10-Q 1 tv506279_10q.htm FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from [ ] to [ ]

Commission file number 001-38640

AudioEye, Inc.

(Exact name of registrant as specified in its charter)

Delaware		20-2939845
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5210 East Williams Circle, Suite 750, Tucson, Arizona		85711
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 866-331-5324

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the last 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	x	Smaller reporting company	x
Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of November 14, 2018, 7,548,464 shares of the registrant’s common stock were issued and outstanding.

		Page

PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 (unaudited)	3

	Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017 (unaudited)	4

	Consolidated Statement of Stockholders’ Equity for nine months ended September 30, 2018 (unaudited)	5

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (unaudited)	6

	Notes to Consolidated Financial Statements (unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	27

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3.	Defaults Upon Senior Securities	29

Item 4.	Mine Safety Disclosures	29

Item 5.	Other Information	29

Item 6.	Exhibits	29

SIGNATURES		30

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

AUDIOEYE, INC.

CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
	2018			2017
	(unaudited)
ASSETS
Current assets:
Cash	$	6,090,665		$	1,960,430
Accounts receivable		231,797			105,817
Marketable securities, held in related party		720			750
Deferred costs, short term		132,884			-
Prepaid expenses and other current assets		26,987			67,406
Total current assets		6,483,053			2,134,403

Property and equipment, net		102,151			34,994

Deferred costs, long term		88,706			-
Intangible assets, net		2,100,758			2,164,463
Goodwill		700,528			700,528

Total assets	$	9,475,196		$	5,034,388

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	237,756		$	82,628
Related party payables		14,467			23,535
Derivative liabilities		-			2,984,010
Capital leases, short term		24,773			-
Deferred rent		5,205			9,402
Deferred revenue		2,498,673			1,233,754
Convertible note-related party, net of debt discount of $34,615		15,385			-
Convertible notes, net of debt discount of $32,955		17,045			-
Total current liabilities		2,813,304			4,333,329

Long term liabilities:
Capital leases, long term		45,496			-
Deferred rent		6,738			5,048

Total liabilities		2,865,538			4,338,377

Stockholders' equity:
Preferred stock, $0.00001 par value, 10,000,000 shares authorized
Series A Convertible Preferred stock, $0.00001 par value, 200,000 shares designated, 105,000 and 110,000 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively		1			1
Common stock, $0.00001 par value, 50,000,000 shares authorized, 7,488,281 and 6,467,066 shares issued and outstanding as of September 30, 2018 and December 31, 2017 respectively		75			65
Additional paid-in capital		47,322,983			40,121,845
Accumulated deficit		(40,713,401	)		(39,425,900	)
Total stockholders' equity		6,609,658			696,011

Total liabilities and stockholders' equity	$	9,475,196		$	5,034,388

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
Revenues	$	1,494,313		$	744,380		$	3,878,552		$	1,863,111

Cost of revenue		672,589			262,738			1,882,698			1,043,813

Gross profit		821,724			481,642			1,995,854			819,298

Operating expenses:
Selling and marketing		625,789			363,951			1,813,345			980,834
Research and development		48,860			44,704			147,889			138,673
General and administrative		1,316,378			822,310			3,197,766			2,175,519
Amortization and depreciation		129,161			143,661			394,238			437,070
Total operating expenses		2,120,188			1,374,626			5,553,238			3,732,096

Operating loss		(1,298,464	)		(892,984	)		(3,557,384	)		(2,912,798	)

Other income (expense):
Unrealized gain on derivative liabilities		-			1,086,044			-			131,855
Unrealized loss on marketable securities		(1,680	)		-			(30	)		-
Interest income (expense), net		(32,892	)		(9,639	)		(32,760	)		(57,759	)
Total other (loss) income		(34,572	)		1,076,405			(32,790	)		74,096

Net (loss) income		(1,333,036	)		183,421			(3,590,174	)		(2,838,702	)

Dividends on Series A Convertible preferred stock		(13,233	)		(20,000	)		(40,507	)		(60,000	)

Net (loss) income available to common stockholders	$	(1,346,269	)	$	163,421		$	(3,630,681	)	$	(2,898,702	)

Net (loss) income per common share-basic	$	(0.19	)	$	0.04		$	(0.54	)	$	(0.65	)

Net (loss) income per common share-diluted	$	(0.19	)	$	0.03		$	(0.54	)	$	(0.65	)

Weighted average common shares outstanding-basic		7,084,716			4,502,565			6,676,968			4,491,028

Weighted average common shares outstanding-diluted		7,084,716			5,027,691			6,676,968			4,491,028

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2018

(unaudited)

										Additional
	Common stock				Preferred stock					Paid in		Accumulated
	Shares		Amount		Shares			Amount		Capital		Deficit			Total
Balance, December 31, 2017		6,467,066	$	65		110,000		$	1	$	40,121,845	$	(39,425,900	)	$	696,011
Common stock sold for cash		1,000,000		10		-			-		5,609,205		-			5,609,215
Common stock issued upon conversion of preferred stock		13,204		-		(5,000	)		-		-		-			-
Common stock issued in exchange for exercise of warrants on a cashless basis		5,842		-		-			-		-		-			-
Common stock issued in exchange for exercise of options on a cashless basis		2,169		-		-			-		-		-			-
Effect of adoption of Accounting Codification Standard 2014-09, Revenue from Contracts with Customers		-		-		-			-		-		80,153			80,153
Reclassify derivative liability to equity upon adoption of Accounting Codification Standard 2017-11, Earnings Per Share		-		-		-			-		761,490		2,222,520			2,984,010
Warrants issued with convertible notes		-		-		-			-		100,000		-			100,000
Restricted stock units, warrants and options issued for services		-		-		-			-		730,443		-			730,443
Net loss		-		-		-			-		-		(3,590,174	)		(3,590,174	)
Balance, September 30, 2018		7,488,281	$	75		105,000		$	1	$	47,322,983	$	(40,713,401	)	$	6,609,658

