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 operations of Creative Realties, Inc. and we are not adding 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., Creative Realities Canada, Inc., 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 have incurred net losses for the years ended December 31, 2018 and 2017 and have negative cash flows
from operating activities as of December 31, 2018. For the three months ended March 31, 2019 and 2018 we have incurred net losses
of $184 and $2,238, respectively. As of March 31, 2019, we had cash and cash equivalents of $2,248 and working capital deficit
of $5,555, which includes $662 representing current maturities of operating leases brought onto the consolidated balance sheet
January 1, 2019 upon adoption of Accounting Standards Update (“ASU”) 2016-02.
On
November 9, 2018, Slipstream Communications, LLC, (“Slipstream”) a related party (see Note 9), extended the maturity
date of our term loan and revolving loan to August 16, 2020. Our intent is to refinance our term loan and revolving loan with
an unrelated third party in the first half of 2019. In conjunction with the extension of the maturity date of our term loan, we
agreed that the cash portion of the interest rate would conditionally increase from 8.0% per annum to 10.0% per annum effective
July 1, 2019 if we have not successfully completed such refinancing activity by June 30, 2019.
Management believes that, based on (i) the
extension of the maturity date on our term loan and revolving loans, (ii) our operational forecast through 2020, and (iii) the
execution of our planned capital raise, we can continue as a going concern through at least May 15, 2020. However, given our net
losses, cash used in operating activities and working capital deficit, we obtained a continued support letter from Slipstream
through May 15, 2020. We can provide no assurance that our ongoing operational efforts will be successful which could have a material
adverse effect on our results of operations and cash flows.
See
Note 9 to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt obligations.
Acquisitions
Acquisition
of Allure Global Solutions, Inc.
On
September 20, 2018, we entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Christie Digital
Systems, Inc. (“Seller”) to acquire the capital stock of Allure, a wholly owned subsidiary of the Seller (the
“Allure Acquisition”). Allure is an enterprise software development company providing software solutions, a suite
of complementary services, and ongoing support for an array of digital media and POS solutions. Allure provides a wide range
of products for the theatre, restaurant, convenience store, theme park, and retail spaces and works to create, develop,
deploy, and maintain enterprise software solutions including those designed specifically to integrate, manage, and power
ambient client-owned networks. Those networks manage data and marketing content that has been designed and proven to
influence consumer purchase behavior. The Allure Acquisition closed on November 20, 2018.
Subject
to the terms and conditions of the Purchase Agreement, upon the closing of the Allure Acquisition, we acquired ownership of all
of Allure’s issued and outstanding capital shares in consideration for a total purchase price of approximately $8,450, subject
to a post-closing working capital adjustment. Of this purchase price amount, we paid $6,300 in cash. Of the remaining purchase
price amount, approximately $1,250 is to be paid to former management of Allure, and approximately $900 due from Allure to the
Seller, under an existing Seller Note which was amended and restated for this reduced amount. That debt is represented by our
issuance to the Seller of a promissory note accruing interest at 3.5% per annum. The promissory note will require us to make quarterly
payments of interest only through February 19, 2020, on which date the promissory note will mature and all remaining amounts owing
thereunder will be due. We are able to prepay in whole or in part amounts owing under the promissory note, without penalty, at
our option, at any time and from time to time.
The
promissory note is convertible into shares of Creative Realities common stock, at the Seller’s option on or after May
19, 2019, 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 Allure Acquisition. We
will grant the Seller customary registration rights for the shares of our common stock issuable upon conversion of the
promissory note.
The
Purchase Agreement contemplates additional consideration of $2,000 to be paid by us to Seller in the event that Allure’s
revenue exceeds $13,000, wherein revenues from one specifically-named customer add only 70% of their gross value to the total,
for any of (i) the 12-month period ending December 31, 2019, or (ii) any of the next following trailing 12-month periods ending
on each of March 31, June 30, September 30 and December 31, 2020.
See
Note 5 to the Condensed Consolidated Financial Statements for further discussion of the Company’s Allure Acquisition.
NOTE
2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1.
Basis of Presentation
The
accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the instructions to Form
10-Q and Article 10 of 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, 2018, included in the Company’s Annual Report on Form 10-K filed with the Securities
and Exchange Commission on March 28, 2019.
The
results of operations for the interim periods are not necessarily indicative of results of operations for a full year. It is the
opinion of management that all necessary adjustments for a fair presentation of the results of operations for the interim periods
have been made and are of a recurring nature unless otherwise disclosed herein.
2.
Revenue Recognition
We
recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 606,
Revenue from Contracts with Customers
, which we adopted effective January 1, 2018,
using the modified retrospective method. See further discussion of the impact of adoption and our revenue recognition policy in
Note 4.
