NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(all
currency in thousands, except per share amounts)
(unaudited)
NOTE
1: NATURE OF ORGANIZATION AND OPERATIONS
Unless
the context otherwise indicates, references in these Notes to the accompanying condensed consolidated financial statements to
“we,” “us,” “our” and “the Company” refer to Creative Realities, Inc. and its
subsidiaries.
Nature
of the Company’s Business
Creative
Realities, Inc. is a Minnesota corporation that provides innovative digital marketing technology and solutions to retail companies,
individual retail brands, enterprises and organizations throughout the United States and in certain international markets. The
Company has expertise in a broad range of existing and emerging digital marketing technologies, as well as the related media management
and distribution software platforms and networks, device management, product management, customized software service layers, systems,
experiences, workflows, and integrated solutions. Our technology and solutions include: digital merchandising systems and omni-channel
customer engagement systems, interactive digital shopping assistants, advisors and kiosks, and other interactive marketing technologies
such as mobile, social media, point-of-sale transactions, beaconing and web-based media that enable our customers to transform
how they engage with consumers. We have expertise in a broad range of existing and emerging digital marketing technologies, as
well as the following related aspects of our business: content, network management, and connected device software and firmware
platforms; customized software service layers; hardware platforms; digital media workflows; and proprietary processes and automation
tools. We believe we are one of the world’s leading interactive marketing technology companies that focuses on the retail
shopper experience by helping retailers and brands use the latest technologies to create better shopping experiences.
On
November 20, 2018, we closed on our acquisition of Allure Global Solutions, Inc. (the “Allure Acquisition”). While
the Allure Acquisition expanded our operations, geographical footprint and customer base and also enhanced our current product
offerings, the core business of Allure is consistent with the existing operations of Creative Realties, Inc. and as a result of
the Allure Acquisition we did not add different operating activities to our business.
Our
main operations are conducted directly through Creative Realities, Inc., and under our wholly owned subsidiaries Allure Global
Solutions, Inc., a Georgia corporation, Creative Realities Canada, Inc., a Canadian corporation, and ConeXus World Global, LLC,
a Kentucky limited liability company. Our other wholly owned subsidiary, Creative Realities, LLC, a Delaware limited liability
company, has been effectively dormant since October 2015, the date of the merger with ConeXus World Global, LLC.
Liquidity
and Financial Condition
The
accompanying Condensed Consolidated Financial Statements have been prepared on the basis of the realization of assets and the
satisfaction of liabilities and commitments in the normal course of business and do not include any adjustments to the recoverability
and classifications of recorded assets and liabilities as a result of uncertainties.
We
produced net income for the year ended December 31, 2019 but incurred a net loss for the year ended December 31, 2018 and had
negative cash flows from operating activities for both the year-ended December 31, 2019 and the six months ended June 30, 2020.
For
the three months ended June 30, 2020 and 2019 we have recognized/(incurred) net income/(losses) of ($2,459) and $417, respectively.
For the six months ended June 30, 2020 and 2019, we recognized/(incurred) net income/(losses) of ($15,642) and 233, respectively.
As of June 30, 2020, we had cash and cash equivalents of $870 and working capital deficit of $9,211, which includes $653 representing
current maturities of operating leases recorded January 1, 2019 upon adoption of Accounting Standards Update (“ASU”)
2016-02.
While
our outlook for the digital signage industry over the long term remains strong, we have experienced rapid and immediate deterioration
in our short term business as a result of the COVID-19 pandemic, generating increased uncertainty across our customer base in
each of our key vertical markets. The elective and forced closures of businesses across the United States and Canada has resulted
in reduced demand for our services, which primarily assist business in engaging with their end customers in a physical space through
digital technology. The elimination and minimizing of public gatherings has materially impacted demand for products and services
in our theater, sports arena and large entertainment markets. These conditions have resulted in downward revisions of our internal
forecasts on current and future projected earnings and cash flows. The effective halting of pending and anticipated projects caused
our projected incoming cash to be delayed, and consequently cash flows have slowed, including a slowdown in payments by customers
for previously completed projects, which has further limited cash collections. We have implemented various cost cutting measures,
including slowing our payments of accounts payable and accrued liabilities, negotiated extensions for certain currently and past
due payments to key vendors, and implemented compensation reductions for most personnel retained following the reduction-in-force
activities taken by the Company in mid-March 2020.
On
April 28, 2020, we announced the joint launch of an AI-integrated non-contact temperature inspection kiosk known as the Thermal
Mirror with our partner, InReality, LLC (“InReality”), for use by businesses as COVID-19 related workplace restrictions
are reduced or eliminated. Although we have experience in providing customers digital integration solutions, our launch of the
Thermal Mirror involves the development, marketing and sale of a new product to new customers involving a joint effort with InReality.
The product also uses hardware and technologies that have not been used with our other customers. Although we believe this product
and our launch will be successful, there are a number of risks involved in such launch, including investing significant time and
resources in the launch, which may ultimately not be successful. While market response has been encouraging, we remain in the
early stages of this product launch as of the date of this report.
On
June 19, 2020, the Company entered into a Sales Agreement (the “Agreement”) with Roth Capital Partners, LLC (“Roth”)
under which the Company may offer and sell, from time to time at its sole discretion, shares of its common stock, par value $0.01
per share (the “Common Stock”), having an aggregate offering price of up to $8,000,000 through Roth as the Company’s
sales agent. Roth may sell the Common Stock by any method permitted by law deemed to be an “at the market offering”
as defined in Rule 415 of the Securities Act of 1933, as amended. Subject to the terms of the Agreement, Roth will use its commercially
reasonable efforts to sell the Common Stock from time to time, based upon instructions from the Company (including any price,
time or size limits or other customary parameters or conditions the Company may impose). The Company or Roth may suspend the offering
of the Common Stock being made through Roth under the Agreement upon proper notice to the other party. The Company will pay Roth
a commission of 3.0% of the gross sales proceeds of any Common Stock sold through Roth under the Agreement, and also has provided
Roth with customary indemnification rights. The sale of Common Stock under the Agreement is registered on a Form S-3 registration
statement (Registration No. 333-238275) and related prospectus supplement filed with the SEC on June 19, 2020, and pursuant to
the “baby shelf” rules that apply to such registration statement, we cannot sell more our common stock in a public
primary offering (including under the Agreement) with a value exceeding more than one-third of our public float in any 12 calendar
month period so long as our public float remains below $75.0 million.
The
Company is not obligated to make any sales of Common Stock under the Agreement. The offering of shares of Common Stock pursuant
to the Agreement will terminate upon the earlier of (i) the sale of all Common Stock subject to the Agreement or (ii) termination
of the Agreement in accordance with its terms.
As
of June 30, 2020, the Company has not sold any shares of common stock under the Agreement. Through August 6, 2020, we received
gross proceeds under the Agreement of $1,300 from the issuance of 558,183 shares of our common stock, and paid an aggregate of
$38 to Roth in commissions, yielding net proceeds of $1,160 after commissions and offering expenses.
On
April 27, 2020, the Company entered into a Promissory Note with Old National Bank (the “Promissory Note”), which provided
for an unsecured loan of $1,552 pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security
Act and applicable regulations (the “CARES Act”). The Promissory Note has a term of two years with a 1% per annum
interest rate. While the Promissory Note currently has a two-year term, the amended law permits the Company to request a five-year
maturity from Old National Bank. Payments are deferred for six months from the date of the Promissory Note and the Company can
apply for forgiveness of the Promissory Note after 60 days. Forgiveness of the Promissory Note will be determined in accordance
with the provisions of the CARES Act and applicable regulations. Any principal and interest amount outstanding after the determination
of amounts forgiven will be repaid on a monthly basis. The Company is in process of finalizing their calculation of amounts forgivable
in accordance with guidance issued by the Small Business Administration and anticipates applying for forgiveness during the fourth
quarter of 2020. No assurance is provided that we will be able to obtain forgiveness of the Promissory Note in whole or in part.