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine months ended September 30,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)	$	(3,590,174	)	$	(2,838,702	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		394,238			437,070
Amortization of debt discounts		32,430			15,751
Bad debt expense		-			358
Non cash interest expense associated with derivative warrants					39,944
Option, warrant, RSU and PSU expense		730,443			876,105
Stock issued for services		-			25,001
Unrealized loss on marketable securities		30			-
Change in fair value of derivative liabilities		-			(131,855	)
Amortization of deferred commission		59,705			-
Changes in operating assets and liabilities:
Accounts receivable		(125,980	)		(28,214	)
Deferred costs		(201,142	)		-
Other current assets		40,419			(13,450	)
Accounts payable and accruals		155,128			(184,184	)
Deferred rent		(2,507	)		(1,273	)
Deferred revenue		1,264,919			681,891
Related party payables		(9,068	)		-
Net cash (used in) operating activities		(1,251,559	)		(1,121,558	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment		(10,893	)		(22,904	)
Software development costs		(308,933	)		(234,841	)
Net cash (used in) investing activities		(319,826	)		(257,745	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock for cash		5,609,215			50,000
Issuance of convertible note payable-related party		50,000
Issuance of convertible notes payable		50,000			50,000
Proceeds from common stock subscription		-			1,450,000
Repayments of notes payable and capital leases		(7,595	)		(18,000	)
Net cash provided by financing activities		5,701,620			1,532,000

Net increase in cash		4,130,235			152,697
Cash-beginning of period		1,960,430			1,409,418
Cash-end of period	$	6,090,665		$	1,562,115

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	1,327		$	-
Income taxes paid	$	-		$	-

Non cash investing and financing activities:
Reclassify fair value of liability warrants from equity to liability upon issuance	$	-		$	6,062
Reclassify fair value of liability warrants from liability to equity upon exercise	$	-		$	184,569
Debt discount originated from derivative feature of warrants attached to note	$	-		$	50,000
Debt discount originated from issuance of warrants attached to notes payable	$	100,000		$	-
Restricted stock units issued in payment of accrued compensation	$	-		$	14,583
Equipment acquired from capital leases	$	77,864		$	-
Reclassify fair value of warrant liabilities to equity upon adoption of ASU 2017-11	$	2,984,010		$	-
Effect of adoption of Accounting Codification Standard 2014-09, Revenue from Contracts with Customers	$	80,153		$	-

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

The accompanying unaudited interim financial statements of AudioEye, Inc. and its wholly-owned subsidiary (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission, and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 2, 2018.

In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements that would substantially duplicate the disclosures contained in the audited financial statements for the year ended December 31, 2017 as reported in the Company’s Annual Report on Form 10-K have been omitted.

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 8)

Revenue Recognition

The Company recognizes revenue 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 receive in exchange for those goods or services.

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.

The Company had one major customer including their affiliates which generated approximately 11.5% and 11.6% of its revenue in the three and nine months ended September 30, 2018, respectively.

At September 30, 2018, the Company had two customers representing 47.0% and 10.2%, aggregate of 57.2% of the outstanding accounts receivable.

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.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

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. There were significant changes in contract liabilities balances during the nine months ended September 30, 2018. Deferred Revenue increased to $2,498,673 at September 30, 2018 compared to $1,233,754 at December 31, 2017 due to cash received of $4,101,239 less revenue recognized of $2,836,320.

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 cost	$	-		$	80,153		$	80,153

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 September 30, 2018 and December 31, 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 Accounting Standards Update (“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

September 30, 2018 (Unaudited)

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

Earnings per Share

Basic earnings 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 nine months ended September 30, 2018 and 2017 are as follows:

	September 30, 2018		September 30, 2017
Preferred stock		280,389		281,199
Options to purchase common stock		1,025,247		1,051,083
Warrants to purchase common stock		1,881,041		2,522,201
Restricted stock units		194,674		156,339
Totals		3,381,351		4,010,822

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

As of September 30, 2018, the outstanding convertible notes payable issued in connection with the October 9, 2015 Note and Warrant Purchase Agreement, were convertible contingent on the occurrence of future events, and therefore not convertible into the Company’s common stock. As a result, they were excluded from the table (See Note 11).

The following represents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computation for the three and nine months ended September 30, 2018 and 2017

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
Net (loss) income	$	(1,333,036	)	$	183,421		$	(3,590,174	)	$	(2,838,702	)
Less: preferred stock dividends		(13,233	)		(20,000	)		(40,507	)		(60,000	)
(Loss) income available to common stockholders		(1,346,269	)		163,421			(3,630,681	)		(2,898,702	)

Basic weighted average common shares outstanding		7,084,716			4,502,565			6,676,968			4,491,028
Plus: incremental shares from assumed exercise-options		-			167,797			-			-
Plus: incremental shares from assumed exercise-warrants		-			357,329			-			-
Adjusted weighted average common shares outstanding		7,084,716			5,027,691			6,676,968			4,491,028

Net income (loss) per share:
Basic	$	(0.19	)	$	0.04		$	(0.54	)	$	(0.65	)
Diluted	$	(0.19	)	$	0.03		$	(0.54	)	$	(0.65	)

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.

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.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

The following are the Company’s assets and liabilities, measured at fair value on a recurring basis, as of September 30, 2018 and December 31, 2017:

			Fair Value
	Fair Value		Hierarchy
Assets
Marketable securities, September 30, 2018	$	720		Level 1
Marketable securities, December 31, 2017	$	750		Level 1

Liabilities
Derivative Liability ,September 30, 2018	$	-		Level 3
Derivative Liability , December 31, 2017	$	2,984,010		Level 3

Recent Accounting Pronouncements

There are various updates recently issued, most of which represented technical corrections to the accounting literature or application to specific industries and are not expected to a have a material impact on the Company's financial position, results of operations or cash flows.

