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CEELOX INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

May 16, 2014

This section of this annual report includes a number of forward-looking statements that reflect our current views with respect to future events and financial performance. Forward-looking statements are often identified by words like: believe, expect, estimate, anticipate, intend, project and similar expressions, or words which, by their nature, refer to future events. You should not place undue certainty on these forward-looking statements, which apply only as of the date of our prospectus. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or our predictions.

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Overview

We were originally formed for the purpose of developing and marketing advanced fingerprint biometric technology and encryption software solutions. Our biometric identification and encryption software solutions provide innovative and new ways for customers to securely access, store, send and receive confidential information. We commenced marketing our products in the first half of 2007 following more than three years of technology and product development. We have invested over $12 million in the operations of the business including research and development, product development and marketing of our products.

As announced on Form 8-K filed with the SEC on January 27, 2012, Ceelox completed the fulfillment of the demand notice from CIP, LLC. In this agreement, Ceelox converted over $9 million in debt to 24 million shares of common stock and turned over all intellectual property and software to CIP. Since that time Ceelox has continued development of its business plan surrounding virtual credit card, social networking, and mobile, security. Ceelox will continue to seek merger and acquisition candidates with synergies within these areas. Ceelox is currently in discussions with CIP and will seek to license and/or purchase the intellectual property from CIP as appropriate to complete their new product rollout.

During the fourth quarter of 2012, the Company announced two purchase agreements.

As announced on Form 8-K filed with the SEC on October 31, 2012, on October 25, 2012, the Company entered into an asset purchase agreement ("Agreement") with Send Global Corporation, a Michigan corporation ("Send Global"), and iTeknik Holding Corporation, a Wyoming corporation and the Parent company of Send Global("Parent," and together with Send Global, the "Sellers," and each a "Seller"). As announced on Form 8-K filed with the SEC on December 3, 2012, on November 27, 2012, the Company entered into an asset purchase agreement ("Agreement" or "Asset Sale") with AllCom, a Nevada corporation ("AllCom" or "Seller").



Both transactions have expired and no additional discussions ensued. The Company has turned their attention to the business plan and product set defined in Item 1.

Results of Operations Net Revenue



For the years ended December 31, 2013 and 2012 the Company had no revenues respectively. No sales occurred in either year as a result of the Company's focus on continued product development and securing funding to execute its business plan.

Total Operating Costs and Expenses

Our total costs and expenses which consist of payroll and related benefits, consulting expenses, and marketing and administrative expenses decreased by $118,059 or 19% for the year ended December 31, 2013 from the year ended December 31, 2012. In connection with our acquisition strategy, we incurred expired acquisition costs $125,000 and $125,000 in the years ended December 31, 2013 and 2013. Compensation expense is $212,923 including $50,000 of stock based compensation and $ 151,837 for the years ended December 31, 2013 and 2012. The remaining The decrease in Operating Costs and Expenses was due to reductions in costs such as legal expense and other operation costs that occurred during the year ended December 31, 2013.

Loss from Operations

Our operating loss for the year ended December 31, 2013 was $502,012 compared to a loss of $620,071 for the year ended December 31, 2012. In connection with our acquisition strategy, we incurred expired acquisition costs $125,000 and $125,000 in the years ended December 31, 2013 and 2013. The decreased loss from operations of $118,059 or 19% was due to reductions in costs such as legal expense and other operation costs that occurred during the year ended December 31, 2013.

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Interest Expense

Interest expense and related financing fees for the year ended December 31, 2013 was $204,262 compared to $152,978 for the year ended December 31, 2012, an increase of $51,284 or 34%. In August 2005, Ceelox of Florida, a majority owned subsidiary of the Company, entered into a convertible note from a related party totaling $300,705. This note was extinguished on January 24, 2012. Interest on that note was $0 for the year ended December 31, 2013 compared to $7,101 for the same period in 2012. In February 2010, the Company issued convertible notes to a related party totaling $450,000 (see footnote 7 of the Company's financial statements). Between December 2009 and February 2010, the Company issued convertible bridge loan notes totaling $626,735, of which $350,000 was converted in February 2010. Interest expense on these notes was $12,167 for the year ended December 31, 2013 compared to $12,919 for the same period in 2012. In 2012, the Company issued promissory notes to a related party in the aggregate amount of $626,824. Interest expense for the year ended December 31, 2013 related to these related party promissory notes amounted to $660. In February 2012, the Company issued a convertible promissory note in the amount of $187,500. Interest expense for the year ended December 31, 2013 related to the amortization of debt discount and deferred finance fees on this note totaled $104,119 versus $116,256 for the same period in 2012. Additionally, between May 2012 and October 2013, the company issued additional convertible promissory notes aggregating $745,288, which contributed to the remaining interest of $87,316.