On
November 6, 2019, Slipstream Communications, LLC (“Slipstream”) extended the maturity date of our term loan and revolver
loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement, aligning the maturity date of our term loan
and revolver loan with the Secured Disbursed Escrow Promissory Note.
On
December 30, 2019, we entered into the Secured Convertible Special Loan Promissory Note (“Special Loan”) as part of
the Seventh Amendment of the Loan and Security Agreement with Slipstream, under which we obtained $2,000, with interest thereon
at 8% per annum payable 6% in cash and 2% via the issuance of paid-in-kind (“SLPIK”) interest, provided however that
upon occurrence of an event of default the interest rate shall automatically be increased by 6% per annum payable in cash. The
entry into the Seventh Amendment adjusted the interest rate on the Company’s Term Loan and Revolving Loan to 8% per annum,
provided, however, at all times when the aggregate outstanding principal amount of the Term Loan and the Revolving Loan exceeds
$4,100 then the Loan Rate shall be 10%, of which eight percent 8% shall be payable in cash and 2% shall be paid by the issuance
of and treated as additional PIK.
Upon
the earlier to occur of an Event of Default or October 1, 2020, if any of the principal amount of the Special Loan is then outstanding,
the principal and accrued but unpaid interest of the Special Loan and the outstanding SLPIK shall be automatically converted into
shares of a new series of Senior Convertible Preferred Stock of CRI (“New Preferred”) having an Appraised Value equal
to three times the then outstanding principal amount and accrued but unpaid interest of the Special Loan and the outstanding SLPIK
and having the following terms and conditions, as reasonably determined by CRI and the Lender, the New Preferred shall:
|
●
|
be
the most senior equity security of CRI, including with respect to the payment of dividends and other distributions;
|
|
●
|
be
on substantially the same terms and conditions as CRI’s Series A-1 6% Convertible Preferred Stock as set forth in its
Certificate of Designation immediately before the same was cancelled pursuant to a Certificate of Cancellation dated as of
March 13, 2019;
|
|
●
|
not
be subject to a right of redemption upon the part of a holder thereof;
|
|
●
|
accrue
and pay quarterly dividends at the rate of twelve percent (12%) per annum which shall be payable in cash;
|
|
●
|
have
a Stated Value that is an amount mutually agreed by CRI and the Lender at the time of issuance;
|
|
●
|
Conversion
Price shall be an amount equal to 80% of the average for the 30-day period ending two days prior to the required conversion
date of the daily average of the range of CRI’s common stock (calculated pursuant to information on The Wall Street
Journal Online Edition), subject to appropriate adjustments; and
|
|
●
|
neither
section 6(e) of the Series A-1 Certificate of Designation nor any similar provision shall apply to the New Preferred.
|
On
April 1, 2020, the Company entered into an Eighth Amendment to Loan and Security Agreement (the “Eighth Amendment”)
with its subsidiaries and Slipstream to amend the terms of the payments and interest accruing on the Company’s Term Loan,
Secured Revolving Promissory Note, and Special Loan. The Eighth Amendment increased the interest rates of these loans from 8%
to 10%, effective April 1, 2020. Until January 1, 2021, rather than cash payments of accrued interest under the term and revolving
loans, interest will be paid by the issuance of and treated as additional principal thereunder. Commencing January 2, 2021, such
interest will be payable in cash. Interest on the special loan will no longer be paid in cash, but by the issuance of and treated
as additional principal thereunder.
Management believes that, based on (i) our receipt
of approximately $1,552 of funding through the Paycheck Protection Program on April 27, 2020, of which a significant portion we
believe will ultimately be forgiven, (ii) our operational forecast through 2021, (iii) our access to capital markets through the
Agreement with Roth, and (iv) a commitment of continued support from Slipstream, we can continue as a going concern through at
least August 15, 2021. However, given our history of net losses, cash used in operating activities and working capital deficit,
each of which continued as of and for the six months ended June 30, 2020, we can provide no assurance that our ongoing operational
efforts or ability to access the public markets for capital will be successful, particularly in consideration of the business interruptions
and uncertainty generated as a result of the COVID-19 pandemic ,which has materially adverse affected our results of operations
and cash flows.
See
Note 8 Loans Payable to the Consolidated Financial Statements for an additional discussion of the Company’s debt
obligations.
NOTE
2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A
summary of the significant accounting policies consistently applied in the preparation of the accompanying Condensed Consolidated
Financial Statements follows:
1.
Basis of Presentation
The
accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the applicable instructions
to Form 10-Q and Regulation S-X and include all of the information and disclosures required by generally accepted accounting principles
in the United States of America (“GAAP”) for interim financial reporting. These unaudited Condensed Consolidated Financial
Statements should be read in conjunction with the Consolidated Financial Statements of the Company and related footnotes for the
year ended December 31, 2019, included in the Company’s Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 13, 2020.
The
results of operations for the interim periods are not necessarily indicative of results of operations for a full year. Management
believes the accompanying unaudited Condensed Consolidated Financial Statements reflect all adjustments, including normal recurring
items, considered necessary for a fair statement of results for the interim periods presented.
2.
Revenue Recognition
We
recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 606, Revenue from Contracts with Customers, applying the five-step model.
If
an arrangement involves multiple performance obligations, the items are analyzed to determine the separate units of accounting,
whether the items have value on a standalone basis and whether there is objective and reliable evidence of their standalone selling
price. The total contract transaction price is allocated to the identified performance obligations based upon the relative standalone
selling prices of the performance obligations. The standalone selling price is based on an observable price for services sold
to other comparable customers, when available, or an estimated selling price using a cost plus margin approach.
The
Company estimates the amount of total contract consideration it expects to receive for variable arrangements by determining the
most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide
and the contractual pricing based on those quantities. The Company only includes some or a portion of variable consideration in
the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized will not
occur when the uncertainty associated with the variable consideration is subsequently resolved. The Company considers the sensitivity
of the estimate, its relationship and experience with the client and variable services being performed, the range of possible
revenue amounts and the magnitude of the variable consideration to the overall arrangement. The Company receives variable consideration
in very few instances.
Revenue
is recognized when a customer obtains control of promised goods or services under the terms of a contract and is measured as the
amount of consideration the Company expects to receive in exchange for transferring goods or providing services. The Company does
not have any material extended payment terms as payment is due at or shortly after the time of the sale, typically ranging between
thirty and ninety days. Observable prices are used to determine the standalone selling price of separate performance obligations
or a cost plus margin approach when one is not available. Sales, value-added and other taxes collected concurrently with revenue
producing activities are excluded from revenue.
The
Company recognizes contract assets or unbilled receivables related to revenue recognized for services completed but not yet invoiced
to the clients. Unbilled receivables are recorded as accounts receivable when the Company has an unconditional right to contract
consideration. A contract liability is recognized as deferred revenue when the Company invoices clients in advance of performing
the related services under the terms of a contract. Deferred revenue is recognized as revenue when the Company has satisfied the
related performance obligation.
The
Company uses the practical expedient for recording an immediate expense for incremental costs of obtaining contracts, including
certain design/engineering services, commissions, incentives and payroll taxes, as these incremental and recoverable costs have
terms that do not exceed one year.
3.