NOTE 2 — MANAGEMENT’S LIQUIDITY PLANS

As of September 30, 2018, the Company had cash of $6,090,665 and a working capital of $3,669,749. In addition, the Company used actual net cash in operations of $1,251,559 during the nine months ended September 30, 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 7). It is anticipated that the Company has cash sufficient to fund operations for the next twelve months (See Note 10).

NOTE 3 — PROPERTY AND EQUIPMENT

Property and equipment as of September 30, 2018 and December 31, 2017 is summarized as follows:

	September 30, 2018			December 31, 2017
Computer equipment	$	62,170		$	63,517
Equipment under capital lease		77,864			-
Furniture and fixtures		4,968			3,128
Total		145,002			66,645
Less accumulated depreciation		(42,851	)		(31,651	)
Property and equipment, net	$	102,151		$	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 $77,864, less accumulated depreciation of $8,648 as of September 30, 2018 and $0, less accumulated depreciation of $0 as of December 31, 2017, respectively.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

The Company spent $10,893 in purchases and leased $77,864 of equipment during the nine months ended September 30, 2018 and $22,904 in purchases of equipment during the nine months ended September 30, 2017. Depreciation expense was $9,851 and $21,600 for the three and nine months ended September 30, 2018; and $1,718 and $2,979 for the three and nine months ended September 30, 2017.

NOTE 4 — INTANGIBLE ASSETS

For the nine months ended September 30, 2018 and 2017, the Company invested in software development costs in the amounts of $308,933 and $234,841 respectively.

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.

Software development costs are amortized over their estimated useful life of three years.

Prior to any impairment adjustment, intangible assets consisted of the following:

	September 30, 2018			December 31, 2017
Patents	$	3,697,709		$	3,697,709
Capitalized software development		1,314,302			1,005,369
Accumulated amortization		(2,911,253	)		(2,538,615	)
Intangible assets, net	$	2,100,758		$	2,164,463

Amortization expense for patents totaled $93,657 and $274,341 for the three and nine months ended September 30, 2018, respectively; and $93,648 and $278,878 for the three and nine months ended September 30, 2017, respectively. Amortization expense for software development totaled $25,653 and $98,297 for the three and nine months ended September 30, 2018, respectively; and $48,295 and $155,213 for the three and nine months ended September 30, 2017, respectively.

Total amortization expense totaled $372,638 and $434,091 for the nine months ended September 30, 2018 and 2017, respectively.

NOTE 5 — 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.

During the nine months ended September 30, 2018, the Company deferred an aggregate $201,142 commissions paid and reclassified from equity $80,153 previously paid and expensed commissions. Amortization of deferred costs for the three and nine months ended September 30, 2018 was $34,214 and $59,705, respectively.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

NOTE 6 — CAPITAL LEASES

	September 30, 2018			December 31, 2017
Capital equipment lease dated April 5, 2018	$	13,921		$	-
Capital equipment lease dated May 8, 2018		15,965			-
Capital equipment lease dated June 27, 2018		23,697			-
Capital equipment lease dated September 18, 2018		16,686			-
Total capital leases payable		70,269			-
Less current portion		(24,773	)		-
Long term portion	$	45,496		$	-

During the nine months ended September 30, 2018, the Company entered into four capital leases for computer equipment for a three year term. The Company recognized these arrangements as a 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 $77,864.

The leases include base monthly payments in aggregate of $2,360, 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 $7,595 during the nine months ended September 30, 2018.

The Company determined that the capital leases exceeded 75% of the estimated economic life of the equipment and therefore classified as a capitalized leases. The effective interest rate of the capitalized lease is estimated at 6.00% based on the Company estimated incremental borrowing rate.

The following summarizes the assets under capital leases:

	September 30, 2018			December 31, 2017
Classes of property
Computer equipment		77,864			-
Less: accumulated depreciation		(8,648	)		-
	$	69,216		$	-

The following summarizes total future minimum lease payments at September 30, 2018:

Period ending December 31,
Three months ended December 31, 2018	$	5,240
2019		28,316
2020		28,316
2021		13,641
Total minimum lease payments		75,513
Amount representing interest		5,244
Present value of minimum lease payments		70,269
Current portion of capital lease obligations		24,773
Capital lease obligation, less current portion	$	45,496

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

NOTE 7 — CONVERTIBLE NOTES PAYABLE

In connection with the October 9, 2015 Note and Warrant Purchase Agreement, in September 2018, the Company issued convertible promissory notes in aggregate principal amount of $100,000 (the “Notes”) and warrants (the “Warrants”) to purchase 40,000 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 8). Subject to the agreement, any investor in the October 9, 2015 Purchase Agreement within the three-year period immediately following the initial closing date, may purchase an additional note in the principal amount equal to 50% of the principal amount of the initial note purchased by such investor at previous closings and an additional warrant equal to the principal amount of such additional note divided by the exercise price of the additional warrant.

The Notes bore interest at 10% and matured on the earlier of October 9, 2018 or after the occurrence of an event of default (as defined in the Note). In the event of any conversion, all interest was converted into equity and shall not be payable in cash.

