares of its common stock in payment for consulting services at a fair value of $25,001.
During the year ended December 31, 2017,
the Company issued 793,317 shares of its common stock upon the cashless exercise of outstanding warrants to purchase 854,133 shares
of common stock. During the year ended December 31, 2017, the Company issued an aggregate of 120,000 shares of its common stock
of the Company for the exercise of warrants, for proceeds of $210,000.
During the year ended December 31, 2017,
the Company sold an aggregate of 442,857 shares of its common stock of the Company for net proceeds of $1,550,000 or $3.50 per
share.
In October 2017, the Company issued 128,161
shares of its common stock upon conversion of 50,000 shares of Series A Convertible Preferred Stock and accrued dividends. In November
2017, the Company issued an aggregate of 61,212 shares of its common stock of the Company for conversion of notes payable and accrued
interest of $102,836. In December 2017, the Company issued an aggregate of 453,869 shares of its common stock of the Company for
conversion of notes payable of $762,500.
During the year ended December 31, 2018,
the Company issued 5,842 shares of its common stock upon the cashless exercise of outstanding warrants to purchase 127,525 shares
of common stock. During the year ended December 31, 2018, the Company issued 3,701 shares of its common stock upon the cashless
exercise of outstanding options to purchase 12,173 shares of common stock.
In June 2018, the Company issued 13,204
shares of its common stock upon conversion of 5000 shares of Series A Convertible Preferred Stock and accrued dividends. In August
2018, the Company issued 1,000,000 shares of its common stock in exchange for net cash, after expenses, of $5,609,215.
In October 2018, the Company issued 60,182
shares of its common stock for conversion of notes payable and accrued interest of $225,687. In December 2018, the Company issued
20,000 shares of its common stock for the exercise of options, for proceeds of $20,500 and 10,000 shares of its common stock for
exercise of warrants, for proceeds of $10,250.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
Options
As of December 31, 2018 and 2017,
the Company has outstanding options to purchase 997,989 and 1,003,836 shares of common stock, respectively.
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Intrinsic
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
Value
|
|
|
|
Number of
|
|
|
Average
|
|
|
Remaining
|
|
|
|
|
|
of
|
|
|
|
Options
|
|
|
Exercise Price
|
|
|
Term
|
|
|
Exercisable
|
|
|
Options
|
|
Outstanding at December 31, 2016
|
|
|
1,029,262
|
|
|
$
|
5.00
|
|
|
|
3.34
|
|
|
|
603,655
|
|
|
$
|
1,161,244
|
|
Granted
|
|
|
58,000
|
|
|
|
4.00
|
|
|
|
5.00
|
|
|
|
|
|
|
|
-
|
|
Forfeited/Expired
|
|
|
(83,426
|
)
|
|
|
8.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2017
|
|
|
1,003,836
|
|
|
$
|
4.69
|
|
|
|
2.64
|
|
|
|
891,087
|
|
|
$
|
1,356,188
|
|
Granted
|
|
|
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
|
|
On January 17, 2017, the Company granted
4,000 options, which vest 50% after one year and 2.08% every month thereafter, have an exercise price of $3.975, and expire on
January 17, 2022. The value on the grant date of the options was $11,119.
On March 10, 2017, the Company granted
4,000 options, which vest 50% after one year and 2.08% every month thereafter, have an exercise price of $3.625, and expire on
March 10, 2022. The value on the grant date of the options was $12,541.
On July 10, 2017, the Company granted
50,000 employee options (including 40,000 of which to a board director) with an exercise price of $4.15 per share and expiration
date five years from the date of grant, of which 40,000 options vested immediately and 10,000 options vest 50% after approximately
nine months, with an additional 4.17% vesting every month thereafter.
Option grants during the year ended December
31, 2017 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 169.46% to 175.56%, risk free interest rate of 1.42% to 1.66%, and expected dividend
yield of 0%.
Effective December 31, 2017, 220,000 expiring
performance-based options granted in 2016 were modified to 100% vested immediately. Previously recognized performance-based stock-based
compensation in 2016 and 2017 of $58,830 was reversed at December 31, 2017 and the estimated fair value of the modified options
of $737,825 was charged to operations. Significant assumptions used in the valuation include expected term of 1.52 years, expected
volatility of 163.87%, risk free interest rate of 1.76%, 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.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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 year ended December 31, 2018 and
2017, total stock compensation expense related to the options totaled $342,384 and $1,236,863, respectively.