Inventories
Inventories
are stated at the lower of cost or market (net realizable value), determined by the first-in, first-out (FIFO) method, and consist
of the following:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Raw materials, net of reserve of $101 and $134, respectively
|
|
$
|
1,996
|
|
|
$
|
200
|
|
Inventory on consignment with distributors
|
|
|
360
|
|
|
|
-
|
|
Work-in-process
|
|
|
275
|
|
|
|
179
|
|
Total inventories
|
|
$
|
2,631
|
|
|
$
|
379
|
|
4.
Impairment of Long-Lived Assets
We
review the carrying value of all long-lived assets, including property and equipment, for impairment in accordance with ASC 360,
Accounting for the Impairment or Disposal of Long-Lived Assets. Under ASC 360, impairment losses are recorded whenever
events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We evaluated whether there
were any triggering events for consideration of impairment of our long-lived assets as of June 30, 2020 and concluded there were
none.
If
the impairment tests indicate that the carrying value of the asset is greater than the expected undiscounted cash flows to be
generated by such asset, an impairment loss would be recognized. The impairment loss is determined as the amount by which the
carrying value of such asset exceeds its fair value. We generally measure fair value by considering sale prices for similar assets
or by discounting estimated future cash flows from such assets using an appropriate discount rate. Assets to be disposed of are
carried at the lower of their carrying value or fair value less costs to sell. Considerable management judgment is necessary to
estimate the fair value of assets, and accordingly, actual results could vary significantly from such estimates.
5.
Basic and Diluted Income/(Loss) per Common Share
Basic
and diluted income/(loss) per common share for all periods presented is computed using the weighted average number of common shares
outstanding. Basic weighted average shares outstanding includes only outstanding common shares. Diluted weighted average shares
outstanding includes outstanding common shares and potential dilutive common shares outstanding in accordance with the treasury
stock method. Shares reserved for outstanding stock options, including stock options with performance restricted vesting, and
warrants totaling approximately 7,309,998 and 5,320,162 at June 30, 2020 and 2019, respectively were excluded from the computation
of income/(loss) per share as all options and warrants were anti-dilutive due to the net loss in each period. In calculating diluted
earnings per share for the three and six months ended June 30, 2020, in accordance with ASC 260 Earnings per share, we
excluded the dilutive effect of the potential issuance of common stock upon an assumed conversion of the Special Loan.
6.
Income Taxes
Deferred
income taxes are recognized in the financial statements for the tax consequences in future years of differences between the tax
basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates. Temporary
differences arise from net operating losses, differences in basis of intangibles, stock-based compensation, reserves for uncollectible
accounts receivable and inventory, differences in depreciation methods, and accrued expenses. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be realized. The Company accounts for uncertain tax positions
utilizing an established recognition threshold and measurement attributes for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. We had no uncertain tax positions as of June 30, 2020 and December
31, 2019.
7.
Goodwill
We
follow the provisions of ASC 350, Goodwill and Other Intangible Assets. Pursuant to ASC 350, goodwill acquired in a purchase
business combination is not amortized, but instead tested for impairment at least annually. The Company uses a measurement date
of September 30 (see Note 7 Intangible Assets and Goodwill).
8.
Use of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting periods. Our significant estimates include:
the allowance for doubtful accounts, valuation allowances related to deferred taxes, the fair value of acquired assets and liabilities,
the fair value of liabilities reliant upon the appraised fair value of the Company, valuation of stock-based compensation awards
and other assumptions and estimates used to evaluate the recoverability of long-lived assets, goodwill and other intangible assets
and the related amortization methods and periods. Actual results could differ from those estimates.
9.
Leases
We
account for leases in accordance with ASU No. 2016-02, Leases (Topic 842), as amended.
We
determine if an arrangement is a lease at inception. Right of use (“ROU”) assets and liabilities are recognized at
commencement date based on the present value of remaining lease payments over the lease term. For this purpose, we consider only
payments that are fixed and determinable at the time of commencement. As most of our leases do not provide an implicit rate, we
use our incremental borrowing rate based on the information available at commencement date in determining the present value of
lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would
be. The ROU asset also includes any lease payments made prior to commencement and is recorded net of any lease incentives received.
Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such
options.
Operating
leases are included in operating lease right-of-use assets, current maturities of operating leases, and long-term obligations
under operating leases on our condensed consolidated balance sheets. Finance leases are included in property and equipment, net,
current maturities of financing leases, and long-term obligations under financing leases on our condensed consolidated balance
sheets.
NOTE
3: RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Recently
adopted
On
January 1, 2020, we adopted ASU 2018-15 Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing
Arrangement That is a Service Contract, which provide guidance on evaluating the accounting for fees paid by a customer in
a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software
license. The adoption of this guidance had no material impact on our Condensed Consolidated Financial Statements.
On
January 1, 2020, we adopted ASU No. 2018-13, Changes to Disclosure Requirements for Fair Value Measurements (Topic 820),
which improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard
removed, modified, and added certain disclosure requirements. The adoption of this guidance had no material impact on our Condensed
Consolidated Financial Statements.
Not
yet adopted
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income
Taxes, which simplifies the accounting for income taxes. This guidance will be effective for us in the first quarter of 2021
on a prospective basis, and early adoption is permitted. We are currently evaluating the impact of the new guidance on our Condensed
Consolidated Financial Statements.
In
June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses. The main objective is to provide
financial statement users with more decision-useful information about the expected credit losses on financial instruments and
other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this update replace the
incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of a broader range
of reasonable and supportable information to calculate credit loss estimates. For trade receivables and loans, entities will be
required to estimate lifetime expected credit losses. The amendments are effective for public business entities that qualify as
smaller reporting companies for fiscal years and interim periods beginning after December 15, 2022. We are currently evaluating
the disclosure requirements related to adopting this guidance.
NOTE
4: REVENUE RECOGNITION
The
Company applies ASC 606 for revenue recognition. The following table disaggregates the Company’s revenue by major source
for the three and six months ended June 30, 2020 and 2019:
(in thousands)
|
|
Three Months
Ended
June 30,
2020
|
|
|
Three Months
Ended
June 30,
2019
|
|
|
Six Months
Ended
June 30,
2020
|
|
|
Six Months
Ended
June 30,
2019
|
|
Hardware
|
|
$
|
1,601
|
|
|
$
|
1,654
|
|
|
$
|
2,968
|
|
|
$
|
3,295
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Installation Services
|
|
|
463
|
|
|
|
1,791
|
|
|
|
1,332
|
|
|
|
4,163
|
|
Software Development Services
|
|
|
37
|
|
|
|
4,259
|
|
|
|
179
|
|
|
|
8,235
|
|
Managed Services
|
|
|
1,555
|
|
|
|
1,610
|
|
|
|
2,881
|
|
|
|
3,105
|
|
Total Services
|
|
|
2,055
|
|
|
|
7,660
|
|
|
|
4,392
|
|
|
|
15,503
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Hardware and Services
|
|
$
|
3,656
|
|
|
$
|
9,314
|
|
|
$
|
7,360
|
|
|
$
|
18,798
|
|
System hardware sales
System hardware revenue is recognized generally
upon shipment of the product or customer acceptance depending upon contractual arrangements with the customer in instances in which
the sale of hardware is the sole performance obligation. Shipping charges billed to customers are included in hardware sales and
the related shipping costs are included in hardware cost of sales. The cost of freight and shipping to the customer is recognized
in cost of sales at the time of transfer of control to the customer. System hardware revenues are classified as “Hardware”
within our disaggregated revenue.
Installation services
The Company performs outsourced installation
services for customers and recognizes revenue upon completion of the installations. Installation services also includes engineering
services performed as part of an installation project.
