AUDIOEYE INC - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2020

or

For the transition period from [                     ] to [                     ]

Commission File Number: 001-38640 

AudioEye, Inc.

(Exact name of registrant as specified in its charter)

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

Securities registered pursuant to Section 12(b) of the Act:

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.

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 August 11, 2020, 9,150,816 shares of the registrant’s common stock were issued and outstanding.

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

The financial information set forth below with respect to the financial statements as of June 30, 2020 and December 31, 2019 and for the three-month and six-month periods ended June 30, 2020 and 2019 is unaudited. This financial information, in the opinion of our management, includes all adjustments consisting of normal recurring entries necessary for the fair presentation of such data. The results of operations for the three-month and six-month periods ended June 30, 2020 are not necessarily indicative of results to be expected for any subsequent period. Our fiscal year end is December 31. Certain prior period amounts have been reclassified to conform to current period classification. The Company presents its unaudited financial statements, footnotes, and other financial information rounded to the nearest thousand United States Dollars (“U.S. Dollar”), except for per share data.

AUDIOEYE, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

THREE AND SIX MONTHS ENDED JUNE 30, 2020 AND 2019

(unaudited) 

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

See Notes to Unaudited Consolidated Financial Statements

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

The accompanying unaudited interim financial statements of AudioEye, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the rules of the Securities and Exchange Commission (the “SEC”), 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 for the fiscal year ended December 31, 2019, as filed with the SEC on March 30, 2020.

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. Certain information and disclosures normally contained in the audited financial statements as reported in the Company’s Annual Report on Form 10-K have been condensed or omitted in accordance with the SEC's rules and regulations for interim reporting. Certain prior period amounts have been reclassified to conform to current period classification. Reclassifications had no material effect on prior year net loss, earnings per share, or shareholders’ equity.

Corporate Information and Background

AudioEye, Inc. (“we”, “our” or 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 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 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 technology. Our intellectual property is primarily comprised of trade secrets, trademarks, issued, published and pending patent applications, copyrights and technological innovations. We have a patent portfolio comprised of eight issued patents in the United States. We also have two pending patent applications and two international patent applications filed via the Patent Cooperation Treaty (“PCT”) and the European Patent Office. The patents have been extended and cover a period from 2002 through 2026. We have a trademark portfolio comprised of eight United States trademark registrations.

Our common stock has been listed on the NASDAQ Capital Market under the symbol “AEYE” since September 4, 2018. Prior to September 4, 2018, our common stock was quoted on the OTCQB and the OTC Bulletin Board beginning on April 15, 2013 under the same symbol.

In April 2020, the Company filed a shelf registration statement on Form S-3 with the SEC to register the sale, in future offerings, of up to $7,000,000 in the aggregate of debt securities, common stock, preferred stock, warrants, rights or units consisting of any two or more of such securities. We intend to use the net proceeds of any offering of securities sold by us under the registration statement for general corporate purposes, which may include acquisitions, repayment of debt, capital expenditures and working capital requirements.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our significant accounting policies are presented in “Note 3 – Significant Accounting Policies” in the fiscal year 2019 Annual Report on Form 10-K. Users of financial information for interim periods are encouraged to refer to the footnotes to the consolidated financial statements contained in the Annual Report on Form 10-K when reviewing interim financial results.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported in the financial statements and accompanying notes. On an ongoing basis, management evaluates its estimates and judgments, including those related to share-based compensation, capitalization of software development costs, and income taxes. Actual results may differ from these estimates.

Revenue Recognition

We recognize revenue in accordance with Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that an entity recognizes 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.

We determine revenue recognition through the following five steps:

We generate substantially all our revenue from Software as a Service (“SaaS”), which are comprised of subscription fees from customer accounts on the Managed Platform. SaaS (also referred to as “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. Certain SaaS fees are invoiced in advanced on an annual, semi-annual, or quarterly basis. Any funds received for services not provided yet are held in deferred revenue and are recorded as revenue when the related performance obligations have been satisfied.  

Non-subscription revenue consists of PDF remediation services and is recognized upon delivery. Consideration payable under these arrangements is based on usage.

The following table presents our revenues disaggregated by sales channel:

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

The Company records accounts receivable for amounts invoiced to customers for which the Company has an unconditional right to consideration as provided under the contractual arrangement. Unbilled receivables include amounts related to the Company’s contractual right to consideration for completed performance obligations not yet invoiced. Deferred revenues include payments received in advance of performance under the contract. Our unbilled receivables and deferred revenue are reported on an individual contract basis at the end of each reporting period. Unbilled receivables are classified as current or noncurrent based on the timing of when we expect to bill the customer. Deferred revenue is classified as current or noncurrent based on the timing of when we expect to recognize revenue.

The table below compares the deferred revenue balance as of June 30, 2020 versus December 31, 2019:

As of June 30, 2020, $5,078,000 was classified as short-term deferred revenue and is expected to be recognized over the next twelve months following June 30, 2020. The remaining $168,000 is long-term deferred revenue to be recognized thereafter. In the six-month period ended June 30, 2020 we recognized $3,762,000, or 68%, in revenue from deferred revenues outstanding as of December 31, 2019.

The Company had one customer (including affiliates of such customer) which generated 16% and 17% of the Company’s revenue in each of the three and six months ended June 30, 2020, respectively, and 10% and 11% of the Company’s revenue in the three and six months ended June 30, 2019, respectively.