The outstanding unamortized stock compensation
expense related to options was $111,027 (which will be recognized through December 2020) as of December 31, 2018.
Warrants
Below is a table summarizing the Company’s
outstanding warrants activity for the two years ended December 31, 2018. The Company had outstanding warrants to purchase 1,781,715
and 1,919,906 shares of the Company’s common stock as of December 31, 2018 and 2017, respectively:
|
|
|
|
|
|
|
|
Weighted
|
|
|
Intrinsic
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
Value
|
|
|
|
Number of
|
|
|
Average
|
|
|
Remaining
|
|
|
of
|
|
|
|
Warrants
|
|
|
Exercise Price
|
|
|
Term
|
|
|
Warrants
|
|
Outstanding at December 31, 2016
|
|
|
2,537,335
|
|
|
$
|
3.75
|
|
|
|
3.55
|
|
|
$
|
3,662,610
|
|
Granted
|
|
|
366,600
|
|
|
|
2.50
|
|
|
|
4.89
|
|
|
|
-
|
|
Exercised
|
|
|
(974,133
|
)
|
|
|
0.75
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(9,896
|
)
|
|
|
12.25
|
|
|
|
|
|
|
|
-
|
|
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/Expired
|
|
|
(303,900
|
)
|
|
|
8.43
|
|
|
|
|
|
|
|
—
|
|
Outstanding at December 31, 2018
|
|
|
1,781,715
|
|
|
$
|
4.20
|
|
|
|
2.23
|
|
|
$
|
8,930,058
|
|
In January 2017, the Company issued 1,600
warrants with an exercise price of $6.25 in connection with the sale of the Company’s 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 $6.25 per share. In January 2017, in exchange for services rendered, the Company issued 10,000 warrants to purchase
shares of the Company’s common stock with an exercise price of $3.00 per share that vested immediately. The fair value on
the grant date of the warrants was $29,433.
In April 2017, the Company issued 20,000
warrants with an exercise price of $2.50 in connection with issuance of a convertible note. 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 $2.50
per share. (Note 8)
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
In October 2017, in exchange for services
rendered, the Company issued 10,000 warrants to purchase shares of the Company’s common stock with an exercise price of $4.475
per share that vested immediately. The fair value on the grant date of the warrants was $33,785.
In October and November 2017, the Company
issued an aggregate of 325,000 warrants with an exercise price of $2.50 in connection with issuance of convertible notes. (Note
8)
The warrant grants for services during
the year ended December 31, 2017 were valued using the Black-Scholes pricing model. Significant assumptions used in the valuation
include expected term of 3.0 years, expected volatility of 175.64%, risk free interest rate of 1.48%, and expected dividend yield
of 0%.
On April 17, 2018, the Company granted
127,525 warrants for services rendered. The warrants are 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, 2018 and
2017, the Company has incurred warrant-based expense of $110,600 and $109,509, respectively. There was no outstanding unamortized
stock compensation expense related to warrants as of December 31, 2018.
Restricted Stock Units (“RSU”)
The following table summarizes the restricted
stock activity for the two years ended December 31, 2018:
Restricted shares issued as of January 1, 2017
|
|
|
50,105
|
|
Granted
|
|
|
106,235
|
|
Total Restricted Shares Issued at December 31, 2017
|
|
|
156,340
|
|
Granted
|
|
|
92,174
|
|
Forfeited/Cancelled
|
|
|
(26,000
|
)
|
Total Restricted Shares Issued at December 31, 2018
|
|
|
222,514
|
|
Vested at December 31, 2018
|
|
|
188,008
|
|
Unvested restricted shares as of December 31, 2018
|
|
|
34,506
|
|
On August 10, 2017, the Company amended
16,092 RSUs granted on February 23, 2017 for accrued and unpaid compensation for the period from December 1, 2016 through March
31, 2017 in the amount of $66,379. The RSUs as amended, vest upon the earlier of (i) on July 1, 2017 provided that service is not
terminated and (ii) and 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,
as amended, is the earlier of (i) July 1, 2024 or (ii) the date on which the Company undergoes a change of control.