When system hardware sales include installation
services to be performed by the Company, the goods and services in the contract are not distinct, so the arrangement is accounted
for as a single performance obligation. Our customers control the work-in-process and can make changes to the design specifications
over the contract term. Revenues are recognized over time as the installation services are completed based on the relative portion
of labor hours completed as a percentage of the budgeted hours for the installation. Installation services revenues are classified
as “Installation Services” within our disaggregated revenue.
The aggregate amount of the transaction
price allocated to installation service performance obligations that are partially unsatisfied as of June 30, 2020 and 2019 were
$0.
Software design and development services
Software and software license sales are
revenue when a fixed fee order has been received and delivery has occurred to the customer. Revenue is recognized generally upon
customer acceptance (point-in-time) of the software product and verification that it meets the required specifications. Software
is delivered to customers electronically. Software design and development revenues are classified as “Software Development
Services” within our disaggregated revenue.
Software as a service
Software as a service includes revenue from
software licensing and delivery in which software is licensed on a subscription basis and is centrally hosted. These services often
include software updates which provide customers with rights to unspecified software product upgrades and maintenance releases
and patches released during the term of the support period. Contracts for these services are generally 12-36 months in length.
We account for revenue from these services in accordance with ASC 985-20-15-5 and recognize revenue ratably over the performance
period. Software as a service revenues are classified as “Managed Services” within our disaggregated revenue.
Maintenance and support services
The Company sells support services which
include access to technical support personnel for software and hardware troubleshooting. The Company offers a hosting service through
our network operations center, or NOC, allowing the ability to monitor and support its customers’ networks 7 days a week,
24 hours a day. These contracts are generally 12-36 months in length. Revenue is recognized over the term of the agreement in proportion
to the costs incurred in fulfilling performance obligations under the contract. Maintenance and Support revenues are classified
as “Managed Services” within our disaggregated revenue.
Maintenance and support fees are based on
the level of service provided to end customers, which can range from monitoring the health of a customer’s network to supporting
a sophisticated web-portal to managing the end-to-end hardware and software of a digital marketing system. These agreements are
renewable by the customer. Rates for maintenance and support, including subsequent renewal rates, are typically established based
upon a fee per location, per device, or a specified percentage of net software license fees as set forth in the arrangement. These
contracts are generally 12-36 months in length. Revenue is recognized ratably and evenly over the service period.
The Company also performs time and materials-based
maintenance and repair work for customers. Revenue is recognized at a point in time when the performance obligation has been fully
satisfied.
NOTE 5: FAIR VALUE MEASUREMENT
We measure certain financial assets, including
cash equivalents, at fair value on a recurring basis. In accordance with ASC 820-10-30, fair value is a market-based measurement
that should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis
for considering such assumptions, ASC 820-10-35 establishes a three-level hierarchy that prioritizes the inputs used in measuring
fair value. The three hierarchy levels are defined as follows:
Level 1 — Valuations based on unadjusted
quoted prices in active markets for identical assets.
Level 2 — Valuations based on observable
inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets
that are not active; or other inputs that are observable, either directly or indirectly.
Level 3 — Valuations based on inputs
that are unobservable and involve management judgment and the reporting entity’s own assumptions about market participants
and pricing.
The Company previously recorded warrant
liabilities that were measured at fair value on a recurring basis using a binomial option pricing model. The fair value of the
warrant liabilities had decreased to $0 as of June 30, 2019. All of the Company’s outstanding warrants classified as liabilities
expired during the three months ended September 30, 2019.
As part of the Allure Acquisition, the Purchase
Agreement contemplated additional consideration of $2,000 to be paid by us to Christie Digital Systems, USA (“Seller”)
in the event that acquiree revenue exceeds $13,000, as defined in the underlying agreement, for any of the trailing twelve-month
periods measured as of December 31, 2019, March 31, 2020, June 30, 2020, September 30, 2020 and December 31, 2020. The fair value
of the earnout liability was determined to be $250 at the time of acquisition. As part of our finalization of opening balance sheet
accounting at the close of the measurement period in November 2019, we recorded an adjustment to reflect the earnout liability
to $0. The fair value estimate remains at $0 as of June 30, 2020. The liability is deemed to be Level 3 as the valuation is based
on revenue projections and estimates developed by management as informed by historical results.
As discussed in Note 8 Loans Payable,
the Special Loan is reported at fair value. This liability is deemed to be a Level 3 valuation. As of June 30, 2020, we updated
our fair value analysis of the Special Loan, which was originally evaluated at March 31, 2020 utilizing the assistance of a third-party
valuation specialist, resulting in recognition of a $551 and $702 loss during the three and six months ended June 30, 2020, respectively,
from the change in fair value of the liability and a corresponding increase in the debt balance recorded in the Condensed Consolidated
Balance Sheet.
NOTE 6: SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Supplemental Cash Flow Information
|
|
|
|
|
|
|
Non-cash Investing and Financing Activities
|
|
|
|
|
|
|
Right of offset settlement of Amended and Restated Seller Note
|
|
$
|
-
|
|
|
$
|
498
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
-
|
|
|
$
|
181
|
|
Income taxes, net
|
|
$
|
2
|
|
|
$
|
-
|
|
NOTE 7: INTANGIBLE ASSETS, INCLUDING GOODWILL
Intangible Assets
Intangible assets consisted
of the following at June 30, 2020 and December 31, 2019:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amortization
|
|
Technology platform
|
|
$
|
4,635
|
|
|
|
3,273
|
|
|
$
|
4,635
|
|
|
|
3,147
|
|
Customer relationships
|
|
|
5,330
|
|
|
|
2,775
|
|
|
|
5,330
|
|
|
|
2,679
|
|
Trademarks and trade names
|
|
|
1,020
|
|
|
|
847
|
|
|
|
1,020
|
|
|
|
752
|
|
|
|
|
10,985
|
|
|
|
6,895
|
|
|
|
10,985
|
|
|
|
6,578
|
|
Accumulated amortization
|
|
|
6,895
|
|
|
|
|
|
|
|
6,578
|
|
|
|
|
|
Net book value of amortizable intangible assets
|
|
$
|
4,090
|
|
|
|
|
|
|
$
|
4,407
|
|
|
|
|
|
For the three months ended June 30, 2020
and 2019, amortization of intangible assets charged to operations was $158 and $147, respectively. For the six months ended June
30, 2020 and 2019 amortization of intangible assets charged to operations was $317 and $303, respectively.
Goodwill
The following is a rollforward of the Company’s
goodwill since December 31, 2019:
|
|
Total
|
|
Balance as of December 31, 2019
|
|
$
|
18,171
|
|
Adjustments due to impairment loss
|
|
|
(10,646
|
)
|
Balance as of June 30, 2020
|
|
$
|
7,525
|
|
Goodwill represents the excess of the purchase
price over the fair value of net assets acquired. Goodwill is subject to an impairment review at a reporting unit level, on an
annual basis as of the end of September of each fiscal year, or when an event occurs, or circumstances change that would indicate
potential impairment. The Company has only one reporting unit, and therefore the entire goodwill is allocated to that reporting
unit.
Despite the excess fair value identified
in our 2019 annual impairment assessment, we determined that the reduced cash flow projections and the significant decline in our
market capitalization as a result of the COVID-19 pandemic during the three months ended March 31, 2020 indicated that an impairment
loss may have been incurred during the first quarter. Therefore, we qualitatively assessed whether it was more likely than not
that the goodwill was impaired as of March 31, 2020. We reviewed our previous forecasts and assumptions based on our current
projections that are subject to various risks and uncertainties, including: (1) forecasted revenues, expenses and cash flows, including
the duration and extent of impact to our business and our alliance partners from the COVID-19 pandemic, (2) current discount rates,
(3) the reduction in our market capitalization, (5) changes to the regulatory environment and (6) the nature and amount of government
support that will be provided. As a result of this qualitative assessment, we concluded that indicators of impairment were present
and that a quantitative interim impairment assessment of our goodwill was necessary as of March 31, 2020.