Liquidity and Capital Resources

As of December 31, 2013, we had a working capital deficit of $1,933,111 as compared to a working capital deficit of $1,237,683 as of December 31, 2012. In the past we have relied on sales of our equity to raise funds for our working capital requirements, as well as loans from our majority stockholder. We will need to raise additional capital in order to implement our business plan and will seek to sell additional equity and/or debt to accomplish this objective. There can be no assurance that we will be able to raise funds sufficient to carry out our business plan, or that if funds are available to us that they will be on acceptable terms.

Operating Activities

Cash used in operations of $305,908 during the year ended December 31, 2013 was primarily a result of our $696,428 net loss reconciled with our net non-cash expenses relating to stock-based compensation expense, derivative expense, accrued interest, and depreciation and amortization expense. Cash used in operations of $464,237 during the year ended December 31, 2012 was primarily a result of our $594,249 net loss reconciled with our net non-cash expenses relating to stock-based compensation expense, derivative expense, accrued interest, and depreciation and amortization expense

Investing Activities

There were no investing activities during the years ended December 31, 2013 and 2012, respectively.

Financing Activities

During the year ended December 31, 2013, we generated proceeds of $303,391 from our financing activities which consisted of: proceeds from notes payable.

Seasonality Results

We do not expect to experience any seasonality in our operating results.

Off-Balance Sheet Arrangements

We currently do not have any off-balance sheet arrangements or financing activities with special purpose entities.

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Principles of Consolidation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and in accordance with the SEC's accounting rules under Regulation S-X. All material inter-company accounts and transactions have been eliminated in consolidation.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates also affect our reported revenues and expenses. On an ongoing basis, management evaluates its estimates and judgment, including those related to revenue recognition, accrued expenses, financing operations and contingencies and litigation. Management bases its estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant accounting estimates inherent in the preparation of our financial statements are set forth in Note 3 to our audited financial statements.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The fair value of the Company's assets and liabilities, which qualify as financial instruments under Financial Accounting Standards Board (FASB) guidance regarding disclosures about fair value of financial instruments, approximate the carrying amounts presented in the accompanying consolidated balance sheets.

Accounts Receivable and Allowance for Doubtful Accounts

The Company carries its accounts receivable at cost less an allowance for doubtful accounts. The allowance for doubtful accounts is determined using a combination of factors to ensure that trade and unbilled receivables balances are not overstated due to uncollectibility. The Company performs ongoing customer credit evaluation within the context of the industry in which it operates, does not require collateral, and maintains allowances for potential credit losses on customer accounts when deemed necessary. A specific allowance for a doubtful account up to 100% of the invoice will be provided for any problematic customer balances. Delinquent account balances are written-off after management has determined that the likelihood of collection is not possible.

Inventory

Inventories consist of computer equipment merchandise that is in its finished form and ready for sale to end-user customers. Inventories are recorded at the lower of average cost or market. In-bound freight-related costs from our vendors are included as part of the net cost of merchandise inventories. Other costs associated with acquiring, storing and transporting merchandise inventories are expensed as incurred. Our inventories are acquired and carried for retail sale and, accordingly, the carrying value is susceptible to, among other things, market trends and conditions and overall customer demand. We use our best estimates of all available information to establish reasonable inventory quantities. However, these conditions may cause our inventories to become obsolete and/or excessive. We review our inventories periodically for indications that reserves are necessary to reduce the carrying values to the lower of cost or market values.

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Property and Equipment

Computer equipment, computer software and furniture and fixtures are stated at cost and depreciated on a straight-line basis over an estimated useful life of five years. Upon disposal, assets and related accumulated depreciation are removed from the accounts and the related gain or loss is included in results from operations.

Software Development Costs, Patents and Trademarks

The Company capitalizes certain direct software development costs based upon stages of development. Capitalization of software development costs begins upon the establishment of technological feasibility. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management with respect to certain external factors, including, but not limited to, technological feasibility, anticipated future gross revenues, estimated economic life, and changes in software and hardware technologies. Capitalization ceases upon the products market introduction. Amortization of software development cost is computed on an individual product basis on the straight-line method over the estimated economic life ranging from three to five years, and begins when a product is available for general release to customers.

Patents and trademarks costs consist of internal and external costs relating to the filing patents and costs of licensing trademarks. Patent and trademark costs are recorded at cost and amortized on a straight-line basis over ten years, the expected period of future utility and economic benefit.

Impairment of Long-Lived Assets and Other Intangible Assets

The Company evaluates the recoverability of long-lived assets with finite lives in accordance with ASC 350. Intangible assets, including purchased technology and other intangible assets, are carried at cost less accumulated amortization. Finite-lived intangible assets are being amortized on a straight-line basis over their estimated useful lives of five to ten years. ASC 350 requires recognition of impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value amount of an asset may not be recoverable. An impairment charge is recognized in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. A significant impairment of finite-lived intangible assets could have a material adverse effect on the Company's financial position and results of operations.