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:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Raw materials, net of reserve of $196 and $207, respectively
|
|
$
|
241
|
|
|
$
|
220
|
|
Work-in-process
|
|
|
424
|
|
|
|
159
|
|
Total inventories
|
|
$
|
665
|
|
|
$
|
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.
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 and warrants totaling approximately 5,320,162 and 1,615,976 at March 31, 2019 and 2018, respectively, were excluded
from the computation of loss per share as they are anti-dilutive. Net loss attributable to common shareholders for the three months
ended March 31, 2019 and 2018 is after dividends on convertible preferred stock of $0 and $111, respectively.
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 March 31, 2019 and December
31, 2018.
7.
Goodwill and Definite-Lived Intangible Assets
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. There was no impairment loss recognized on goodwill or definite-lived intangible assets during the three months
ended March 31, 2019 and 2018 (see Note 8).
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, recognition of revenue, right-of-use assets and related lease liabilities, deferred taxes,
deferred revenue, the fair value of acquired assets and liabilities, valuation of warrants and other stock-based compensation
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.
Reverse Stock Split
On October 17, 2018, the Company effectuated
a l-for-30 reverse stock split of its outstanding common stock. The accompanying financial statements and notes to the financial statements give effect to the reverse stock
split for all periods presented. The shares of common stock retained a par value of $0.01 per share. Accordingly, the stockholders’
equity for the three-months ended March 31, 2018 reflects the reverse stock split by reclassifying from “common stock”
to “additional paid-in capital” an amount equal to the par value of the decreased shares resulting from the reverse
stock split.
10.
Business Combinations
Accounting
for acquisitions requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition
date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net acquisition
date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately
value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our
estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one
year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding
offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities
assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. Refer to
Note 5, “Business Combination” for a discussion of the accounting for the Allure Acquisition.
11.
Leases
On January 1, 2019, we adopted ASU No. 2016-02,
Leases
(Topic 842), as amended, which supersedes
the lease accounting guidance under ASC 840, and generally requires lessees to recognize operating and financing lease liabilities
and corresponding right-of-use (“ROU”) assets on the balance sheet and to provide enhanced disclosures surrounding
the amount, timing and uncertainty of cash flows arising from leasing arrangements. We adopted the new guidance using the modified
retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not
restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating
leases, while our accounting for finance leases remained substantially unchanged. For information regarding the impact of Topic
842 adoption, see Note 17— Leases.
Lease accounting results and disclosure requirements
for reporting periods beginning after January 1, 2019 are presented under Topic 842, while prior period amounts have not been
adjusted and continue to be reported in accordance with our historical accounting under Topic 840.
We
elected the package of practical expedients permitted under the transition guidance, which allowed us to carryforward our historical
lease classification, our assessment on whether a contract was or contains a lease, and our initial direct costs for any leases
that existed prior to January 1, 2019. We also elected to combine our lease and non-lease components. We have no leases with an
initial term of 12 months or less.
Upon adoption, we recognized total ROU assets
of $2,319, with corresponding liabilities of $2,319 on the condensed consolidated balance sheets. This included $54
of pre-existing finance lease ROU assets previously reported in computer equipment within property and equipment, net. The ROU
assets include adjustments for prepayments and accrued lease payments. The net effect of the adoption resulted in an insignificant
cumulative effect adjustment to retained earnings on January 1, 2019 but did not impact our prior year consolidated statements
of income, statements of cash flows, or statements of shareholders’ equity.
Under
Topic 842, we determine if an arrangement is a lease at inception. 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, 2019, we adopted ASU No.
2016-02,
Leases
(Topic 842), as amended. For information regarding the impact of Topic 842 adoption, see Note
2 – Summary of Significant Accounting Policies and Note 17— Leases.
In October 2018, the FASB issued ASU No.
2018-16 (“ASU 2018-16”),
Derivatives and Hedging
. ASU 2018-16 expands the permissible benchmark interest rates
to include the Secured Overnight Financing Rate (SOFR) to be eligible as a U.S. benchmark interest rate for purposes of applying
hedge accounting under Topic 815, Derivatives and Hedging. The Company adopted this ASU effective January 1, 2019 on a prospective
basis for qualifying or redesignated hedging relationships entered on or after the date of adoption. As we previously adopted the
amendments in Update 2017-12, and as the benchmark rate on our term loan debt does not utilize the SOFR, the adoption of this amendment
had no effect on the Company’s results of operations, financial position and cash flows.