As a result of the adoption of ASU 2017-04,
Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment the impairment test consists
solely of comparing the carrying value of the reporting unit with its fair value and recording impairment, if identified.
The fair value of the reporting unit was
estimated via the income approach. Under the income approach, fair value is determined based on the present value of estimated
future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows
and include an estimate of long-term future growth rates based on our most recent views of the long-term outlook for our industry.
Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model
and by analyzing published rates relevant to our business to estimate the cost of equity financing. We use discount rates that
are commensurate with the risks and uncertainty inherent in the respective businesses and in our internally developed forecasts.
We utilized a discount rate of 15.3% in our valuation completed as of March 31, 2020.
While our outlook for the digital signage
industry over the long term remains strong, we have experienced rapid and immediate deterioration in our short term business as
a result of the COVID-19 pandemic, generating increased uncertainty across our customer base in each of our key vertical markets.
The elective and forced closures of businesses across the United States has resulted in reduced demand for our services, which
primarily assist business in engaging with their end customers in a physical space through digital technology. The elimination
and minimization of public gatherings has materially impacted demand for products and services in our theater, sports arena and
large entertainment markets. These conditions resulted in downward revisions of our internal forecasts on current and future projected
earnings and cash flows, leading to an implied fair value of goodwill substantially below the carrying value. Therefore, during
the three months ended March 31, 2020, we recorded a non-cash impairment loss of $10,646. We recorded the estimated impairment
losses in the caption "Goodwill impairment" in our Condensed Consolidated Statement of Operations. After the impairment
loss, there is $7,525 remaining goodwill as of March 31, 2020.
As of June 30, 2020, we performed a qualitative
impairment assessment in accordance with ASU 2011-08 Testing Goodwill for Impairment to determine whether any indicators
of impairment of intangible assets were present as of the balance sheet date. Our analysis included evaluating events and circumstances
impacting the Company, including the continued closure of numerous businesses through the second quarter as a result of the COVID-19
pandemic and the Company’s previously goodwill impairment. As a result of our analysis, we concluded that the Company’s
actual and forecasted financial results remain in-line with estimates made during our impairment assessment as of March 31, 2020
and that the factors analyzed support an assertion that it is not more likely than not that the fair value of the reporting unit
is less than its carrying amount. As a result, no further impairment was recorded during the three months ended June 30, 2020.
The Company recognizes that any changes
in our projected 2020 results could potentially have a material impact on our assessment of goodwill impairment. The Company will
continue to monitor the actual performance of its operations against expectations and assess further indicators of possible impairment.
The valuation of goodwill and intangible assets is subject to a high degree of judgment, uncertainty and complexity. Should any
indicators of impairment occur in subsequent periods, the Company will be required to perform an analysis in order to determine
whether goodwill is impaired.
NOTE 8: LOANS PAYABLE
The outstanding debt with detachable warrants,
as applicable, are shown in the table below. Further discussion of the notes follows.
Debt Type
|
|
Issuance
Date
|
|
Principal
|
|
|
Maturity
Date
|
|
Warrants
|
|
|
Interest Rate Information
|
|
A
|
|
6/30/2018
|
|
$
|
264
|
|
|
6/30/2021
|
|
|
-
|
|
|
0.0%
interest
|
|
B
|
|
1/16/2018
|
|
|
1,032
|
|
|
6/30/2021
|
|
|
61,729
|
|
|
10.0%
interest (1)
|
|
C
|
|
8/17/2016
|
|
|
3,096
|
|
|
6/30/2021
|
|
|
588,236
|
|
|
10.0%
interest (1)
|
|
D
|
|
11/19/2018
|
|
|
1,637
|
|
|
2/15/2020
|
|
|
-
|
|
|
3.5%
interest
|
|
E
|
|
12/30/2019
|
|
|
2,773
|
|
|
6/30/2021
|
|
|
-
|
|
|
10.0% interest (2)
|
|
F
|
|
4/27/2020
|
|
|
1,552
|
|
|
4/27/2022
|
|
|
-
|
|
|
1.0%
interest (3)
|
|
|
|
Total debt, gross
|
|
|
10,354
|
|
|
|
|
|
649,965
|
|
|
|
|
|
|
Debt discount
|
|
|
(338
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total debt, net
|
|
$
|
10,016
|
|
|
|
|
|
|
|
|
|
|
|
|
Less current maturities
|
|
|
(8,464
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Long term debt
|
|
|
1,552
|
|
|
|
|
|
|
|
|
|
|
A – Secured Disbursed Escrow Promissory Note with related
party
B – Secured Revolving Promissory Note with related party
C – Term Loan with related party
D – Amended and Restated Seller Note from acquisition
of Allure
E – Secured Convertible Special Loan Promissory Note,
at fair value
F – Paycheck Protection Program Loan from Small Business
Administration
|
(1)
|
8.0% cash interest per annum through March 31, 2020. 10.0%
paid-in-kind interest (“PIK”) interest per annum from April 1, 2020 through December 31, 2020. 8.0% cash interest
per annum January 1, 2021 through the maturity date.
|
|
(2)
|
8.0% cash interest per annum, comprised of 6.0% cash, 2.0%
PIK through March 31, 2020. 10.0% PIK interest per annum through September 30, 2020. In an event of default, the interest rate
increases by 6.0% to 16.0%. Debt is convertible to preferred stock at the earlier of an event of default or October 1, 2020. While
the stated maturity date of the Special Loan is June 30, 2021, the mandatory conversion feature into preferred stock as of October
1, 2020 results in the classification of this debt instrument as a current liability on the consolidated balance sheet.
|
|
|
|
|
(3)
|
1,0% cash interest per annum. Payments are deferred for six
months from the date of the Promissory Note and the Company can apply for forgiveness of the Promissory Note after 60 days. Forgiveness
of the Promissory Note will be determined in accordance with the provisions of the CARES Act and applicable regulations. Any principal
and interest amounts outstanding after the determination of amounts forgiven will be repaid on a monthly basis.
|
SBA Paycheck Protection Program Loan
On April 27, 2020, the Company entered into
a Promissory Note with Old National Bank (the “Promissory Note”), which provided for an unsecured loan of $1,552 pursuant
to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act and applicable regulations (the
“CARES Act”). The Promissory Note has a term of two years with a 1% per annum interest rate. While the Promissory Note
currently has a two-year term, the amended law permits the Company to request a five-year maturity from Old National Bank. Payments
are deferred for six months from the date of the Promissory Note and the Company can apply for forgiveness of the Promissory Note
after 60 days. Forgiveness of the Promissory Note will be determined in accordance with the provisions of the CARES Act and applicable
regulations. Any principal and interest amount outstanding after the determination of amounts forgiven will be repaid on a monthly
basis. The Company is in process of finalizing their calculation of amounts forgivable in accordance with guidance issued by the
Small Business Administration and anticipates applying for forgiveness during the fourth quarter of 2020. No assurance is provided
that we will be able to obtain forgiveness of the Promissory Note in whole or in part.
Loan and Security Agreement
On August 17, 2016, the Company entered
into a Loan and Security Agreement with Slipstream (“Loan and Security Agreement”). Since the initial entry into the
Loan and Security Agreement in 2016, the Company has entered into several financing arrangements with varying interest rates, maturity
dates, and number of associated detachable warrants, each entered within the structure of the Loan and Security Agreement. The
debt instruments outstanding under the Loan and Security Agreement as of March 31, 2020 include the Term Loan, Secured Revolving
Promissory Note, Secured Disbursed Escrow Promissory Note, and the Special Loan.