At June 30, 2020 and December 31, 2019, the Company had one customer representing 13% and 40%, respectively, of the outstanding accounts receivable.

Deferred Costs (Contract acquisition costs)

The Company capitalizes initial and renewal sales commission payments in the period a customer contract is obtained and customer payment is received, and amortizes deferred commission costs on a straight-line basis over the expected period of benefit, which we have deemed to be the contract term.

The table below summarizes the activity within the deferred commission costs account for the six months ended June 30, 2020:

Amortization expense associated with sales commissions was included in selling and marketing expenses on the consolidated statements of operations and totaled $55,000 and $111,000, respectively, for the three- and six-month periods ended June 30, 2020, and $57,000 and $108,000, respectively, for the three- and six-month periods ended June 30, 2019. There were no impairment losses for these capitalized costs for the three and six months ended June 30, 2020 and 2019.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Share-Based Compensation 

The Company periodically issues options, warrants and restricted stock units (“RSUs”) as compensation for services received. The fair value of the award is measured on the grant date. The fair value amount is then recognized as expense over the requisite vesting period during which services are required to be provided in exchange for the award.

The fair value of options and warrants awards is measured on the grant date using a Black-Scholes option pricing model, which includes assumptions that are subjective and are generally derived from external (such as risk-free rate of interest) and historical (such as volatility factor, expected term, and forfeiture rates) data. Future grants of equity awards accounted for as share-based compensation could have a material impact on reported expenses depending upon the number, value, and vesting period of future awards.

The fair value of RSUs is based on the market closing price per share on the date of grant. We expense the compensation cost of these awards as the restriction period lapses, which is typically a one- to three-year service period to the Company.

In the three- and six-month periods ending June 30, 2020, we awarded 76,192 options, and 339,667 and 354,667 RSUs, respectively, to employees, officers, and consultants of the of the Company.

In the three- and six-month periods ending June 30, 2020, no warrants were issued and no stock compensation expense was incurred. As of June 30, 2020, there was no remaining unamortized stock-based compensation expense related to warrants.

The following table summarizes the stock compensation expense for the three and six months ended June 30, 2020 and 2019:

As of June 30, 2020, the outstanding unamortized stock compensation expense related to options and RSUs was $921,000 and $2,684,000, respectively, which will be recognized through June 2023.

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 (i.e., the difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock is computed using the if-converted method, which assumes conversion at the beginning of the year. However, when a net loss exists, no potential common stock equivalents are included in the computation of the diluted per-share amount because the computation would result in an anti-dilutive per-share amount.

Potentially dilutive securities excluded from the computation of basic and diluted net earnings (loss) per share for the six months ended June 30, 2020 and 2019 are as follows:

The following table summarizes the stock options activity for the six months ended June 30, 2020:

The following table summarizes the restricted stock unit activity for the six months ended June 30, 2020:

The following table summarizes the warrants activity for the six months ended June 30, 2020:

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Fair Value Measurements

Fair value is an estimate of the exit price, representing the amount that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants (i.e., the exit price at the measurement date). Fair value measurements are not adjusted for transaction cost. Fair value measurement under U.S. GAAP 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.

The Company has no assets measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019.

The table below provides information on our liabilities that are measured at fair value on a recurring basis :

Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This ASU clarifies the accounting treatment for implementation costs for cloud computing arrangements (hosting arrangements) that is a service contract. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. We adopted this guidance effective January 1, 2020. The adoption of this guidance did not have a material impact our financial position, results of operations or disclosures.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU adds, modifies, and removes several disclosure requirements relative to the three levels of inputs used to measure fair value in accordance with Topic 820, “Fair Value Measurement.” This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. We adopted this guidance effective January 1, 2020. The adoption of this guidance did not impact our financial position, results of operations or disclosures.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 3 — GOING CONCERN AND MANAGEMENT’S LIQUIDITY PLANS

As of June 30, 2020, the Company had cash and cash equivalents of $2,130,000 and a working capital deficit of $1,893,000. In addition, the Company used actual net cash in operations of $791,000 during the six-month period ended June 30, 2020. The Company has incurred net losses since inception. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

On August 14, 2019, the Company entered into a Loan Agreement (the “Loan Agreement”) with Sero Capital LLC, a stockholder who owns more than 10% of the outstanding shares of common stock of the Company. The beneficial owner of Sero Capital LLC is David Moradi, who became a director of the Company on November 8, 2019. The Loan Agreement provides the Company with an unsecured credit facility under which the Company may borrow up to the aggregate principal amount of $2,000,000. Any advances under the Loan Agreement will bear interest at a per annum rate of 10.0% (subject to increase in the event of a default), which is payable monthly and may, at the Company’s option, be paid either in cash or by the issuance of shares of the Company’s common stock. The term of the Loan Agreement extends through August 14, 2020, subject to earlier termination as provided in the Loan Agreement. No amounts have been drawn under the Loan Agreement as of June 30, 2020. In consideration of the Loan Agreement, the Company issued to Sero Capital LLC a common stock warrant to acquire up to a total of 146,667 shares of the Company’s common stock at an exercise price of $6.00 per share, which exercise price may be paid in cash or, at the election of the holder, in a cashless, or “net,” exercise transaction. The warrant expires on August 14, 2020.