On January 1, 2019, we adopted the final
rule under SEC Release No. 33-10532,
Disclosure Update and Simplification
, which amended certain disclosure requirements
that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements
on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in
each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. We
have updated our Condensed Consolidated Financial Statements to include a reconciliation of the beginning balance to the ending
balance of stockholders’ equity for each period for which a statement of comprehensive income is filed.
On January 1, 2019, we adopted ASU 2017-04,
Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
which aimed to address concerns
over the cost and complexity of the two-step goodwill impairment test by removing the second step of the test. Prior to adoption,
an entity was required to perform a two-step test to determine the amount, if any, of goodwill impairment. In Step 1, an entity
compared the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting
unit exceeds its fair value, the entity performed Step 2 by comparing the implied fair value of goodwill with the carrying amount
of that goodwill for that reporting unit. An impairment charge equal to the amount by which the carrying amount of goodwill for
the reporting unit exceeds the implied fair value of that goodwill is recorded, limited to the amount of goodwill allocated to
that reporting unit. As a result of adoption, in completing our annual impairment testing of goodwill as of September 30, 2019,
we will apply a one-step quantitative test and record the amount of goodwill impairment, if any, as the excess of a reporting unit’s
carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. There was no impact
on our condensed consolidated financial statements as the result of adoption.
Not yet adopted
In August 2018, the FASB issued ASU 2018-15
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract
.
The amendments in this update 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 amendments in
this ASU are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within
those fiscal years. Early adoption of the amendments in this ASU is permitted, including adoption in any interim period, for all
entities. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13,
Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement
.
This standard modifies the disclosure requirements for fair value measurements by removing the requirements to disclose: (i) amount
of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) timing of recognizing transfers between
levels within the fair value hierarchy; and (iii) valuation processes used for Level 3 fair value measurements. Additionally,
the standard now requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive
income (loss) for recurring Level 3 fair value measurements held at the end of each reporting period and the range and weighted
average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal
years beginning after December 15, 2019, including interim periods within those fiscal years. An entity is permitted to early
adopt all of the disclosure changes or early adopt only the removed disclosure requirements and delay adoption of the additional
disclosures until the effective date of this amendment. We are currently evaluating the impact of adopting this guidance on our
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 for fiscal years and interim periods beginning after December 15, 2019. The Company
is evaluating the impact that adoption will have on its consolidated financial statements.
NOTE
4: REVENUE RECOGNITION
On
January 1, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts not completed as of the
date of adoption. Results for reporting periods beginning on or after January 1, 2018 are presented under ASC 606, while prior
period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. Under
this method, we concluded that the cumulative effect of applying this guidance was not material to the financial statements and
no adjustment to the opening balance of accumulated deficit was required on the adoption date.
Under
ASC 606, the Company accounts for revenue using the following steps:
|
●
|
Identify
the contract, or contracts, with a customer
|
|
●
|
Identify the performance obligations in the
contract
|
|
●
|
Determine the transaction price
|
|
●
|
Allocate the transaction price to the identified
performance obligations
|
|
●
|
Recognize revenue when, or as, the Company satisfies
the performance obligations
|
The
Company combines contracts with the same customer into a single contract for accounting purposes when the contracts are entered
into at or near the same time and the contracts are negotiated as a single commercial package, consideration in one contract depends
on the other contract, or the services are considered a single performance obligation. 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.
As
discussed in more detail below, 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. 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.
Deferred
contract acquisition costs were evaluated for inclusion in other assets; however, the Company elected to use the practical expedient
for recording an immediate expense for those 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.
The
Company 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’s 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
typically generate revenue through the following sources:
|
○
|
System hardware sales – displays, computers
and peripherals
|
|
○
|
Professional implementation
and installation services
|
|
○
|
Software design
and development services
|
|
○
|
Software as a service,
including content management
|
|
○
|
Maintenance and
support services
|
The
following table disaggregates the Company’s revenue by major source for the three months ended March 31,
2019:
(in thousands)
|
|
Three Months Ended
March 31,
2019
|
|
Hardware
|
|
$
|
1,641
|
|
|
|
|
|
|
Services:
|
|
|
|
|
Installation Services
|
|
|
2,372
|
|
Software Development Services
|
|
|
3,976
|
|
Managed Services
|
|
|
1,495
|
|
Total Services
|
|
|
7,843
|
|
|
|
|
|
|
Total Hardware and Services
|
|
$
|
9,484
|
|
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 March 31, 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.
In
addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification
of certain costs relating to revenue arrangements with customers. As a result of our analysis, we did not identify any components
of our revenue transactions which required reclassification between gross and net presentation.