The Company also assesses the impairment of long-lived assets in accordance with ASC 360, Property, Plant and Equipment, when circumstances indicate that the carrying value may not be recoverable. The Company determines if impairment has occurred through adverse changes. When it is determined that the estimated future cash flows of an asset will not be sufficient to recover its carrying amount, an impairment loss must be recorded to reduce the carrying amount to its estimated fair value.

Revenue Recognition Overview



We recognize revenue when persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is reasonably assured. If any of these criteria are not met, we defer recognizing the revenue until such time as all criteria are met. Determination of whether or not these criteria have been met may require us to make judgments, assumptions and estimates based upon current information and historical experience.

The Company has marketed its software products direct to commercial customers, to Value Added Resellers and Systems Integrators and to Original Equipment Manufacturers ("OEM"). Revenue may have four components: 1) license software revenue which provides a right to use Ceelox software products on a per seat/client or per server basis for an unlimited period; 2) software maintenance, 3) hardware, such as fingerprint readers and flash memory devices, and 4) professional services, primarily installation support. The Company also performs custom software development on a limited basis when necessary to support significant account or revenue opportunities.

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The Company has developed suggested retail pricing for all revenue components which include volume related discounting where appropriate. In addition the Company may negotiate prices on an individual case basis for significant volume or significant account opportunities.

Hardware and Software Revenue

The Company recognizes hardware revenue upon invoicing. Invoicing is triggered upon shipping. In products that have a hardware and software component that is not broken out in the Company's pricing, that includes hardware in the form of flash memory, the Company considers the value of the hardware to be de minimis and records the sale under the Software/Hardware classification.

Software License Revenue

License software revenue is recognized at the time of invoicing. Invoicing is timed with shipment or delivery of licensed software. The Company warrants that its software is free from material defects and will replace any defective products with a functional replacement.

Maintenance includes customer access to and right to software bug fixes and new releases of the company's software. These releases are made available to customers who download releases at their discretion. The Company's licensed software includes first-year maintenance. Subsequent year maintenance is offered, at a percentage of the initial software license revenue, on an annual basis on the anniversary of the original purchase date. When deemed material, this revenue is amortized over the life of the license agreement on a straight-line basis.

Contract Revenue

Professional Services: Our customers occasionally request professional services support related to server installation support. The Company recognizes professional services revenue at the time the support is provided. Billing is on a rate per day basis.

Custom Software Development: Revenues from multi-element arrangements are allocated to the individual elements based upon relative fair values using vendor-specific objective evidence of fair value. Revenues received from customers where all revenue recognition criteria have not been established are deferred until such criteria have been achieved.

Research and Development

The Company expenses research and development costs as they are incurred.

Advertising and Marketing Costs

The company expenses advertising and marketing costs as they are incurred.

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Stock-Based Compensation and Equity Incentive Plans

For the years ended December 31, 2013 and 2012, the Company maintained a stock plan covering equity grants including stock options and warrants.

The Company accounts for stock-based compensation in accordance with ASC 718. The standard requires the measurement and recognition of compensation expense in the Company's statement of operations for all share-based payment awards made to the Company's employees, directors and consultants including employee stock options, non-vested equity stock and equity stock units, and employee stock purchase grants. Stock-based compensation expense is measured at grant date, based on the estimated fair value of the award, reduced by an estimate of the annualized rate of expected forfeitures, and is recognized as expense over the employees' expected requisite service period, generally using the straight-line method. In addition, ASC 718 requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under previous accounting rules. Ceelox Inc.'s forfeiture rate represents the historical rate at which Ceelox Inc.'s stock-based awards were surrendered prior to vesting. ASC 718 requires forfeitures to be estimated at the time of grant and revised on a cumulative basis, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Computation of (Loss) Per Share

Basic earnings (loss) per share is calculated by dividing the earnings (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing the earnings (loss) by the weighted average number of common shares and potentially dilutive securities outstanding during the period. Potentially dilutive common shares consist of incremental common shares issuable upon exercise of stock options, warrants and shares issuable upon the conversion of convertible notes. The dilutive effect of the convertible notes is calculated under the if-converted method. The dilutive effect of outstanding shares is reflected in diluted earnings per share by application of the treasury stock method. This method includes consideration of the amounts to be paid by the employees, the amount of excess tax benefits that would be recognized in equity if the instruments were exercised and the amount of unrecognized stock-based compensation related to future services. No potential dilutive common shares are included in the computation of any diluted per share amount when a loss is reported. Accordingly, we did not include 12,683,616 and 12,668,595 of potentially dilutive options, warrants and convertible debt instruments at December 31, 2013 and 2012 respectively.

For the years ended December 31, 2013 2012 Potentially dilutive options 2,181,111 2,181,111 Potentially dilutive warrants 7,063,116 7,129,783



Potentially dilutive convertible instruments 3,372,722 3,357,701

12,616,949 12,668,595 -17-



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