On April 15, 2020, the Company entered into an agreement in the amount of $1,302,000 with Liberty Capital Bank (“Term Loan”) pursuant to the Paycheck Protection Program (“PPP”) of the CARES Act, which is administered by the Small Business Administration (“SBA”). The Loan has been funded. Loan interest payments are deferred for six months. The loan has a maturity of two years and an interest rate of 1.0% per annum. The loan is not collateralized and is not personally guaranteed. No fees were charged in connection with the loan. The Company intends to use all proceeds from the Loan to fund payroll and pay for occupancy costs. All or a portion of the Loan may be forgiven upon application by the Company in accordance with the SBA requirements.

In April 2020, the Company filed a registration statement on Form S-3 with SEC to register the sale, in future offerings, of up to $7,000,000 in the aggregate of debt securities, common stock, preferred stock, warrants, rights or units consisting of any two or more of such securities. We intend to use the net proceeds of any offering of securities sold under the registration statement or otherwise for general corporate purposes, which may include acquisitions, repayment of debt, capital expenditures and working capital requirements.

The Company expects that cash flows from operations will continue to be negative in the near future. The company expects to become cash flow positive, under normal economic circumstances, in 2021. The Company may need to raise additional funds through debt or equity financing if its operating plan doesn’t come to fruition. If the Company is unsuccessful in raising additional financing, it will need to reduce operating costs in the future.

Accordingly, the accompanying financial statements have been prepared in conformity with U.S. GAAP, which contemplates continuation of the Company as a going concern and the realization of assets and satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the financial statements do not necessarily purport to represent realizable or settlement values. The financial statements do not include any adjustment that might result from the outcome of this uncertainty.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 4 — LEASE LIABILITIES AND RIGHT OF USE ASSETS

We determine whether an arrangement is a lease at inception. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. 

Finance Leases

The Company has finance leases to purchase computer equipment. The amortization expense of the leased equipment is included in depreciation expense. As of June 30, 2020 and December 31, 2019, the Company’s outstanding finance lease obligations totaled $97,000 and $104,000, respectively. The effective interest rate of the finance leases is estimated at 6.0% based on the implicit rate in the lease agreements.

The following summarizes the right of use assets under finance leases included in property and equipment: 

Operating Leases

Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the expected lease term. Since our lease arrangements do not provide an implicit rate, we use our incremental borrowing rate for the expected remaining lease term at commencement date for new leases, or as of January 1, 2019 for existing leases, in determining the present value of future lease payments. Operating lease expense is recognized on a straight-line basis over the lease term.

The Company has operating leases for office space in Tucson, Arizona and Marietta, Georgia. The company also leases office in Scottsdale, Arizona from a company controlled by our Executive Chairman, which continues on a month-to-month basis, therefore was not measured under Topic 842.

In addition, the Company entered into membership agreements to occupy shared office space in New York and Portland, Oregon. The membership agreements do not qualify as a lease under ASC 842 as the owner has substantive substitution rights, therefore the Company recognizes expenses membership fees as incurred. In addition, the membership agreement for the New York office continues on a month-to-month basis. See Note 11 – Commitments and Contingencies for further details on our shared office arrangements.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 4 — LEASE LIABILITIES AND RIGHT OF USE ASSETS (continued)

The Company has made operating lease payments in the amount of $127,000 during the six months ended June 30, 2020.  

The following summarizes the total lease liabilities and remaining future minimum lease payments at June 30, 2020 (in thousands):

The following summarizes lease expenses for the six months ended June 30, 2020 (in thousands):

The following table provides information about the remaining lease terms and discount rates applied as of June 30, 2020:

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 5 — DEBT

Related party credit facility

On August 14, 2019, the Company entered into a Loan Agreement (the “Loan Agreement”) with Sero Capital LLC, a stockholder who owns more than 10% of the outstanding shares of common stock of the Company. The beneficial owner of Sero Capital LLC is David Moradi, who became a director of the Company on November 8, 2019. The Loan Agreement provides the Company with an unsecured credit facility under which the Company may borrow up to the aggregate principal amount of $2,000,000. Any advances under the Loan Agreement will bear interest at a per annum rate of 10% (subject to increase in the event of a default), which is payable monthly and may, at the Company’s option, be paid either in cash or by the issuance of shares of the Company’s common stock. The term of the Loan Agreement extends through August 14, 2020, subject to earlier termination as provided in the Loan Agreement. The Company’s obligations under the Loan Agreement are subject to acceleration upon the occurrence of an event of default (as defined in the Loan Agreement). The Company may prepay its obligations under the Loan Agreement without penalty, but subject to certain limitations regarding the number, timing and dollar amounts of prepayments. The Loan Agreement provides for certain customary covenants, representations and events of default. No amounts have been drawn under the Loan Agreement as of June 30, 2020.

In consideration of the Loan Agreement, the Company issued to Sero Capital LLC a common stock warrants to acquire up to a total of 146,667 shares of the Company’s common stock at an exercise price of $6.00 per share, which exercise price may be paid in cash or, at the election of the holder, in a cashless, or “net,” exercise transaction. The warrants expire on August 14, 2020 and are classified as a liability instrument since the holder has the option to require the Company to repurchase the warrants when certain events occur that are considered outside of the control of the Company. The estimated fair value of the Sero Capital LLC warrant was $219,000 at date of issuance and included as debt issuance costs in current assets on the consolidated balance sheet. The unamortized balance of debt issuance costs was $27,000 on June 30, 2020.