NOTE
5: BUSINESS COMBINATION
On
November 20, 2018, the Company completed the Allure Acquisition. Pursuant to the Stock Purchase Agreement, the total purchase
price was $8,450, which was primarily funded using cash from the Company’s public offering closed on November 19, 2018.
The difference between the total purchase price and the net consideration transferred is driven by the cash acquired in the acquisition.
The preliminary purchase price of Allure consisted of the following items:
(in thousands)
|
|
Consideration
|
|
Cash consideration for stock
|
|
|
$
6,300
|
(1)
|
Payable to former Allure management
|
|
|
1,021
|
(2)
|
Seller note payable
|
|
|
900
|
(3)
|
Earnout liability
|
|
|
250
|
(4)
|
Total consideration
|
|
|
8,471
|
|
Cash acquired
|
|
|
(26)
|
(5)
|
Net consideration transferred
|
|
$
|
8,445
|
|
(1)
|
Cash consideration for outstanding shares of
Allure common stock per Stock Purchase Agreement.
|
|
|
(2)
|
Represents a payable due to two former members
of the Allure management team for a total of $1,250 as a result of the acquisition; 30% due in November 2018 and 70% due in
November 2019. The fair value of the payable as of the acquisition date was deemed to be $1,021.
|
|
|
(3)
|
Represents a note payable due from Allure to
Seller, under a pre-existing Seller Note which was amended and restated for this amount 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. The Seller Note thereby increased from $900 per the Stock Purchase Agreement to
$2,303 at the opening balance sheet. That debt is represented by our issuance to the Seller of a promissory note accruing
interest at 3.5% per annum. The promissory note will require us to make quarterly payments of interest through February 19,
2020, on which date the promissory note will mature and all remaining amounts owing thereunder will be due. We are able to
prepay in whole or in part amounts owing under the promissory note, without penalty, at our option, at any time and from time
to time.
|
(4)
|
The Stock Purchase Agreement contemplates additional
consideration or $2,000 to be paid by us to Seller in the event that acquiree revenue exceeds $13,000, as defined in the underlying
agreement. The fair value of the earnout liability was determined to be $250 at the time of acquisition.
|
|
|
(5)
|
Represents the Allure cash balance acquired
at acquisition.
|
The
Company accounted for the Allure Acquisition using the acquisition method of accounting. The preliminary allocation of the purchase
price is based on estimates of the fair value of assets acquired and liabilities assumed as of November 20, 2018. The Company
is continuing to obtain information to determine the acquired assets and liabilities, including tax assets, liabilities and other
attributes. The components of the preliminary purchase price allocation are as follows:
(in thousands)
|
|
Total
|
|
Accounts receivable
|
|
$
|
2,477
|
|
Unbilled receivables
|
|
|
221
|
|
Inventory
|
|
|
142
|
|
Prepaid expenses & other current assets
|
|
|
18
|
|
Property and equipment
|
|
|
177
|
|
Other assets
|
|
|
7
|
|
Identified intangible assets:
|
|
|
|
|
Definite-lived trade names
|
|
|
340
|
|
Developed technology
|
|
|
1,770
|
|
Customer relationships
|
|
|
2,870
|
|
Goodwill
|
|
|
3,911
|
|
Accounts payable
|
|
|
(331
|
)
|
Accrued expenses
|
|
|
(975
|
)
|
Customer deposits
|
|
|
(503
|
)
|
Deferred revenues
|
|
|
(276
|
)
|
Accounts payable converted into Seller Note
|
|
|
(1,403
|
)
|
Net consideration transferred
|
|
$
|
8,445
|
|
The
preliminary fair value of the customer relationship intangible asset has been estimated using the income approach through a discounted
cash flow analysis with the cash flow projections discounted using a rate of 26.0%. The cash flows are based on estimates used
to price the Allure Acquisition, and the discount rates applied were benchmarked with reference to the implied rate of return
from the Company’s pricing model and the weighted average cost of capital.
The
definite-lived trade name represents the Allure brand name as marketed primarily in the sports & entertainment, large venue
and quick service restaurant verticals of the digital signage industry. The Company applied the income approach through an excess
earnings analysis to determine the preliminary fair value of the trade name asset. The Company identified this asset as definite-lived
as opposed to indefinite-lived as the Company plans to utilize the Allure trade name as a product name as opposed to go-to-market
company name. The Company applied the income approach through a relief-from-royalty analysis to determine the preliminary fair
value of this asset.
The
developed technology assets are primarily comprised of know-how and functionality embedded in Allure’s proprietary content
management application which drives currently marketed products and services. The Company applied the income approach through
a relief-from-royalty analysis to determine the preliminary fair value of this asset.
The
Company is amortizing the identifiable intangible assets on a straight-line basis over the weighted average lives ranging from 5 to 15
years.