The Loan and Security Agreement contains
certain customary restrictions including, but not limited to, restrictions on mergers and consolidations with other entities, cancellation
of any debt or incurring new debt (subject to certain exceptions), and other customary restrictions. Obligations under the loan
and security agreement are secured by a grant of collateral security in all of the tangible assets of Creative Realities, Inc.
and each of its wholly owned subsidiaries.
Eighth Amendment; Modification of Interest
Rates under Loan and Security Agreement
On April 1, 2020, the Company entered into
an Eighth Amendment to Loan and Security Agreement (the “Eighth Amendment”) with its subsidiaries and Slipstream to
amend the terms of the payments and interest accruing on the Company’s Term Loan, Secured Revolving Promissory Note, and
Special Loan. The Eighth Amendment increased the interest rates of these loans from 8% to 10%, effective April 1, 2020. Until January
1, 2021, rather than cash payments of accrued interest under the term and revolving loans, interest will be paid by the issuance
of and treated as additional principal thereunder. Commencing January 2, 2021, such interest will be payable in cash. Interest
on the special loan will no longer be paid in cash, but by the issuance of and treated as additional principal thereunder.
Upon entry into the Eighth Amendment, the
Company completed an analysis of the changes in the Loan and Security Agreement within ASC 470 Debt, concluding that the
changes represent a modification to the existing debt that was not a troubled debt restructuring and will account for the modified
terms prospectively as yield adjustments, based on the revised terms.
Seventh Amendment; Entry into Secured
Convertible Special Loan Promissory Note
On December 30, 2019, we entered into the
Special Loan as part of the Seventh Amendment under which we obtained $2,000, with interest thereon at 8% per annum payable 6%
in cash and 2% via the issuance of SLPIK interest, provided however that upon occurrence of an event of default the interest rate
shall automatically be increased by 6% per annum payable in cash. The entry into the Seventh Amendment adjusted the interest rate
on the Company’s Term Loan and Revolving Loan to 8% per annum, provided, however, at all times when the aggregate outstanding
principal amount of the Term Loan and the Revolving Loan exceeds $4,100 then the Loan Rate shall be 10%, of which eight percent
8% shall be payable in cash and 2% shall be paid by the issuance of and treated as additional PIK.
Upon the earlier to occur of an Event of
Default or October 1, 2020, if any of the principal amount of the Special Loan is then outstanding, the principal and accrued but
unpaid interest of the Special Loan and the outstanding SLPIK shall be automatically converted into shares of a new series of Senior
Convertible Preferred Stock of CRI (“New Preferred”) having an Appraised Value equal to three times the then outstanding
principal amount and accrued but unpaid interest of the Special Loan and the outstanding SLPIK and having the following terms and
conditions, as reasonably determined by CRI and the Lender, the New Preferred shall:
|
●
|
be the most senior equity security of CRI, including with respect to the payment of dividends and other distributions;
|
|
●
|
be on substantially the same terms and conditions as CRI’s Series A-1 6% Convertible Preferred Stock as set forth in its Certificate of Designation immediately before the same was cancelled pursuant to a Certificate of Cancellation dated as of March 13, 2019;
|
|
●
|
not be subject to a right of redemption upon the part of a holder thereof;
|
|
●
|
accrue and pay quarterly dividends at the rate of twelve percent (12%) per annum which shall be payable in cash;
|
|
●
|
have a Stated Value that is an amount mutually agreed by CRI and the Lender at the time of issuance;
|
|
●
|
Conversion Price shall be an amount equal to 80% of the average for the 30-day period ending two days prior to the required conversion date of the daily average of the range of CRI’s common stock (calculated pursuant to information on The Wall Street Journal Online Edition), subject to appropriate adjustments; and
|
|
●
|
neither section 6(e) of the Series A-1 Certificate of Designation nor any similar provision shall apply to the New Preferred.
|
In entering the Seventh Amendment and Special
Loan, pursuant to ASC 825-10-25-1, Fair Value Option, we made an irrevocable election to report the Special Loan at fair
value, with changes in fair value recorded through the Company’s consolidated statements of operations in each reporting
period. For the three and six months ended June 30, 2020, we utilized the assistance of a third-party valuation specialist to assist
in updating our fair value analysis of the Special Loan, resulting in recognition of a $551 and $702 loss, respectively, from the
change in fair value of the liability.
Sixth Amendment; Extension of Maturity
Dates
On November 6, 2019, Slipstream extended
the maturity date of our term loan and revolver loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement,
aligning the maturity date of our Term Loan and Secured Revolving Promissory Note with the Secured Disbursed Escrow Promissory
Note.
Amended and Restated Seller Note
from acquisition of Allure
The Amended and Restated Seller Note represents
a note payable due from Allure to Seller, under a pre-existing Seller Note which was amended and restated to a reduced amount of
$900 through the Stock Purchase Agreement. At the closing date, the estimated net working capital deficit of Allure was $801 in
excess of the target net working capital as defined in the Stock Purchase Agreement. As of the acquisition date, Allure also had
accounts payable to Seller for outsourced services of $2,204. We agreed with the Seller to settle the estimated net working capital
deficit through a reduction in the accounts payable to Seller as of the acquisition date and to further amend the Seller Note to
include the remaining $1,403 accounts payable due from Allure to Seller, resulting in a Seller Note of $2,303. That debt is represented
by our issuance to the Seller of a promissory note accruing interest at 3.5% per annum. The promissory note requires us to make
quarterly payments of interest only through February 19, 2020, on which date the promissory note matured and all remaining amounts
owing thereunder became due.
The promissory note is convertible into
shares of Creative Realities common stock, at the seller’s option on or after the 180th day after issuance, at an initial
conversion price of $8.40 per share, subject to customary equitable adjustments. Conversion of all amounts owing under the promissory
note will be mandatory if the 30-day volume-weighted average price of our common stock exceeds 200% of the common stock trading
price at the closing of the acquisition. We granted the seller customary registration rights for the shares of our common stock
issuable upon conversion of the promissory note.
On February 20, 2020, the Company and Allure
filed a demand for arbitration against Seller for (1) breach of contract, (2) indemnification, and (3) fraudulent misrepresentation
under the Allure Purchase Agreement. This demand included a claim for the right to offset the amounts owing under the Amended and
Restated Seller Note due February 20, 2020. We have not paid, nor do we intend to pay, the Amended and Restated Seller Note, which
is now past its maturity date, without resolution of our demand for arbitration. On February 27, 2020, Seller sent the Company
a notice of breach for failure to pay the Amended and Restated Seller Note on the maturity date of February 20, 2020 and demanding
immediate payment. The Company continues to accrue interest on the Amended and Restated Seller Note and have included $43 in accrued
expenses in the Condensed Consolidated Financial Statements as of June 30, 2020. See Note 9 Commitments and Contingencies for
further discussion.
NOTE 9: COMMITMENTS AND CONTINGENCIES
Litigation
On August 2, 2019, the Company filed suit
in Jefferson Circuit Court, Kentucky, against a supplier of Allure for breach of contract, breach of warranty, and negligence with
respect to equipment installations performed by such supplier for an Allure customer. This case remains in the early stages of
litigation, in part due to delays resulting from the COVID-19 pandemic, and, as a result, the outcome of each case is unclear,
so the Company is unable to reasonably estimate the possible recovery, or range of recovery, if any.