Under the terms of the October 9, 2015 Note and Warrant Purchase Agreement, if the Company sells equity securities in a single transaction or series of related transactions for cash of at least $1,000,000 (excluding the conversion of the Notes and excluding the shares of common stock to be issued upon exercise of the warrants) on or before the maturity date, all of the unpaid principal on the Note plus accrued interest shall be automatically converted at the closing of the equity financing into a number of shares of the same class or series of equity securities as are issued and sold by the Company in such equity financing (or a class or series of equity securities identical in all respects to and ranking pari passu with the class or series of equity securities issued and sold in such equity financing) as is determined by dividing (i) the principal and accrued and unpaid interest amount of the Notes by (ii) 60% of the price per share at which such equity securities are issued and sold in such equity financing.

On October 2, 2018, the Company’s board of directors approved to convert the debt, upon maturity, at $3.75 per share, which is 60% of the price per share at which equity was sold in August 2018 and will be treated as debt extinguishment at conversion.

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. Effective January 1, 2018, the Company adopted ASU No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480)-see Note 1).

In accordance with Accounting Standards Codification subtopic 470-20, the Company estimated relative fair value of the issued warrants, determined to be $77,978 and recognized a debt discount of $100,000 as a credit to additional paid in capital. The Company amortized $32,430 of the debt discount to current period operations as interest expense for the three and nine months ended September 30, 2018.

NOTE 8 — RELATED PARTY TRANSACTIONS

Dr. Carr Bettis, Executive Chairman and Chairman of Board of Directors

As of September 30, 2018 and December 31, 2017, the Company owed Dr. Bettis $5,992 in accrued salary. In addition, AudioEye sub-leases office space in Scottsdale, Arizona for certain Company employees, including Todd Bankofier, CEO, from Verus Analytics, Inc, a company in which Dr. Bettis has a controlling interest. As the Company has taken on more employees and space, the sub-lease amount increased from $500 per month to $3,502 per month in 2017 totaling $11,320 and $32,333 for the three and nine months ended September 30, 2018; and $3,252 and $8,004 for the three and nine months ended September 30, 2017, respectively. The amount of $0 was due as of September 30, 2018 and December 31, 2017. At September 30, 2018 and December 31, 2017, an estimated $8,475 and $14,000 was due and accrued to Dr. Bettis for unreimbursed travel related expenses, respectively.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

Sean Bradley, President, Chief Technology Officer, and Secretary

As of September 30, 2018 and December 31, 2017, the Company owed Sean Bradley $0 and $3,543 in accrued salary, respectively.

Issuance of convertible notes payable

On September 26, 2018, the Company issued a convertible note payable to an entity that Alexandre Zyngier, a member of the Company’s board of directors is deemed a beneficial owner (Note 7).

NOTE 9 — STOCKHOLDERS’ EQUITY

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 on August 1, 2018 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.

Preferred stock

As of September 30, 2018 and December 31, 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. For the nine months ended September 30, 2018, preferred shareholders earned, but were not paid $40,507 in annual dividends, or equivalent to 9,238 common shares based on a conversion price of $4.385 per share. As of September 30, 2018 and December 31, 2017, cumulative and unpaid dividends were $179,507 and $146,918, or equivalent to 40,937 and 33,505 common shares based on a conversion price of $4.385 per share, respectively.

Common stock

As of September 30, 2018 and December 31, 2017 on a post-split basis, the Company had 7,488,281 and 6,467,066 shares of common stock issued and outstanding, respectively.

In April 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.

In June 2018, the Company issued 2,169 shares of its common stock upon the cashless exercise of outstanding options to purchase 8,667 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.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

Options

As of September 30, 2018 and December 31, 2017, the Company had outstanding options to purchase 1,025,247 and 1,003,836 shares of common stock, respectively.

										Intrinsic
						Wtd Avg.				Value
	Number of			Wtd Avg.		Remaining				of
	Options			Exercise Price		Term		Exercisable		Options
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		(8,667	)		3.88
Forfeited/Expired		(43,362	)		9.69
Outstanding at September 30, 2018		1,025,247		$	4.60		2.35		933,304	$	5,257,173

On March 9, 2018, the Company granted an aggregate of 60,390 options to employees as compensation for services rendered. The options are exercisable at $6.45 per share for five years with (i) 37,890 options vesting 50% over the first year on the first day of each month beginning January 1, 2018 through December 1, 2018, 25% vesting over the year on the first day of each month from January 1, 2019 through December 1, 2019 and 25% vesting over the year on the first day of each month beginning January 1, 2020 through December 1, 2020; (ii) 12,500 options vesting 50% on January 1, 2018, 50% vesting over the year on each month beginning on January 1, 2019 for 24 months; and (iii) 10,000 options fully vesting on January 1, 2018. The exercise price was determined using the 10-day average closing price beginning with the closing price on January 9, 2018. The value on the grant date of the options was $298,914.

On April 12, 2018, the Company granted 6,000 options to purchase the Company’s common stock for services rendered at an exercise price of $6.20 per share for five years with 2,000 options vesting immediately and 1,000 options vesting every 90 days thereafter. The exercise price was determined using the 10-day average closing price beginning with the closing price on March 12, 2018. The value on the grant date of the options was $29,694.

On May 31, 2018, the Company granted an aggregate of 7,050 options to employees as compensation for services rendered. The options are exercisable at $5.30 per share for five years with 50% of options vesting upon one year employee anniversary and 50% vesting at a rate of 1/24 per month thereafter. The exercise price was determined using the 10-day average closing price beginning with the closing price on May 16, 2018. The value on the grant date of the options was $33,130.

Option grants during the nine months ended September 30, 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 three and nine months ended September 30, 2018 and 2017, total stock compensation expense related to the options totaled $60,020 and $283,218 and $78,746 and $503,779, respectively.