The
table below sets forth the preliminary valuation and amortization period of identifiable intangible assets:
(in thousands)
|
|
Preliminary Valuation
|
|
|
Amortization Period
|
Identifiable intangible assets:
|
|
|
|
|
|
Definite-lived trade names
|
|
$
|
340
|
|
|
5 years
|
Developed technology
|
|
|
1,770
|
|
|
7 years
|
Customer relationships
|
|
|
2,870
|
|
|
15 years
|
Total
|
|
$
|
4,980
|
|
|
|
The
Company estimated the preliminary fair value of the acquired property, plant and equipment using a combination of the cost and
market approaches, depending on the component. The preliminary fair value of property, plant and equipment of $177.
The
excess of the purchase price over the preliminary estimated fair value of the tangible net assets and identifiable intangible
assets acquired was recorded as goodwill and is subject to change upon final valuation. The factors contributing to the recognition
of the amount of goodwill are based on several strategic and synergistic benefits that are expected to be realized from the Allure
Acquisition. These benefits include a comprehensive portfolio of iconic customer brands, complementary product offerings, enhanced
national footprint, and attractive synergy opportunities and value creation. None of the goodwill is expected to be deductible
for income tax purposes.
The following unaudited pro forma information presents the combined financial results for the Company
and Allure, adjusted for Allure’s fiscal year ended March 31, as if the Allure Acquisition had been completed January 1,
2017. Prior to the Allure Acquisition, Allure had a fiscal year reporting from April 1 to March 31 annually. The pro forma financial
information set forth below for the three months ended March 31, 2019 and 2018 includes Allure’s pro forma information for
the three month period January 1, 2018 through March 31, 2018.
|
|
Three Months Ended
March 31,
|
|
(in thousands, except earnings per common share)
|
|
2019
|
|
|
2018
|
|
|
|
(unaudited)
|
|
Net sales
|
|
$
|
9,484
|
|
|
$
|
6,434
|
|
Net loss
|
|
$
|
(184
|
)
|
|
$
|
(2,513
|
)
|
Loss per common share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.91
|
)
|
NOTE
6: 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 following table presents information
about the Company’s warrant liabilities that are measured at fair value on a recurring basis, and indicates the fair value
hierarchy of the valuation techniques the Company used to determine such fair value. See Note 14 for the inputs used for the probability
weighted Black Scholes valuations at March 31, 2019.
|
|
|
|
|
Quote Prices In Active Markets
|
|
|
Significant Other Observable Inputs
|
|
|
Significant Other Unobservable Inputs
|
|
Description
|
|
Fair Value
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Warrant liabilities at December 31, 2018
|
|
$
|
21
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
21
|
|
Warrant liabilities at March 31, 2019
|
|
$
|
22
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The change in level 3 fair value is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability as of December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
21
|
|
New warrant liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Increase in fair value of warrant liability
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Ending warrant liability as of March 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
22
|
|
As part of the Allure Acquisition, the Stock Purchase Agreement contemplated additional consideration
of $2,000 to be paid by us to 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. There were
no changes to the assumptions nor adjustments recorded to the fair value of the earnout liability as of March 31, 2019 given limited
passage of time in the measurement period and performance in-line with those estimates utilized in developing the initial estimate.
NOTE
7: SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Supplemental Cash Flow Information
|
|
|
|
|
|
|
Non-cash Investing and Financing Activities
|
|
|
|
|
|
|
|
|
Issuance of warrants with term loan extensions / revolver draws
|
|
$
|
-
|
|
|
$
|
266
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
80
|
|
|
$
|
168
|
|
Income taxes, net
|
|
$
|
-
|
|
|
$
|
-
|
|
NOTE
8: INTANGIBLE ASSETS
Intangible
Assets
Intangible
assets consisted of the following at March 31, 2019 and December 31, 2018:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amortization
|
|
Technology platform
|
|
$
|
4,635
|
|
|
|
2,957
|
|
|
$
|
4,635
|
|
|
|
2,895
|
|
Customer relationships
|
|
|
5,330
|
|
|
|
2,536
|
|
|
|
5,330
|
|
|
|
2,477
|
|
Trademarks and trade names
|
|
|
1,020
|
|
|
|
588
|
|
|
|
1,020
|
|
|
|
553
|
|
|
|
|
10,985
|
|
|
|
6,081
|
|
|
|
10,985
|
|
|
|
5,925
|
|
Accumulated amortization
|
|
|
6,081
|
|
|
|
|
|
|
|
5,925
|
|
|
|
|
|
Net book value of amortizable intangible assets
|
|
$
|
4,904
|
|
|
|
|
|
|
$
|
5,060
|
|
|
|
|
|
For
the three months ended March 31, 2019 and 2018, amortization of intangible assets charged to operations was $156 and $232, respectively.