Term loan

On April 15, 2020, the Company entered into a loan agreement in the amount of $1,302,000 with Liberty Capital Bank pursuant to the Paycheck Protection Program (“PPP Loan”) of the CARES Act, which is administered by the Small Business Administration (“SBA”). Loan interest payments are deferred for six months. The loan has a maturity of two years and an interest rate of 1.0% per annum. The PPP Loan is not collateralized and is not personally guaranteed. No fees were charged in connection with the loan. All or a portion of the PPP Loan may be forgiven upon application by the Company in accordance with the SBA requirements. As of June 30, 2020, outstanding principal balance totaled $1,302,000 and was classified as long term liability on the consolidated balance sheets.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 6 — SERIES A CONVERTIBLE PREFERRED STOCK

As of June 30, 2020 and December 31, 2019, the Company had 100,000 and 105,000 shares of Series A Convertible Preferred Stock (the “Preferred Stock”) outstanding, respectively, which was issued at $10 per share, paying a 5% cumulative annual dividend, and convertible into the Company’s common stock at a price of $4.385 per share. For the six months ended June 30, 2020, preferred stockholders collectively earned, but were not paid, approximately $26,000 in quarterly dividends, which is equivalent to 5,835 shares of common stock based on a conversion price of $4.385 per share. As of June 30, 2020 and December 31, 2019, cumulative and unpaid dividends were approximately $258,000 and approximately $245,000, respectively, which is equivalent to 58,949 and 55,927 shares of common stock, respectively, based on a conversion price of $4.385 per share.

On any matter presented to the stockholders of the Company, holders of Preferred Stock are entitled to cast the number of votes equal to the number of shares of common stock into which their shares of Preferred Stock are convertible as of the record date to vote on such matter. As long as any shares of Preferred Stock are outstanding, the Company has certain restrictions on share repurchases or amendments to the Certificate of Incorporation in a manner that adversely affects any rights of the Preferred Stockholders.

In addition, the preferred stockholders have a liquidation preference for purposes of which the Preferred Stock would be valued at $10 per share plus accrued cumulative annual dividends. At June 30, 2020 and December 31, 2019, the liquidation preference was valued at $1,258,000 and $1,295,000, respectively. 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.

AUDIOEYE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2020 (Unaudited)

NOTE 7 — RELATED PARTY TRANSACTIONS

As discussed in Note 5 – Debt, we entered into a Loan Agreement with Sero Capital LLC, a stockholder who owns more than 10% of the outstanding shares of common stock of the Company. The beneficial owner of Sero Capital LLC is David Moradi, who became a director of the Company on November 8, 2019. The Loan Agreement extends through August 14, 2020 and provides the Company with an unsecured credit facility under which we may borrow up to the aggregate principal amount of $2,000,000. No amounts have been drawn under the Loan Agreement as of June 30, 2020.

In consideration of the Loan Agreement, we issued to Sero Capital LLC common stock warrants to acquire up to a total of 146,667 shares of the Company’s common stock at an exercise price of $6.00 per share. The warrants expire on August 14, 2020 and are included on the consolidated balance sheets at a fair value of $593,000 as of June 30, 2020. See Note- 5 – Debt for additional detail on our outstanding warrant liability.

As discussed in Note 4 – Lease Liabilities and Right of Use Assets, we lease office space from a company controlled by our Executive Chairman. For the three- and six- month periods ended June 30, 2020, rent payments for this office space totaled $17,000 and $35,000, respectively.

NOTE 8 — COMMITMENTS AND CONTINGENCIES

Membership agreement to occupy shared office space

In the second quarter of 2020, the Company entered into a membership agreement to occupy shared office space in Portland, Oregon. Our new shared office arrangement commenced upon taking possession of the space and ends in August 2021. Fees due under the membership agreement are based on the number of contracted seats and the use of optional office services. As of June 30, 2020, minimum fees due under the shared office arrangement totaled $49,000.

Litigation

We may become involved in various routine disputes and allegations incidental to our business operations. While it is not possible to determine the ultimate disposition of these matters, 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 9 — SUBSEQUENT EVENTS

We have evaluated subsequent events occurring after June 30, 2020 and based on our evaluation we did not identify any events that would have required recognition or disclosure in these consolidated financial statements, except for the following.  

In third quarter of 2020, the Company amended its membership agreement to occupy shared office space in New York, New York. The amendment provides for additional space and establishes a new commitment term ending on July 2021. Fees due under the membership agreement are based on the number of contracted seats and the use of optional office services. Total minimum fees due under this shared office arrangement totals $94,000.

On August 11, 2020, warrants to acquire 146,667 shares of the of the Company’s common stock were exercised at $6.00 per share by Sero Capital LLC, a stockholder who owns more than 10% of the outstanding shares of common stock of the Company, and which is beneficially owned by David Moradi, a director of the Company, as discussed in Note 5 - Debt. As consideration for the warrants exercise, the company will receive $880,000 in cash.

As part of the Company’s strategic shift to build a more modern, scalable technology stack, we are building our technology center in Portland, Oregon. As a result, along with executive changes, there will be an impact on our current employees as well, mostly in the technology function. We have already started hiring personnel in Portland, and will continue to do so in the near future. The Company  expects to pay approximately $400,000 in separation costs, including severance and accrued vacation, of which approximately $70,000 has been accrued as of June 30, 2020.

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, 2019 and elsewhere in this Report, especially under the headings "Risk Factors," "Legal Proceedings," and "Management's Discussion and Analysis of Financial Condition and Results of Operations." These factors may cause our actual results to differ materially from those contemplated by any forward-looking statement. Although we believe that our expectations reflected in the forward-looking statements are reasonable, we cannot guarantee or offer any assurance of future results, levels of activity, performance or achievements or other future events. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. 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 not 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.