The outstanding unamortized stock compensation expense related to options was $170,192 (which will be recognized through December 2020) as of September 30, 2018.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

Warrants

Below is a table summarizing the Company’s outstanding warrants as of September 30, 2018 and December 31, 2017:

								Intrinsic
						Wtd Avg.		Value
	Number of			Wtd Avg.		Remaining		of
	Warrants			Exercise Price		Term		Warrants
Outstanding at December 31, 2017		1,919,906		$	4.98		2.61	$	1,656,083
Granted		253,244		$	5.66
Exercised		(127,525	)	$	6.25
Forfeited/Expired		(164,584	)		7.13
Outstanding at September 30, 2018		1,881,041		$	4.66		2.23	$	9,391,094

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, the Company issued 40,000 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 nine months ended September 30, 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 159.81% to 162.35%, risk free interest rate of 1.68% to 2.96%, and expected dividend yield of 0%.

For the three and nine months ended September 30, 2018 and 2017, the Company has incurred warrant-based expense of $0 and $110,600 and $12,762 and $71,545, respectively. There was no outstanding unamortized stock compensation expense related to warrants as of September 30, 2018.

Restricted stock units (“RSU”)

The following table summarizes the restricted stock unit activity for the nine months ended September 30, 2018:

Restricted stock units issued as of January 1, 2018			156,340
Granted			38,334
Total Restricted stock units issued at September 30, 2018			194,674
Vested at September 30, 2018			156,408
Unvested restricted stock units as of September 30, 2018			38,266

On March 27, 2018, the Company granted 38,334 RSUs, on a post-split basis, 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 September 30,2018, no RSUs have been settled. The fair value of the RSU’s at grant date was $247,250.

For the three and nine months ended September 30, 2018 and 2017, the Company has incurred RSU-based expense of $32,398 and $336,625 and $213,281 and $315,364, respectively. The outstanding unamortized stock compensation expense related to RSUs was $63,803 (which will be recognized through April 2019) as of September 30, 2018.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

NOTE 10 — COMMITMENTS AND CONTINGENCIES

Litigation

On January 23, 2017, the court granted preliminary approval of the settlement pursuant to the terms set forth in the Stipulation of Settlement, provisionally certified a settlement class of shareholders, and directed plaintiffs' counsel to provide notice to that class. The Court held a Settlement Hearing May 8, 2017 to consider any objections to the Settlement that might be raised by settlement class members, to consider plaintiffs’ counsel's application for an award of fees and costs, and to determine whether the Order and Final Judgment as provided under the Stipulation of Settlement should be entered, dismissing the case with prejudice. On May 8, 2017, this Court granted final approval to the settlement of the securities class action brought by Lead Plaintiffs, individually and on behalf of all others similarly situated. On February 9, 2018, the Court authorized distribution of the Net Settlement Fund and approved the proposed modified plan of allocation.

On May 16, 2016, a 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.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 (Unaudited)

NOTE 11 — SUBSEQUENT EVENTS

Convertible promissory notes:

In connection with the October 9, 2015 Note and Warrant Purchase Agreement, in October 2018, the Company issued convertible promissory notes in aggregate principal amount of $124,975 (the “Notes”) and warrants (the “Warrants”) to purchase 49,990 shares of common stock of the Company. 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 Note bears interest at 10% and matures 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 shall be also converted into equity and shall not be payable in cash. All notes and accumulated interest have been converted by the maturity date.

Under the terms of the 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.

On October 29, 2018, the Company issued an aggregate of 60,183 shares of its common stock in settlement of notes payable and accrued interest of $224,975 and $712, respectively. In connection with the conversion, the Company incurred a $267,812 loss on settlement of debt.

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.

Capital lease:

In October 2018, the Company entered into a capital lease for computer equipment for a three year term with payments of $503 per month.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations or MD&A, should be read in conjunction with our consolidated financial statements and related notes in Part I, Item 1 of this report.

As used in this quarterly report, the terms “we,” “us,” “our” and similar references refer to AudioEye, Inc. and our wholly-owned subsidiary, unless otherwise indicated.

Cautionary Note Regarding Forward-Looking Statements

Any statements in this Quarterly Report on Form 10-Q about our expectations, beliefs, plans, objectives, prospects, financial condition, assumptions or future events or performance are not historical facts and are “forward-looking statements” as that term is defined under the federal securities laws. These statements are often, but not always, made through the use of words or phrases such as “believe”, “anticipate”, “should”, “intend”, “plan”, “will”, “expects”, “estimates”, “projects”, “positioned”, “strategy”, “outlook” and similar words. You should read the statements that contain these types of words carefully. Such forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from what is expressed or implied in such forward-looking statements. There may be events in the future that we are not able to predict accurately or over which we have no control. Potential risks and uncertainties include, but are not limited to, those discussed in “Part I, Item 1A. Risk Factors” in our Annual Report filed on Form 10-K for the year ended December 31, 2017. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or uncertainties after the date hereof or to reflect the occurrence of unanticipated events.

Overview

AudioEye is a marketplace leader providing digital accessibility solutions for our clients’ customers through our Ally Platform Products. Our technology advances accessibility with patented technology solutions that reduce access barriers, expand access for individuals with disabilities, and enhance the user experience for a broader audience of users. When implemented, we believe that our solutions offer businesses the opportunity to reach more customers, improve brand image, and build additional brand loyalty. In addition, our solutions help organizations comply with internationally accepted Web Content Accessibility Guidelines (WCAG) as well as US, Canadian, Australian, and United Kingdom accessibility laws.

We generate revenues through the sale of subscriptions of our software as a service (SaaS) technology platform, called the AudioEye Ally Platform, to website owners, publishers, developers, and operators and through the delivery of managed services combined with the implementation of the AudioEye solution. Our solutions have been adopted by some of the largest and most influential companies in the world. Our customers span disparate industries and target market verticals, which encompass (but are not limited to) the following categories: human resources, finance, transportation, media, and education. Government agencies have also integrated our software in their digital platforms. Today, AudioEye technology has been deployed across thousands of customer web domains and, on a daily basis, removes billions of access barriers for our clients’ customers.