AUDIOEYE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
On August 10, 2017, the Company amended
10,543 RSUs granted June 22, 2017 for accrued and unpaid compensation for the period from April 1, 2017 through June 30, 2017 in
the amount of $43,486. The RSUs, as amended, vest upon the earlier of (i) on July 1, 2017 provided that service is not terminated
and (ii) and 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, as amended,
is the earlier of (i) July 1, 2024 or (ii) date on which the Company undergoes a change of control during the seven-year term of
the award.
In connection with the issuance of the
above described RSUs as payment for accrued compensation, the Company reclassified to equity the settled aggregate salary accrual
of $102,083 and recorded addition compensation costs of $7,782 during the year ended December 31, 2017. Out of the total settled
accrued salary of $102,083 during year ended December 31, 2017, $14,583 was for the compensation accrued as of December 31, 2016
and $87,500 was for compensation expense earned during the year ended December 31, 2017. Due to the August 10, 2017 modification
to the 24,104 RSU’s granted in 2016, the Company recorded an incremental expense of $26,515 in current period.
On June 22, 2017, the Company following
consideration of the report prepared by Farient Advisors LLC granted 26,600 RSUs for services provided by a board member. The RSUs
vest upon the earlier of (i) on July 1, 2018 provided that service is not terminated and (ii) and 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 (i) July 1, 2024 or (ii) the date on which the Company
undergoes a change of control during the seven-year term of the award.
On August 10, 2017, the Company following
consideration of the report prepared by Farient Advisors LLC granted 16,600 RSUs to each of Alexandre Zyngier, Ernest Purcell and
Anthony Coelho for their continued service on the Board of Directors and 1,600 RSUs to each Alexandre Zyngier and Ernest Purcell
for their continued service as the chairs of committees of the Board of Directors (for an aggregate grant of 53,000 RSUs). Such
RSUs vest upon the first to occur of the following: (i) April 30, 2018 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, 2024 or (ii) the date on which the Company undergoes a change of control.
On August 10, 2017, the Company amended
the terms of an aggregate of 26,000 RSUs previously granted in 2016. The vesting terms were amended from conditional based on a
change of control to vesting as of July 1, 2017. The settlement date for such RSUs, as amended, in the earlier of (i) July 1, 2024
or (ii) the date on which the Company undergoes a change of control. The Company recorded the fair value of the previously issued
RSUs of $107,250 as a charge to current period operations. These RSUs were subsequently cancelled subject to the terms of the grant.
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, 2018 and
2017, the Company has incurred RSU-based expense of $372,537 and $418,832, respectively. The outstanding unamortized stock
compensation expense related to RSUs was $488,223 (which will be recognized through April 2019) as of December 31, 2018.
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:
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Net operating loss carry forwards
|
|
$
|
5,329,518
|
|
|
$
|
5,014,461
|
|
Less valuation allowance
|
|
|
(5,329,518
|
)
|
|
|
(5,014,461
|
)
|
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 $25,378,656 and $23,878,387
as of December 31, 2018 and 2017, respectively and will start to expire in 2031. The Company’s tax return for the years
2015, 2016 and 2017 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. As a result of the reduction in the U.S. corporate income tax rate from 35% to 21% under the
Tax Act, we revalued our ending net deferred tax assets at December 31, 2017, which were fully offset by a valuation allowance.
NOTE 13 — SUBSEQUENT EVENTS
In January 2019, the Company issued 20,000
shares of its common stock of the Company for the exercise of options, for proceeds of $19,000. In January and February 2019,
the Company issued 10,000 and 1,395 shares of its common stock, respectively, upon the exercise of outstanding warrants to purchase
an aggregate of 11,395 shares of common stock, for aggregate proceeds of $23,450. In January and February 2019, the Company issued
an aggregate of 11,837 shares of its common stock upon the cashless exercise of outstanding options and outstanding warrants to
purchase 17,733 shares of common stock.
On February 7, 2019, the Company granted
an aggregate of 28,700 incentive stock options to employees newly hired since June 4, 2018. The options to purchase shares of common
stock are exercisable at $10.55 for five years with options vesting 50% at the vesting commencement date, subject to the employee’s
continuous service on the first anniversary of their date of hire (vesting commencement dates range from June 4, 2019 through January
25, 2020), and 50% vesting in eight equal quarterly installments to vest on the first day of each calendar quarter following the
vesting commencement date and installments continuing for the first day of each of the seven calendar quarters thereafter. The
exercise price was determined using the closing price of the Company’s common stock on February 7, 2019.