Background

AudioEye, Inc. (“AudioEye” or the “Company”) 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. The financial statements have been retroactively restated to reflect the reverse stock split.

In August 2018, the Company completed a private placement of $6,250,000 million (before expenses) growth equity financing with institutional investors to accelerate expansion efforts for the company's indirect partnership business. Further, we listed the Company's common stock on the NASDAQ Capital Market in September 2018.

Overview

AudioEye is an industry-leading software solution provider delivering website accessibility compliance at all price points to businesses of all sizes. Our solutions advance accessibility with patented technology that reduces barriers, expands access for individuals with disabilities, and enhances the user experience for a broader audience. We believe that, when implemented, our solution offers businesses and organizations the opportunity to reach more customers, improve brand image, build additional brand loyalty, and, most importantly, provide an accessible and usable web experience to the expansive and ever-growing global population of individuals with disabilities. AudioEye provides an always-on testing, remediation, and monitoring solution that continually improves conformance with the Web Content Accessibility Guidelines (WCAG), helping businesses and organizations comply with WCAG standards as well as applicable U.S., Canadian, Australian, and United Kingdom accessibility laws.

AudioEye stands out among its competitors because it delivers machine-learning/artificial intelligence (“AI”)-driven accessibility without fundamental changes to the website architecture. Our technology publishes more than one billion remediations daily, and our solution is trusted by some of the largest and most influential companies in the world, including ADP, Tommy Hilfiger, AMI, Ferrari and more. Government agencies, both at the federal level and state and local levels, have also integrated our software in their digital platforms.

AudioEye primarily generates revenue through the sale of subscriptions for our software-as-a-service (“SaaS”) accessibility solution plans. Plans range in scale from “do-it-yourself” to “do-it-for-me.” All are backed by the power of AudioEye’s machine-learning/AI-driven technology that finds and fixes the most common accessibility errors. Do-it-yourself plans, AudioEye Starter and Pro, also equip site owners with the remediation tools needed to fix remaining issues, ensuring accessibility standards are met. Do-it-for-me, AudioEye Managed/Enterprise, is for those who want AudioEye to continuously ensure legal compliance and accessibility for users of all abilities. Managed and Enterprise also come with the AudioEye Trusted Certification, our attestation of a site owner’s commitment to digital inclusion as defined by WCAG success criteria, which mitigates a customer’s risk of a costly digital accessibility-related legal action. AudioEye also provides Mobile App and PDF remediation services.

AudioEye customers may purchase tiered plans directly through the AudioEye marketplace, in a platform partner marketplace, through a vertical Content Management System (“CMS”) authorized reseller, or by working directly with the AudioEye sales team:

Recent Developments – Impact of COVID 19 to our Business

On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. In an effort to protect the health and safety of our teammates, we took proactive action to adopt social distancing policies at all our locations, including working from home, and suspending teammate travel. Governments around the world have also enacted various measures, including orders to close all businesses not deemed “essential,” isolate residents to their homes or places of residence, and practice social distancing when engaging in essential activities.

The COVID-19 pandemic has negatively impacted the global and local economies and workforce participation. While we observed some impact of COVID-19 on our first half of 2020 financial results, we are uncertain of the significance of its impact on our future results as clients evaluate the impact of COVID-19 on their businesses, their profitability and liquidity. We continue to evaluate ways to shore up our liquidity for uncertain economic conditions ahead.

We are not immune to the effects of a global pandemic or a related macroeconomic slowdown. The same goes for our customers, many of whom are small businesses that have been disproportionately impacted by the current economic environment. In response, we have been proactive in providing options for pricing terms and other concessions on a temporary basis to help our customers withstand the financial impacts they may be experiencing. As a result of the pandemic, some of our customers have requested shorter term contracts, asked us to accept delayed payments or to forgive payments, and have sought price reductions. These factors have adversely affected, and may continue to adversely affect our revenue and collections and may become more material in the future if economic conditions worsen.

Nobody knows how long the current business environment will persist. However, it is our expectation that some of our COVID-19 related programs will need to continue for some time. In that case, it would be reasonable to expect more meaningful negative impacts to our financial and operating performance. More generally, based on what we know right now, we anticipate at least a near-term impact on our revenue, and collections as we expect our Account Receivables aging will continue to worsen. This in-turn may put further pressure on our liquidity in the short- to medium- term. We will continue to monitor the impact on our business and evaluate the value of our assets and assess them for any impairment resulting from the effects of the pandemic driven uncertainty in accordance with our policy.

The ultimate extent of the impact of the COVID-19 pandemic on our business operations, financial performance and results of operation, including our ability to execute our business strategies and initiatives in the expected time frame, is currently unknown and will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted. This includes, but is not limited to, the duration and spread of the COVID-19 pandemic, its severity, the actions to contain the virus or treat its impact, such as related restrictions on travel and transportation, and how quickly and to what extent normal economic and operating conditions can resume.

We will continue to actively monitor the situation and anticipate further actions altering our business operations that we determine will be in the best interests of our teammates, clients, partners, suppliers, and shareholders, or as required by federal, state, or local authorities. It is not clear what the potential effects of any such alterations or modifications may have on our business, including the effects on our clients, teammates, and prospects, or on our financial results for the remainder of 2020.

Accordingly, our current results and financial condition discussed herein may not be indicative of future operating results and trends. See “Risk Factors” in Part II, Item 1A of this report for additional risks we face due to the COVID-19 pandemic.