The AudioEye Solution

AudioEye uses proprietary technology and mature processes to provide digital accessibility solutions that offer significant savings in time and money relative to traditional solutions. Our compliance solutions focus on rapid remediation of the most important accessibility issues, followed by in-depth analysis identifying and addressing a more comprehensive compliance program. Our technology was built to not only provide users with a cloud-based assistive toolset that gets embedded and made freely available to users within our client websites, but to also improve the code in a way that optimizes the user experience for users of existing third-party assistive technologies, such as screen readers.

Intellectual Property

Our technology development was initiated at the University of Arizona Science & Technology Park in Tucson, Arizona. In 2006, we received technology development venture funding from the Maryland Technology Development Corporation (TEDCO), which contributed to the development of our platform strategy. Beginning in 2009, we engaged in a multi-year technology development program with the Eller College of Management’s Department of Management Information Systems at the University of Arizona. In connection with our proprietary technology, our company has been issued a number of U.S. patents in two distinct patent families. Today, an experienced team of in-house engineers, designers, and developers in our Atlanta, GA, and Tucson, AZ, offices develop the Company’s technology & software and are actively engaged in the expansion of the AudioEye IP Portfolio.

Our patented technology was a 2013 Edison Gold Award winner for innovation in the category of “Quality of Life.”

Our intellectual property is primarily comprised of trade secrets, trademarks, issued, published and pending patent applications, copyrights and technological innovation. We have a patent portfolio comprised of six issued patents in the United States; we have six published/pending patent applications (5 USPTO, 1 PCT – International).

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. It involves the creation of audio files for each section within a website, and then assigning a hierarchy and navigation system in line with the website design. To implement the system, a script is installed across the pages of the website and, when loaded, it plays an audible tone upon a user’s visit indicating that the website is enhanced with our proprietary technology. Upon hearing the tone, a user presses a key on the keyboard to enter the audible website. Audible narration is played through the user’s computer, reading text and describing non-text information, such as images. The narration includes menus for navigating the site which have a hierarchy in line that of the original website. Users navigate the website menus and move from webpage to webpage by making keystrokes or using a mouse.

Our current portfolio has established a foundation for building unique technology solutions that contribute to the way in which we differentiate ourselves from other competitors in the B2B Web Accessibility marketplace. We plan to continue to invest in research and development, and demonstrate expansion in the portfolio of proprietary intellectual property.

Our Annual Report filed on Form 10-K for the year ended December 31, 2017 provides additional information about our business and operations.

Results of Operations

Our consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles (“GAAP”). The discussion of the results of our operations compares the three and nine months ended September 30, 2018 with the three and nine months ended September 30, 2017 and are not necessarily indicative of the results which may be expected for any subsequent period. Our prospects should be considered in light of the risks, expenses and difficulties encountered by companies in similar positions. We may not be successful in addressing these risks and difficulties.

Comparative for the Three Months ended September 30, 2018 and September 30, 2017

Results of Operations

	Three Months Ended September 30,
	2018			2017
Revenue	$	1,494,313		$	744,380

Cost of sales		672,589			262,738
Gross profit		821,724			481,642
Operating expenses:
Selling & marketing		625,789			363,951
Research & development		48,860			44,704
General and administrative expenses		1,316,378			822,310
Amortization & depreciation		129,161			143,661
Total operating expenses		2,120,188			1,374,626
Operating loss		(1,298,464	)		(892,984	)

Unrealized gain on derivative liabilities		-			1,086,044
Unrealized loss on marketable securities		(1,680	)		-
Interest expense		(32,892	)		(9,639	)

Net (loss) income		(1,333,036	)		183,421
Deemed dividend on Series A Convertible preferred stock		(13,233	)		(20,000	)
Net (loss) income attributable to common stockholders	$	(1,346,269	)	$	163,421
Net (loss) income per common share – basic		(0.19	)		0.04
Net (loss) income per common share – diluted		(0.19	)		0.03
Weighted average common shares outstanding – basic		7,084,716			4,502,565
Weighted average common shares outstanding – diluted		7,084,716			5,027,691

Revenue

For the three months ended September 30, 2018 and 2017, revenue was $1,494,313 and $744,380, respectively, consisting primarily of revenues from various levels of subscriptions and technology development. Revenues increased due to the execution of the Company’s business plan which includes the hiring of additional sales team members, securing new negotiated channel partnerships thus increasing the volume of reselling of the AudioEye service, and a continued marketing focus on highly transactional industry verticals.

Cost of Sales

For the three months ended September 30, 2018 and 2017, cost of sales was $672,589 and $262,738, respectively, consisting primarily of sub-contracting to outside sources, direct labor and direct technology costs.

Gross Profit

An increase in our revenues resulted in a gross profit of $821,724 for the current period, as compared to a gross profit of $481,642 during the three months ended September 30, 2017. Gross profit increased as a result of increased revenues in 2018 as compared to the same period in 2017.

Selling and Marketing Expenses

Selling and marketing expenses were $625,789 and $363,951 for the three months ended September 30, 2018 and 2017, respectively. The increase is attributed to increased sales personnel and new strategic marketing directives driving higher sales activity in 2018 as compared to 2017.

Research and Development Expenses

Research and development expenses were $48,860 and $44,704 for three months ended September 30, 2018 and 2017, respectively. Research and development expenses increased from period to period and reflect the continued importance of the development of our product.

General and Administrative Expenses

General and administrative expenses were $1,316,378 and $822,310 for the three months ended September 30, 2018 and 2017, respectively. General and administrative expenses increased $494,068 due primarily to higher service provider costs as compared to 2017. Stock based compensation for the three months ended September 30, 2018 was $92,418 as compared to $304,789 for the same period last year.