NOTE
9: 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
(1)
|
B
|
|
1/16/2018
|
|
|
1,000
|
|
|
8/16/2020
|
|
|
61,729
|
|
|
8.0% interest
(2)
|
C
|
|
8/17/2016
|
|
|
3,000
|
|
|
8/16/2020
|
|
|
588,236
|
|
|
8.0% interest
(2)
|
D
|
|
11/19/2018
|
|
|
2,303
|
|
|
2/15/2020
|
|
|
-
|
|
|
3.5% interest
(3)
|
|
|
|
|
$
|
6,567
|
|
|
|
|
|
649,965
|
|
|
|
|
|
Debt discount
|
|
|
(875
|
)
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
5,692
|
|
|
|
|
|
|
|
|
|
A
– Secured Disbursed Escrow Promissory Note with related party
B
– Revolving Loan with related party
C
– Term Loan with related party
D
– Amended and Restated Seller Note from acquisition of Allure
(1)
0.0% interest per annum when total borrowings under the term and revolver loans, in aggregate, are below $4,000 in principal
(disregarding paid-in-kind (“PIK”) interest); 8.0% cash, when total borrowing under the term and revolver loans, in
aggregate, exceed $4,000 in principal (disregarding PIK interest)
(2)
8.0% cash interest per annum when total borrowings under the term and revolver loans, in aggregate, are below $4,000 in
principal (disregarding PIK interest); 8.0% cash, 2.0% PIK when total borrowing under the term and revolver loans, in
aggregate, exceed $4,000 in principal (disregarding PIK interest). If the Company does not successfully refinance the
term loan debt facility (C above) with a third party by June 30, 2019, the cash portion of the interest rate will increase
from 8.0% to 10.0% per annum.
(3)
3.5% simple cash interest per annum; interest payable quarterly with the first payment due on December 31, 2018 with payments
of accrued interest continuing quarterly thereafter until the maturity date of February 20, 2020.
Obligations
under the secured convertible promissory notes are secured by a grant of collateral security in all of the tangible assets of
the co-makers pursuant to the terms of an amended and restated security agreement.
Term
Notes and Secured Disbursed Escrow Promissory Note
On
August 17, 2016, we entered into a Loan and Security Agreement with Slipstream, and obtained a $3.0 million term loan, with interest
thereon at 8% per annum. The term loan 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.
On January 16, 2018, we entered into the
Third Amendment to the Loan and Security Agreement with Slipstream and obtained a $1.0 million revolving loan, with interest thereon
at 8% per annum, maturing on January 16, 2019, which was amended to August 16, 2020 in conjunction with the Fifth Amendment to
the Loan and Security Agreement. In connection with the loan, we issued Slipstream a five-year warrant to purchase up to 61,729
shares of Creative Realities’ common stock at a per share price of $8.10 (subject to adjustment and subsequently adjusted
to $8.09 in April 2018). The fair value of the warrants was $266, which was accounted for as an additional debt discount and is
being amortized over the remaining life of the loan.
On April 27, 2018, we entered into the Fourth
Amendment to the Loan and Security Agreement with Slipstream, under which we obtained a $1.1 million revolving loan, with interest
thereon at 8% per annum, provided, however, at all times when the aggregate outstanding principal amount of the Term Loan and the
Revolving Loan (excluding the additional principal added pursuant to this proviso) exceeds $4,000 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 principal
of the Term Loan (“PIK”); provided, further, however, that the Loan Rate with respect to the Disbursed Escrow Loan
shall be 0%. The revolving loan was originally set to mature on January 16, 2019, which was amended to August 16, 2020 in conjunction
with the Fifth Amendment to the Loan and Security Agreement. In connection with the loan, we issued the lender a five-year warrant
to purchase up to 143,791 shares of Creative Realities’ common stock at a per share price of $7.65 (subject to adjustment).
The fair value of the warrants was $543, which was accounted for as an additional debt discount and is being amortized over the
remaining life of the loan.
The
Fourth Amendment to the Loan and Security Agreement included entry into a Secured Disbursed Escrow Promissory Note between the
Company and Slipstream, and, effective June 30, 2018 we drew $264 in conjunction with our exit from a previously leased operating
facility. The principal amount of the Secured Disbursed Escrow Promissory Note will bear simple interest at the 8%; provided,
further, however, that the Loan Rate with respect to the Secured Disbursed Escrow Promissory Note shall be 0% at all times when
the aggregate outstanding principal amount of the Term Loan and the Revolving Loan (excluding the additional principal added pursuant
to this proviso) is at or below $4,000.