The AudioEye Solution

AudioEye uses proprietary technology and development tools to offer web accessibility solutions that offer significant savings in time and money relative to traditional solutions. Our compliance solutions focus on rapid remediation of the most important accessibility issues, followed by in-depth analysis identifying and addressing a more comprehensive compliance program. Our technology was built to not only provide users with a cloud-based assistive toolset that gets embedded in and is made freely available to users within our customers’ 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 intellectual property is primarily comprised of trade secrets, trademarks, issued, published and pending patent applications, copyrights and technological innovation. We have a patent portfolio comprised of eight issued patents in the United States. We also have two pending patent applications and two international patent applications filed via the Patent Cooperation Treaty (“PCT”) and the European Patent Office. The patents have been extended and cover a period from 2002 through 2026.

We have a trademark portfolio comprised of eight United States trademark registrations.

Our current patented inventions relate to:

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

Our Annual Report filed on Form 10-K for the year ended December 31, 2019 as filed with the SEC on March 30, 2020 provides additional information about our business and operations.

Results of Operations

Our unaudited consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”). The discussion of the results of our operations compares the three and six months ended June 30, 2020 with the three and six months ended June 30, 2019. Our results of operations in these interim periods 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.

The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and workforce participation. While we observed some impact on our first half of 2020 financial results, the ultimate extent of the impact of the COVID-19 pandemic on our future business operations, financial performance and results of operation, including our ability to execute our business strategies and initiatives in the expected time frame, is currently unknown and will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted.

Comparative for the Three Months ended June 30, 2020 and June 30, 2019

Results of Operations

Revenue

For the three months ended June 30, 2020 and 2019, revenue was approximately $5,283,000 and $2,436,000, respectively, consisting primarily of revenues from core product sales. Revenues increased due to the execution of the Company’s business plan which includes the hiring of additional sales team members, increased penetration within its channel partnerships thus increasing the volume of reselling of the AudioEye products and services, and a continued focus on highly transactional industry verticals.   

The following table presents our revenues disaggregated by sales channel:

Cost of Revenue

For the three months ended June 30, 2020 and 2019, cost of revenue was approximately $1,607,000 and $1,124,000, respectively, and consisted 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. The increase in cost of revenue was due to significant increase in direct labor headcount and related payroll and use of sub-contracting to support the increase in revenues.

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations, including internal department structure changes, employee movements, intellectual property and technology related expenses, and facility expenses. For the purposes of comparability, the company reclassified prior period results to conform with our current period presentation. The reclassification resulted in a net decrease of approximately $23,000 to previously reported cost of revenue for the three months ending June 30, 2019.

Gross Profit

An increase in our revenues and increase in cost of revenue resulted in a gross profit of approximately $3,676,000 for the current period, as compared to a gross profit of approximately $1,312,000 during the three months ended June 30, 2019. Gross profit increased as a result of increased revenue and continued improvement in efficiencies as we scale, offset in part by an increase in costs for investments and support.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $1,705,000 and $1,345,000 for the three months ended June 30, 2020 and 2019, respectively.  The increase resulted primarily from staff additions and related compensation costs, including increases in salary and commission expenses, as we continue expand our business.

As discussed above, in 2020 the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted in a net increase of approximately $251,000 to previously reported selling and marketing expenses for the three months ending June 30, 2019.

Research and Development Expenses

Research and development expenses were approximately $265,000 and $152,000 for the three months ended June 30, 2020 and 2019, respectively. The increase was primarily as a result of an increase in our efforts on new product development and outsourced hosting and cloud computing related costs for the research and development of new technologies.

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted in a net increase of approximately $5,000 to previously reported research and development expenses for the three months ending June 30, 2019.

General and Administrative Expenses

General and administrative expenses were approximately $2,556,000 and $1,834,000 for the three months ended June 30, 2020 and 2019, respectively. General and administrative expenses increased approximately $722,000 due primarily to higher salaries and service provider costs in the 2020 period as compared to the 2019 period. Salaries, wages, benefits and other related expenses increased to approximately $1,517,000 in the current year period compared to approximately $659,000 to the same period in 2019. Legal, consulting and other professional fees decreased from the prior year period and were approximately $599,000 in the second quarter of 2020 compared to approximately $648,000 in the prior year comparable period. Much of the overall increase in general and administrative expenses over the prior year comparable period was primarily due to increased headcount.

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted a net decrease of approximately $233,000 to general and administrative expenses for the three months ending June 30, 2019.

Interest Expense

Interest expense for the three months ended June 30, 2020 and 2019 was approximately $56,000 and $1,000, respectively. Interest expense consists primarily of amortization of debt issuance costs from our line of credit and interest on our finance lease liabilities, and is partially offset by interest income earned on our cash balances.

Comparative for the Six Months ended June 30, 2020 and June 30, 2019

Results of Operations

Revenue

Revenues for the first half of 2020 were a record of approximately $9,544,000, representing an increase of 116% from approximately $4,421,000 in the prior year comparable period. Revenue for the second quarter of 2020 was approximately $5,283,000, an increase of 24% from approximately $4,261,000 in revenue recognized in the first quarter of 2020. The revenues for the second quarter of 2020 represent the 18^th consecutive quarter of topline growth for the Company. Revenues increased due to the execution of the Company’s business plan which includes the hiring of additional sales team members, increased penetration within its channel partnerships thus increasing the volume of reselling of the AudioEye products and services, and a continued focus on highly transactional industry verticals.   