Amortization and Depreciation

Amortization and depreciation expenses were $129,161 and $143,661 for the three months ended September 30, 2018 and 2017, respectively. The decrease in expense was primarily related to expiring software development costs in 2017.

Gain on change in Fair Value of Derivative Liabilities

In October 2015, 2016 and 2017, we issued warrants with an embedded reset provision requiring us to fair value the derivatives each reporting period and mark to market as a non-cash adjustment to our current period operations. This resulted in a gain of $1,086,044 on change in fair value of derivative liabilities for the three months ended September 30, 2017. The primary driver of the change in our derivative liability is our stock price. Generally, as our stock price decreases, the liability decreases resulting in a larger non-cash loss for the period to period change.

On January 1, 2018, we adopted ASU 2017-11 by electing the 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, we are no longer required to treat as derivatives our financial instruments with embedded anti-dilutive (reset) provisions.

Interest Expense, net

Interest expense, net during the three months ended September 30, 2018 was $32,892 compared to $9,639 for the three months ended September 30, 2017. In 2018, we incurred interest expenses relating to our capital leases for equipment and non-cash interest relating debt discounts in connection with our issued convertible notes as compared to non-cash interest expense and debt discounts relating to our convertible note payable of $8,425in 2017

Comparative for the Nine Months ended September 30, 2018 and September 30, 2017

Results of Operations

	Nine Months Ended September 30,
	2018			2017
Revenue	$	3,878,552		$	1,863,111

Cost of sales		1,882,698			1,043,813
Gross profit		1,995,854			819,298
Operating expenses:
Selling & marketing		1,813,345			980,834
Research & development		147,889			138,673
General and administrative expenses		3,197,766			2,175,519
Amortization & depreciation		394,238			437,070
Total operating expenses		5,553,238			3,732,096
Operating loss		(3,557,384	)		(2,912,798	)

Unrealized gain on derivative liabilities		-			131,855
Unrealized loss on marketable securities		(30	)		-
Interest income (expense), net		(32,760	)		(57,759	)

Net loss		(3,590,174	)		(2,838,702	)
Deemed dividend on Series A Convertible preferred stock		(40,507	)		(60,000	)
Net loss attributable to common stockholders	$	(3,630,681	)	$	(2,898,702	)
Net loss per common share – basic and diluted		(0.54	)		(0.65	)
Weighted average common shares outstanding – basic and diluted		6,676,968			4,491,028

Revenue

For the nine months ended September 30, 2018 and 2017, revenue was $3,878,552 and $1,863,111, respectively, consisting primarily of revenues from various levels of subscriptions and technology development.

Revenues increased due to the execution of the Company’s business plan which includes the hiring of additional sales team members, securing new negotiated channel partnerships thus increasing the volume of reselling of the AudioEye service, and a continued marketing focus on highly transactional industry verticals.

Cost of Sales

For the nine months ended September 30, 2018 and 2017, cost of sales was $1,882,698 and $1,043,813, respectively, consisting primarily of sub-contracting to outside sources, direct labor and direct technology costs.

Gross Profit

An increase in our revenues resulted in a gross profit of $1,995,854 for the current period, as compared to a gross profit of $980,834 during the nine months ended September 30, 2017. Gross profit increased as a result of lower implementation costs as compared to the same period in 2017.

Selling and Marketing Expenses

Selling and marketing expenses were $1,813,345 and $980,834 for the nine months ended September 30, 2018 and 2017, respectively. The increase is attributed to increased sales personnel and new strategic marketing directives driving higher sales activity in 2018 as compared to 2017.

Research and Development Expenses

Research and development expenses were $147,889 and $138,673 for nine months ended September 30, 2018 and 2017, respectively. Research and development expenses increased from period to period and reflect the importance of the continued developments of our product.

General and Administrative Expenses

General and administrative expenses were $3,197,766 and $2,175,519 for the nine months ended September 30, 2018 and 2017, respectively. General and administrative expenses increased $1,022,247 due primarily to higher service provider costs as compared to 2017. Stock based compensation for the nine months ended September 30, 2018 was $730,443 as compared to $901,106 for the same period last year.

Amortization and Depreciation

Amortization and depreciation expenses were $394,238 and $437,070 for the nine months ended September 30, 2018 and 2017, respectively. The decrease in expense was primarily related to expiring software development costs in 2017.

Gain on change in Fair Value of Derivative Liabilities

In October 2015, 2016 and 2017, we issued warrants with an embedded reset provision requiring us to fair value the derivatives each reporting period and mark to market as a non-cash adjustment to our current period operations. This resulted in a gain of $131,855 on change in fair value of derivative liabilities for the nine months ended September 30, 2017. The primary driver of the change in our derivative liability is our stock price. Generally, as our stock price increases, the liability increases resulting in a larger non-cash loss for the period to period change.

Interest Expense, net

Interest expense, net during the nine months ended September 30, 2018 was $32,760 compared to $57,759 interest expense for the nine months ended September 30, 2017. In 2018, interest expense primarily was due incurred non-cash interest expense related to our convertible notes payable as compared to non-cash interest expense and debt discount amortization related to our convertible note payable of $55,695 in 2017.

Contracts in Process/Revenue Recognition

Under current accounting procedures, the Company only recognizes revenue on new contracts for the actual services delivered in the period under the following criteria: (i) the contract has been signed and delivered to the Company; (ii) the services have been performed or delivered; and (iii) the client has been billed for the services delivered. The Company does not record deferred revenues for new contracts until the first payment for services has been received. The Company only records accounts receivable for the amount of revenue recognized as service is rendered, even if the client has been billed for the entire contract value. The table below summarizes the amount of contract value in excess of the revenue recognized of $6,448,925, our deferred revenue of $2,498,673 and amount recognized in the amount of $3,878,552 in 2018. Contract and deferred revenues are expected to be recognized in future periods. The Company also receives contracts for service hours but whose total contract value is uncertain. These “fee for service contracts” are recorded in the table below only if the services have been delivered and the associated revenue has been recognized.