On October 10, 2019, the Allure customer
that is the basis of our claim above sent a demand to the Company for payment of $3,200 as settlement for an alleged breach of
contract related to hardware failures of equipment installations performed by Allure between November 2017 and August 2018. The
suits filed by and against Allure have been adjoined in the Jefferson Circuit Court, Kentucky in January 2020. This suit remains
in the early stages of litigation and, as a result, the outcome of the suit and the allocation of liability, if any, remain unclear,
so the Company is unable to reasonably estimate the possible liability, recovery, or range of magnitude for either the liability
or recover, if any, at the time of this filing.
The Company has notified its insurance company
on notice of potential claims and continues to evaluate both the claim made by the customer and potential avenues for recovery
against third parties should the customer prevail.
On February 20, 2020, the Company and Allure
filed a demand for arbitration against Seller for breach of contract, indemnification, and fraudulent misrepresentation under the
Allure Purchase Agreement. This demand included a claim for the right to offset the amounts owing under the Amended and Restated
Seller Note due February 20, 2020. We have not paid the Amended and Restated Seller Note which is now past its maturity date. On
February 27, 2020, Seller sent the Company a notice of breach for failure to pay the Amended and Restated Seller Note on the maturity
date of February 20, 2020 and demanding immediate payment.
Except as noted above, the Company is not
party to any other material legal proceedings, other than ordinary routine litigation incidental to the business, as of August
14, 2020, and there were no other such proceedings pending during the period covered by this Report.
Employee-related Expenses
We implemented cost-control measures in
light of the effect of the COVID-19 pandemic on our business, including employment compensation reductions designed to achieve
preliminary cost savings. On March 19, 2020, the Company’s Board of Directors approved a six-month reduction of the salaries
of our Chief Executive Officer and Chief Financial Officer by twenty percent (20%), thereby reducing the salaries payable to such
officers in 2020 to $297,000 and $224,100, respectively.
On March 20, 2020, we completed a reduction-in-force
and accrued one-time termination benefits related to severance to the affected employees of $135, the total of which was paid during
the three months ended June 30, 2020 with $0 remaining in accrued expenses on the Condensed Consolidated Balance Sheet as of June
30, 2020.
NOTE 10: RELATED PARTY TRANSACTIONS
In addition to the financing transactions
with Slipstream, a related party, discussed in Note 8 Loans Payable, we have the following related party transactions.
On August 14, 2018, we entered into a payment
agreement with 33 Degrees Convenience Connect, Inc., a related party that is approximately 17.5% owned by a member of our senior
management (“33 Degrees”) outlining terms for repayment of $2,567 of aged accounts receivable as of that date. The
payment agreement stipulated a simple interest rate of 12% on aged accounts receivable to be paid on the tenth day of each month
through the maturity date of December 31, 2019. As of December 31, 2019, 33 Degrees paid the note in full.
Following repayment of the note, 33 Degrees
has continued to purchase additional hardware and services from the Company under normal payment terms.
For the three and six months ended June
30, 2020, the Company had sales to 33 Degrees of $291, or 8.0%, and $791, or 10.7%, respectively, of consolidated revenue. For
the three and six months ended June 30, 2019, the Company had sales to 33 Degrees of $275, or 3.0%, and $470, or 2.5%, respectively,
of consolidated revenue.
Accounts receivable due from 33 Degrees
was $28, or 0.8%, and $1, or 0.0% of consolidated accounts receivable at June 30, 2020 and December 31, 2019, respectively.
NOTE 11: INCOME TAXES
Our deferred tax assets are primarily related
to net federal and state operating loss carryforwards (NOLs). We have substantial NOLs that are limited in usage by IRC Section
382. IRC Section 382 generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when
a corporation has undergone significant changes in stock ownership within a statutory testing period. We have performed a preliminary
analysis of the annual NOL carryforwards and limitations that are available to be used against taxable income. Based on the history
of losses of the Company, there continues to be a full valuation allowance against the net deferred tax assets of the Company with
a definite life.
For the three and six-months ended June
30, 2020, we reported tax (expense)/benefit of ($4) and $151, respectively. As of June 30, 2020, the net deferred tax assets totaled
$0 after valuation allowance, as compared to $175 at December 31, 2019. The reduction is primarily the result of the impairment
to goodwill, which resulted in adjusting the deferred tax impact associated with indefinite lived goodwill from a deferred tax
liability to a deferred tax asset. As the indefinite-lived intangibles can no longer provide a source of income, a full valuation
allowance was placed against the deferred tax assets.
NOTE 12: WARRANTS
A summary of outstanding equity warrants
is included below:
|
|
Warrants (Equity)
|
|
|
|
Amount
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life
|
|
Balance January 1, 2020
|
|
|
4,733,028
|
|
|
$
|
4.83
|
|
|
|
3.41
|
|
Warrants issued
|
|
|
(27,600
|
)
|
|
|
4.38
|
|
|
|
-
|
|
Warrants expired
|
|
|
(89,238
|
)
|
|
|
9.49
|
|
|
|
-
|
|
Balance June 30, 2020
|
|
|
4,616,190
|
|
|
$
|
4.74
|
|
|
|
2.97
|
|
NOTE 13: STOCK-BASED COMPENSATION
A summary of outstanding options is included
below:
Time Vesting Options
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Range of Exercise
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Options
|
|
|
Exercise
|
|
Prices between
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
$0.01 - $5.39
|
|
|
1,605,000
|
|
|
|
9.92
|
|
|
$
|
2.52
|
|
|
|
-
|
|
|
$
|
-
|
|
$5.40 - $7.50
|
|
|
184,830
|
|
|
|
5.85
|
|
|
$
|
6.72
|
|
|
|
159,830
|
|
|
$
|
6.60
|
|
$7.51 - $160.50
|
|
|
103,979
|
|
|
|
4.95
|
|
|
|
11.74
|
|
|
|
94,396
|
|
|
$
|
12.05
|
|
|
|
|
1,893,809
|
|
|
|
9.25
|
|
|
$
|
3.44
|
|
|
|
254,226
|
|
|
|
|
|
Performance Vesting Options
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Range of Exercise
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Options
|
|
|
Exercise
|
|
Prices between
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
$0.01 - $5.39
|
|
|
800,000
|
|
|
|
9.93
|
|
|
$
|
2.53
|
|
|
|
-
|
|
|
$
|
-
|
|
$5.40 - $7.50
|
|
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
800,000
|
|
|
|
9.93
|
|
|
$
|
2.53
|
|
|
|
-
|
|
|
|
|
|
|
|
Time Vesting Options
|
|
|
Performance Vesting Options
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
Options
|
|
|
Exercise
|
|
|
Options
|
|
|
Exercise
|
|
Date/Activity
|
|
Outstanding
|
|
|
Price
|
|
|
Outstanding
|
|
|
Price
|
|
Balance, December 31, 2019
|
|
|
313,809
|
|
|
$
|
8.06
|
|
|
|
-
|
|
|
$
|
-
|
|
Granted
|
|
|
1,580,000
|
|
|
|
2.53
|
|
|
|
800,000
|
|
|
|
2.53
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited or expired
|
|
|
(51
|
)
|
|
|
367.50
|
|
|
|
-
|
|
|
|
-
|
|
Balance, June 30, 2020
|
|
|
1,893,809
|
|
|
|
3.44
|
|
|
|
800,000
|
|
|
$
|
2.53
|
|
The weighted average remaining contractual
life for options exercisable is 5.2 years as of June 30, 2020.
Valuation Information for Stock-Based Compensation
For purposes of determining estimated fair
value under FASB ASC 718-10, Stock Compensation, the Company computed the estimated fair values of stock options using the
Black-Scholes model.