The following table presents our revenues disaggregated by sales channel:

Cost of Revenue

For the six months ended June 30, 2020 and 2019, cost of revenue was approximately $2,927,000 and $2,046,000, respectively, and consisted 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. The increase in cost of revenue was due to significant increase in direct labor headcount and related payroll and use of sub-contracting to support the increase in revenues.

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations, including internal department structure changes, employee movements, intellectual property and technology related expenses, and facility expenses. For the purposes of comparability, the company reclassified prior period results to conform with our current period presentation. The reclassification resulted in a net decrease of approximately $4,000 to previously reported cost of revenue for the six months ending June 30, 2019.

Gross Profit

An increase in our revenues and related cost of revenue resulted in a gross profit of approximately $6,617,000 for the current period, as compared to a gross profit of approximately $2,375,000 during the six months ended June 30, 2019. Gross profit increased as a result of increased revenue and continued improvement in efficiencies as we scale, offset in part by an increase in costs for investments and support.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $3,523,000 and $2,658,000 for the six months ended June 30, 2020 and 2019, respectively.  The increase resulted primarily from staff additions and related compensation costs, including increases in salary and commission expenses, as we continue expand our business.

As discussed above, in 2020 the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted a net increase of approximately $692,000 to previously reported selling and marketing expenses for the six months ending June 30, 2019.

Research and Development Expenses

Research and development expenses were approximately $598,000 and $293,000 for the six months ended June 30, 2020 and 2019, respectively. The increase was primarily as a result of an increase in outsourced hosting and cloud computing related costs for the research and development of new technologies.

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted in a net decrease of approximately $69,000 to previously reported research and development expenses for the six months ending June 30, 2019.

General and Administrative Expenses

General and administrative expenses were approximately $4,998,000 and $3,583,000 for the six months ended June 30, 2020 and 2019, respectively. General and administrative expenses increased approximately $1,405,000 due primarily to higher salaries and service provider costs in the 2020 period as compared to the 2019 period. Salaries, wages, benefits and other related expenses increased to approximately $2,618,000 in the current year period compared to approximately $1,523,000 to the same period in 2019. Legal, consulting and other professional fees increased from the prior year period and were approximately $1,459,000 in the first six-month period 2020 compared to approximately $1,189,000 in the prior year comparable period. Much of the overall increase in general and administrative expenses over the prior year comparable period was primarily due to increased headcount with some of the increase due to increased legal fees related to the shelf registration statement and other matters during the first quarter of 2020. 

In 2020, the Company amended the categorization of certain expenses to conform with changes incurred in its operations. For the purposes of comparability, certain prior period amounts have been reclassified to conform to current period classification. This reclassification resulted a net decrease of approximately $620,000 to general and administrative expenses for the six months ending June 30, 2019.

Interest Expense

Interest expense for the six months ended June 30, 2020 and 2019 was approximately $106,000 and $2,000, respectively. Interest expense consists primarily of amortization of debt issuance costs from our line of credit and interest on our finance lease liabilities, and is partially offset by interest income earned on our cash balances. We reclassified approximately $55,000 of deferred issuance costs from the three months ended March 31, 2020 to interest expense in order to conform to current presentation of interest expense for the six months ending June 30, 2020.

About Key Operating Metrics

To supplement our financial information presented in accordance with U.S. GAAP, we consider certain operating measures that are not prepared in accordance with U.S GAAP, including monthly recurring revenue, contract bookings and contracts in excess of revenue and deferred revenue. AudioEye has historically reviewed a number of operating metrics such as these to evaluate its business, measure performance, identify trends, formulate business plans, and make strategic decisions.

AudioEye's monthly recurring revenue (“MRR”) for a paid customer account is a determination made by assessing the terms of each paid customer account, as of the date of determination, as to the revenue we expect to generate on an average monthly basis for that paid customer account, assuming no changes to the subscription and without taking into account any usage above the subscription or recurring revenue base, if any, that may be applicable to such subscription. This includes both annual and monthly contracts. Audioeye’s MRR was about $1.6 million at the end of the second quarter, which represents an increase of 105% year-over-year.

Contract bookings for the second quarter of 2020 were approximately $4,290,000. This represents a decrease of approximately 41% from approximately $7,281,000 in the prior year comparable period, and an increase of 9% sequentially from approximately $3,928,000 in the first quarter of 2020. This year over year decrease was largely driven by a non-recurring extraordinarily large multi-year contract in the prior year comparable period. This dynamic was expected.

AudioEye’s contracts in excess of revenue and deferred revenue is the remaining bookings that have not yet been recognized as revenue or deferred revenue. This measure represents the contractually agreed amount of consideration that we expect to recognize as revenue in subsequent periods, as company fulfills its service obligations.

A summary of our contracts in excess of revenue and deferred revenue is as follows (in thousands):  

As a result of the ongoing expansion of its Indirect sales channel (both Vertical partners and new channels), MRR has become the key operating metric of focus for the Company, and both the bookings and contracts in excess of revenue and deferred revenue metrics have become less useful as leading indicators of AudioEye’s business. The mix shift towards Vertical Partners and other new channels results in the creation of future revenue opportunities that are not reflected in bookings or contracts in excess of revenue and deferred revenue. This quarter illustrates the dynamic. MRR grew 105% despite contracts in excess of revenue increasing 18% and bookings falling 41%, primarily as a result of an extraordinarily large multi-year contract in the previous year.