A summary of our contracts in process is as follows:

Contracts in Process

September 30, 2018

Revenue

Revenue
Recognized

Deferred

Contract Amount in
Excess of Deferred

Contract

Recognized

9 Months Ended

Revenue

Revenue and

Amount

prior to 2018

September 30, 2018

Recognized Revenue

Fixed Contracts

15,017,986

2,191,836

3,878,552

2,498,673

6,448,925

Liquidity and Capital Resources

Working Capital

	At September 30,		At December 31,
	2018		2017
Current Assets	$	6,483,053	$	2,134,403
Current Liabilities		2,813,304		4,333,329
Working Capital (Deficit)	$	3,669,749	$	(2,198,926	)

The working capital (deficit - current liabilities in excess of current assets) for the periods ended September30, 2018 and December 31, 2017 was $3,669,749 and $(2,198,926) respectively. The increase in working capital was primarily due to increase in our cash of $4,130,235, accounts receivable of $125,980, in our deferred costs of $132,884, elimination of liability treatment of our previously issued anti-dilutive warrants of $2,984,010, net, with an increase in accounts payable and accrued expenses of $155,128, increases in our deferred revenue of $1,264,919 and short term portion of our capital leases and convertible debt of $57,203. In addition, the Company used actual net cash in operations of $1,251,559 during the nine months ended September 30, 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 addition, the Company received proceeds from convertible notes of $100,000 in September 2018 and an additional $124,975 in the subsequent month of October. It is anticipated that the Company has cash sufficient to fund operations for the next twelve months.

Cash Flows

	For the Nine months ended
	September 30,
	2018			2017

Net Cash (Used in) Operating Activities	$	(1,251,559	)	$	(1,121,558	)
Net Cash (Used in) Investing Activities		(319,826	)		(257,745	)
Net Cash Provided by Financing Activities		5,701,620			1,532,000
Increase in Cash	$	4,130,235		$	152,697

We had cash in the amount of $6,090,665 and $1,960,430 as of September 30, 2018 and December 31, 2017, respectively.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with the accounting principles generally accepted in the United States. Preparing financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by our management’s application of accounting policies. We believe that understanding the basis and nature of the estimates and assumptions involved with the following aspects of our financial statements is critical to an understanding of our financial statements.

Our critical accounting policies, as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, relate to capitalized legal patent costs, income taxes, goodwill, intangible assets, share-based payments, revenue recognition, and research and other accounting descriptions. There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required under Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we carried out an evaluation under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2018. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of September 30, 2018 were not effective, for the same reasons as previously disclosed under Item 9A. “Controls and Procedures” in our Annual Report on Form 10-K for our fiscal year ended December 31, 2017.

Changes in Internal Controls over Financial Reporting

There have been no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-(f) of the Exchange Act) that occurred during the our last fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in Item 1.A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2017.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On August 6, 2018, the “Company closed on the sale of a total of 1,000,000 shares of the Company’s common stock (the “Shares”) in a private placement to certain eligible investors for an aggregate purchase price of approximately $6,250,000, or $6.25 per Share, with the first tranche of 992,000 shares being issued on the date thereof for an aggregate purchase price of $6,200,000 funded immediately and the second tranche of 8,000 shares being issued on or about August 20, 2018 for an aggregate purchase price of $50,000 (the “Private Placement”).

At the closing of the Private Placement, the Company also 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. Under the terms of the Registration Rights Agreement, the Company was obligated to file a registration statement covering the resale or other disposition of the Registrable Securities by the Investors no later than 30 days after the initial closing and to use its reasonable best efforts to cause the registration statement to become effective no later than 90 days after the initial closing. On September 4, 2018, the Company filed a registration statement on Form S-1 (333-227183) thereby registering the shares issued in the Private Placement and satisfying the Company’s filing obligation pursuant to the Registration Rights Agreement, and the Registration Statement was deemed effective on September 14, 2018. In the event that the Company fails to maintain effectiveness of the registration statement, the Company is subject to certain penalties, including making certain maintenance payments to the investors. A copy of the form of Registration Rights Agreement is filed herewith as Exhibit 4.1 and is incorporated herein by reference.

The Shares were offered and sold in the Private Placement pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Shares have not been registered under the Securities Act, or the securities laws of any other jurisdiction, and may not be offered or sold in the United States absent registration or an applicable exemption from such registration requirements. This Current Report on Form 8-K does not constitute an offer to sell, or a solicitation of an offer to purchase, the Shares in any jurisdiction in which such offer or solicitation would be unlawful.

In September 2018, the Company issued three convertible promissory notes in the aggregate principal amount of $100,000 (the “Notes”) and warrant (the “Warrants”) to purchase 40,000 shares of common stock of the Company. The Notes and Warrants were issued in connection with an election granted under our October 9, 2015 Note and Warrant Purchase Agreement (the “October 9, 2015 Purchase Agreement”) whereby 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.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit No.		Description
31.1*		Certification of the Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*		Certification of the Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS*		XBRL Instance Document

101.SCH*		XBRL Taxonomy Extension Schema Document

101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*		XBRL Taxonomy Extension Label Linkbase Document

101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

Filed herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 14th day of November, 2018.

	AUDIOEYE, INC.

	By:	/s/ Dr. Carr Bettis
		Dr. Carr Bettis
		Principal Executive Officer

	By:	/s/ Todd Bankofier
		Todd Bankofier
		Chief Executive Officer