On June 1, 2020 the Board of Directors of
the Company granted 10-year options to purchase an aggregate of 2,380,000 shares of its common stock to employees of the Company
subject to shareholder approval of an increase in the reserve of shares authorized for issuance under the Company’s 2014
Stock Incentive Plan (the “Plan”). On July 10, 2020, the Company held a special meeting of the Company’s shareholders
at which the shareholders approved the amendment to the Plan, which increased the reserve of shares authorized for issuance thereunder
to 6,000,000 shares.
Of the 2,380,000 options awarded, 1,580,000
vest over 3 years and have an exercise price of $2.53, the market value of the Company’s common stock on the grant date.
The fair value of the options on the grant date was $1.87 and was determined using the Black-Scholes model. These values were calculated
using the following weighted average assumptions:
Risk-free interest rate
|
|
|
0.66
|
%
|
Expected term
|
|
|
6.25 years
|
|
Expected price volatility
|
|
|
89.18
|
%
|
Dividend yield
|
|
|
0
|
%
|
The remaining 800,000 options awarded vest
in equal installments over a three-year period subject to satisfying the Company revenue target and earnings before interest, taxes,
depreciation and amortization (“EBITDA”) target for the applicable year. In each of calendar years 2020, 2021 and 2022,
one-third of the total shares may vest (if the revenue and EBITDA targets are met), and the shares that are subject to vesting
each year are allocated equally to each of the revenue and EBITDA targets for such year.
These performance options include a catch-up
provision, where any options that did not vest during a prior year due to the Company’s failure to meet a prior revenue or
EBITDA target may vest in a subsequent vesting year if the revenue or EBITDA target, as applicable, is met in the future year.
The revenue and EBITDA targets for the following three years are as follows:
Calendar Year
|
|
Revenue Target
|
|
EBITDA Target
|
2020
|
|
$32 million
|
|
$2.2 million
|
2021
|
|
$35 million
|
|
$3.1 million
|
2022
|
|
$38 million
|
|
$3.5 million
|
The exercise price
of the foregoing options is $2.53 per share, the closing price of the Company’s common stock on the date of issuance. The
options were issued from the Company’s 2014 Stock Incentive Plan. The fair value of the options on the grant date was $1.87
and was determined using the Black-Scholes model. These values were calculated using the same weighted average assumptions as the
time vesting options issued. Performance against the identified revenue and EBITDA targets will be assessed quarterly by the Company
in order to determine whether any compensation expense should be recorded. As of June 30, 2020, the Company had recorded no compensation
expense in the Consolidated Statement of Operations with respect to these awards.
Stock Compensation Expense Information
ASC 718-10, Stock Compensation, requires
measurement and recognition of compensation expense for all stock-based payments including warrants, stock options, restricted
stock grants and stock bonuses based on estimated fair values. Under the Amended and Restated 2006 Equity Incentive Plan, the Company
reserved 1,720,000 shares for purchase by the Company’s employees and under the Amended and Restated 2006 Non-Employee Director
Stock Option Plan the Company reserved 700,000 shares for purchase by the Company’s employees. There are 12,186 options outstanding
under the 2006 Equity Incentive Plan.
In October 2014, the Company’s shareholders
approved the 2014 Stock Incentive Plan, under which 7,390,355 shares were reserved for purchase by the Company’s employees.
In August 2018, a special meeting of shareholders was held in which the shareholders voted to amend the Company’s 2014 Stock
Incentive Plan to increase the reserve of shares authorized for issuance thereunder, from 7,390,355 shares to 18,000,000 shares.
Following a 1-for-30 reverse stock split, the shares authorized for issuance under the Company’s 2014 Stock Incentive Plan
was reduced to 600,000. On July 10, 2020, the Company’s shareholders approved an amendment to the Company’s 2014 Stock
Incentive Plan to increase the reserve of authorized for issuance thereunder to 6,000,000.
Compensation expense recognized for the
issuance of stock options for the three and six months ended June 30, 2020 of $19 and $119, respectively, was included in general
and administrative expense in the Condensed Consolidated Financial Statements. Compensation expense recognized for the issuance
of stock options for the three and six months ended June 30, 2019 of $41 and $83, respectively, was included in general and administrative
expense in the Condensed Consolidated Financial Statements. Amounts recorded include stock compensation expense for awards granted
to directors of the Company in exchange for services at fair value.
At June 30, 2020, there was approximately
$3,014 and $1,499 of total unrecognized compensation expense related to unvested share-based awards with time vesting and performance
vesting criteria, respectively. Generally, expense related to the time vesting options will be recognized over the next three years
and will be adjusted for any future forfeitures as they occur. Compensation expense related to performance vesting options will
be recognized if it becomes probable that the Company will achieve the identified performance metrics.
NOTE 14: SIGNIFICANT CUSTOMERS/VENDORS
Significant Customers
We had one (1) and one (1) customers that
in the aggregate accounted for 16% and 18.5% of accounts receivable as of June 30, 2020 and December 31, 2019, respectively.
We had two (2) customers that accounted
for 27% and 51% of revenue for the three months ended June 30, 2020 and 2019, respectively. We had two (2) customers that accounted
for 22% and 41% of revenue for the six months ended June 30, 2020 and 2019, respectively.
Significant Vendors
We had one (1) vendor that accounted
for 22% and 50% of outstanding accounts payable at June 30, 2020 and December 31, 2019, respectively.
NOTE 15: LEASES
We have entered into various non-cancelable
operating lease agreements for certain of our offices and office equipment. Our leases have original lease periods expiring between 2020 and 2023.
Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals
are deemed to be reasonably assured at lease commencement. Our lease agreements do not contain any material residual value guarantees
or material restrictive covenants.
The components of lease costs, lease term
and discount rate are as follows:
(in thousands)
|
|
Six Months Ended
June 30,
2020
|
|
|
Six Months Ended
June 30,
2019
|
|
Finance lease cost
|
|
|
|
|
|
|
Amortization of right-of-use assets
|
|
$
|
12
|
|
|
$
|
16
|
|
Interest
|
|
|
1
|
|
|
|
3
|
|
Operating lease cost
|
|
|
343
|
|
|
|
393
|
|
Total lease cost
|
|
$
|
356
|
|
|
$
|
412
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Remaining Lease Term
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
3.0 years
|
|
|
|
3.8 years
|
|
Finance leases
|
|
|
1.0 years
|
|
|
|
1.4 years
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Discount Rate
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
10.0
|
%
|
|
|
10.0
|
%
|
Finance leases
|
|
|
14.0
|
%
|
|
|
13.5
|
%
|
The following is a schedule, by years, of
maturities of lease liabilities as of June 30, 2020:
(in thousands)
|
|
Operating
Leases
|
|
|
Finance
Leases
|
|
The remainder of 2020
|
|
$
|
342
|
|
|
$
|
9
|
|
2021
|
|
|
630
|
|
|
|
4
|
|
2022
|
|
|
377
|
|
|
|
1
|
|
2023
|
|
|
375
|
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
|
|
-
|
|
Total undiscounted cash flows
|
|
|
1,724
|
|
|
|
14
|
|
Less imputed interest
|
|
|
(237
|
)
|
|
$
|
(1
|
)
|
Present value of lease liabilities
|
|
$
|
1,487
|
|
|
$
|
13
|
|
Supplemental cash flow information related
to leases are as follows:
(in thousands)
|
|
Six Months Ended
June 30,
2020
|
|
|
Six Months Ended
June 30,
2019
|
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
171
|
|
|
$
|
383
|
|
Operating cash flows from finance leases
|
|
|
2
|
|
|
|
1
|
|
Financing cash flows from finance leases
|
|
|
12
|
|
|
|
15
|
|