As a result of bookings and contracts in excess of revenue and deferred revenue becoming less meaningful due to our shift towards a multiple sales channels model, the Company is going to discontinue presenting these two metrics starting in the third quarter of 2020.

Vertical Partner is a CMS provider or a company which provides a web-hosting platform for private and public entities and resells the AudioEye Managed service as an accessibility service offering to its customers. CMS providers who are focused on a specific industry vertical are referred to as Vertical Partners by AudioEye. CMS providers who are not focused on a specific vertical are referred to as Platform partners by AudioEye.

Liquidity and Capital Resources

Working Capital

As of June 30, 2020, the Company had cash of approximately $2,130,000 and working capital deficit of approximately $1,893,000. While the Company has been successful in raising capital in the past, there is no assurance that it will be successful at raising additional capital in the future. Extreme volatility of the capital markets during the COVID-19 pandemic could have an adverse impact on the Company’s ability to access the capital markets. Additionally, if the Company’s plans are not achieved and/or if significant unanticipated events occur, the Company may have to further modify its business plan, which may require us to raise additional capital.

Cash Flows

We had cash in the amount of approximately $2,130,000 and approximately $1,972,000 as of June 30, 2020 and December 31, 2019, respectively. Cash used in operating activities resulted from increased headcount, personnel, sales and marketing costs, an increase in accounts receivable of approximately $1,066,000, an increase in deferred costs of approximately $90,000, a decrease in operating lease liabilities of approximately $102,000, and a decrease in deferred revenue of approximately $279,000, and an increase in prepaid expenses and other current assets of approximately $2,000, which was partially offset by an increase in accounts payable and accrued expenses of approximately $1,536,000, and a decrease in unbilled receivables of approximately $160,000. The Company used actual net cash in operations of approximately $791,000 during the six months ended June 30, 2020 compared to approximately $2,917,000 during the six months ended June 30, 2019.

We may raise additional capital through the sale of equity or debt securities or borrowings from financial institutions or third parties or a combination of the foregoing. Capital raised will be used to implement our business plan, grow current operations, make acquisitions and/or start new vertical businesses among some of the anticipated uses of such capital.

The Company is currently considering the potential reallocation of resources and costs to build scalable technology and increased efficiency in the future.

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 U.S. GAAP. 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, 2019, relate to revenue recognition, cost of revenue, capitalized software development costs, allowance for doubtful accounts, property and equipment, goodwill, intangible assets, long-lived assets, impairment of long-lived assets, income taxes, cash and cash equivalents, investments in equity securities, earnings per share, derivative instrument liability, financial instruments, fair value measurements, stock based compensation, and research and development. 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, 2019.

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 June 30, 2020. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of June 30, 2020 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, 2019. 

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 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

Currently, there are no pending material legal proceedings to which the Company is a party to or to which any of its property is subject.

Item 1A. Risk Factors

Except as set forth below, there have been no material changes in our risk factors from those set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2019:

The extent to which the COVID-19 pandemic and measures put in place in response to the pandemic will further impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted.

The worldwide COVID-19 pandemic and the measures put in place to address it have materially and negatively impacted the global economy and have significantly increased worldwide economic uncertainty.

The outbreak has resulted in the implementation by authorities of numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders, and business shutdowns. These measures have negatively impacted, and may continue to negatively impact, business spending by our customers, and they have also adversely impacted and may further adversely impact our workforce and operations and the operations of our customers and business partners. These measures may remain in place for a significant but unpredictable period of time, and they are likely to continue to adversely affect our business, results of operations and financial condition.

As a result of the pandemic, some of our customers have requested shorter term contracts, asked us to accept delayed payments or to forgive payments, and have sought price reductions. These factors have adversely affected, and may continue to adversely affect our revenue and collections and may become more material in the future if economic conditions worsen. The spread of COVID-19 has caused us to modify our business practices (including with respect to employee travel, employee work locations and physical participation in meetings with customers and prospective customers. We may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners. These changes in business practices may negatively impact our business, results of operations and financial condition.

The extent to which the COVID-19 pandemic adversely impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the pandemic, its severity, the measures put in place to contain the virus or treat its impact, and when, how quickly and to what extent the global economy will improve and more normal economic and business conditions can resume. In the event, even after the COVID-19 outbreak subsides, we may experience materially adverse effects to our business as a result of its global economic impact, including any economic recession or depression that has occurred or may occur in the future.

We may not receive forgiveness of all or a portion of our recently received PPP Loan.

As discussed in this report, including in Notes 3 and 5 in the footnotes to the unaudited financial statements included herein, on April 15, 2020, we entered into a note agreement in the amount of approximately $1,302,000 with Liberty Capital Bank (the “PPP Loan”) pursuant to the Paycheck Protection Program of the CARES Act, which is being administered by the Small Business Administration. The Loan has been funded. All or a portion of the Loan may be forgiven upon application by the Company in accordance with the Small Business Administration Requirements. No assurance can be provided, however, that we will elect to pursue forgiveness of all or a portion of the PPP Loan or that we will be eligible for and obtain forgiveness of all or a portion of the PPP Loan. If we elect not to pursue or are unable to qualify for or obtain forgiveness of all or a portion of the PPP Loan, our liquidity could be reduced, and our business, financial condition and results of operations may be adversely affected.

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

None.

Item 3. Defaults Upon Senior Securities

None. 

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

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.