On November 19, 2018, we used proceeds from
our public offering to repay Slipstream $1,283, inclusive of $125 of accrued interest, to reduce borrowings under the Loan and
Security Agreement to an aggregate of $4,264, comprised of $3,000 term loan, $1,000 revolving loan and $264 secured disbursed escrow
promissory note. The condensed consolidated balance sheet includes $27 of accrued interest as of March 31, 2019 representing one
month’s interest at 8.0% on the $4,000 outstanding balance.
On November 9, 2018, Slipstream, extended
the maturity date of our term loan and revolver loan to August 16, 2020 through the Fifth Amendment to the Loan and Security Agreement.
Our intent is to refinance our term loan with an unrelated third party in the first half of 2019. In conjunction with the extension
of the maturity date of our term loan, we agreed that the interest rate would conditionally increase from 8.0% per annum to 10.0%
per annum effective July 1, 2019 if we have not successfully completed such refinancing activity by June 30, 2019.
See
Note 14 for the Black Scholes inputs used to calculate the fair value of the warrants.
Convertible
Promissory Notes
On
October 29, 2018, the holder of convertible promissory notes, Slipstream, agreed to convert $4,955 of outstanding principal, including
paid-in-kind interest and all accrued interest thereon into shares of our common stock and warrants at a conversion price equal
to the lower of $7.65, or 80% of the price at which shares of common stock were sold in the Public Offering. The conversion was
contingent upon (i) the conversion of the Company’s Series A Preferred Stock, and (ii) the successful completion of a Public
Offering of at least $10 million, each of which were successfully completed on November 19, 2018. In exchange for participation
in the Public Offering, subject to a minimum participation requirement as agreed between the underwriters and the Company, and
Slipstream’s execution of a lock-up agreement, Slipstream received, as a one-time incentive, additional common stock
and warrants in such number that decreased the effective conversion price of the convertible notes to 70% of the lowest of those
scenarios outlined above. Upon completion of the Company’s Public Offering on November 19, 2018, the convertible promissory
notes were converted into shares of the Company’s common stock. The Company issued 653,062 shares of common stock at the
stated conversion rate and an additional 1,386,090 shares of common stock in exchange for conversion of the convertible promissory
notes as a result of the one-time incentive. The lock-up agreement applied to all shares of common stock and warrants issued to
Slipstream.
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 balance sheet 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 will require us to make quarterly payments of interest only through February 19, 2020, on which
date the promissory note will mature and all remaining amounts owing thereunder will be due. The condensed consolidated balance sheet includes $29 of accrued interest as of March 31, 2019 representing
all interest accrued under the note since close of the Allure Acquisition. We are able to prepay in whole or
in part amounts owing under the promissory note, without penalty, at our option, at any time and from time to time.
The
promissory note is convertible into shares of Creative Realities common stock, at the seller’s option on or after May
19, 2019, 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.
NOTE
10: COMMITMENTS AND CONTINGENCIES
Lease
termination
On
August 10, 2017, we announced the planned closure of our office facilities located at 22 Audrey Place, Fairfield, New Jersey 07004
which housed our previous operations center and ceased use of the facilities in February 2018. In ceasing use of these facilities,
we recorded a one-time non-cash charge of $474 to accrue for the remaining rent under the lease term, net of anticipated subtenant
rental income.
Settlement
of obligations
During the three months ended March 31, 2019,
the Company wrote off obligations of $7 and recognized a gain of $7. There were no such settlements in the three months ended
March 31, 2018.
Litigation
The
Company is involved in various legal proceedings incidental to the operations of its business. The Company believes that the outcome
of all such other pending legal proceedings in the aggregate will not have a material adverse effect on its business, financial
condition, liquidity, or operating results.
Termination
benefits
On
December 21, 2018, the Company announced certain restructuring activities following completion of its acquisition of Allure and
accrued one-time termination benefits related to severance to the affected employees of $386, $31 of which was paid prior to the
year end date. During the three-months ended March 31, 2019, cash payments for termination benefits of $92 were paid and a liability
of $263 remains included in accrued expenses on the condensed consolidated balance sheet.
NOTE
11: RELATED PARTY TRANSACTIONS
In
addition to the financing transactions with Slipstream, a related party, discussed in Note 9, 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 stipulates 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. Remaining payments due under the agreement as of March 31, 2019 were $1,317, $300
of which has been paid subsequent to the reporting date as of the date of this filing. Remaining payments of $150 are to be paid
on the first day of each month beginning June 1, 2019 through the maturity date, or December 31, 2019. All amounts under this note
are included in accounts receivable in current assets as all amounts are expected to be collected within one year of the balance
sheet date. Since inception of this agreement up to and through the filing date, all payments due under this agreement have been
received from 33 Degrees timely, including monthly interest payments and payments for ongoing services.
Since
the Company entered into the payment agreement with 33 Degrees, 33 Degrees has continued to purchase additional hardware and services
from the Company, on a prepaid basis, in addition to making payments under the payment agreement. In aggregate, 33 Degrees has
paid $433 to the Company for new hardware and services above and beyond their contractual obligations under the payment agreement,
primarily from 33 Degrees Menu Services, LLC (33 Degrees MS), a wholly-owned subsidiary of 33 Degrees.
On March 12, 2019 the Company
entered into a security agreement and promissory note with 33 Degrees MS providing a line of credit of $300 for hardware, installation
and SaaS services. Under the agreement, product will be shipped and installed by the Company upon evidence of a valid purchase
order from the ultimate payer being provided as collateral.
For
the three months ended March 31, 2019 and 2018, the Company had sales to 33 Degrees of $195, or 2.1%, and $417, or 10.3%, respectively,
of consolidated revenue. Accounts receivable due from 33 Degrees was $1,516, or 17.3%, and $1,933, or 30.0% of consolidated accounts
receivable at March 31, 2019 and December 31, 2018, respectively.
On January 16, 2018, we entered into the Third
Amendment to the Loan and Security Agreement with Slipstream Communications, LLC, a related party investor, under which we obtained
a $1.0 million revolving loan, with interest thereon at 8% per annum, maturing on January 16, 2019 (subsequently extended to August
2020). In connection with the loan, we issued the lender a five-year warrant to purchase up to 61,729 shares of Creative Realities’
common stock at a per share price of $8.10 (subject to adjustment and subsequently adjusted to $6.09 in November 2019). The fair
value of the warrants was $266, which is accounted for as an additional debt discount and amortized over the remaining life of
the loan.
NOTE
12: 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 its 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 months ended March 31, 2019, we reported tax expense of $21. The net deferred tax liability at March 31, 2019 of $147
represents the liability relating to indefinite lived assets. This indefinite lived deferred tax liability is used as a source
of taxable income to more likely than not realize some of the Company’s indefinite lived deferred tax assets.
NOTE
13: CONVERTIBLE PREFERRED STOCK
The
Series A Convertible Preferred Stock (the “preferred stock”) entitled its holders to a 6% dividend, payable semi-annually
in cash or in kind through the three-year anniversary of the original issue date, and from and after such three-year anniversary
in duly authorized, validly issued, fully paid and non-assessable shares of common stock. The three-year anniversary of the initial
investment date occurred during the second half of 2017 for $5.2 million and the first quarter of 2018 for the remaining $0.3
million originally issued preferred stock and therefore dividends on those investments will be paid via issuance of common shares
at all future dividend dates.
On
November 5, 2018, the shareholders of preferred stock agreed to convert the entire class of preferred stock into common stock
at an exchange ratio of $7.65 per share. The conversion was contingent upon a successful Public Offering of at least $10 million,
which the Company completed on November 19, 2018.
Holders
of preferred stock received common stock at the stated conversion rate of $7.65 per share, or 723,561 shares of common
stock. Those holders of preferred stock who executed a customary lock-up agreement for a period continuing for 90 days after
the consummation of the public offering were issued, as a one-time incentive, additional common stock and warrants, in such
number as defined in underlying agreements. The Company issued an additional 1,123,367 shares of common stock in exchange for
execution of such lock-up agreements. The lock-up agreements applied to all shares of common stock issued to convert the
holder’s preferred stock, and the additional shares of common stock and warrants, and underlying warrant shares, issued
by the Company in exchange for the holder’s execution of the lock-up agreement and participation in the public
offering. As a result of this conversion, there remained no Series A Preferred Stock outstanding as of December 31, 2018.
On
March 18, 2019, we filed Statements of Cancellation with the Secretary of State of the State of Minnesota that, effective
upon filing, eliminated from the Company’s Articles of Incorporation all matters set forth in the Certificates of
Designation of Preferences, Rights and Limitations with respect to the Series A Convertible Preferred Stock and Series A-1
Convertible Preferred Stock of the Company. No shares of Series A Convertible Preferred Stock or Series A-1 Convertible
Preferred Stock were issued or outstanding at the time of the filing of the Statements of Cancellation. A copy of the
Statements of Cancellation were attached as Exhibit 3.1 and 3.2 to Form 8-K filed the same date.
As
of March 31, 2018, the pro rata portion of earned dividends to be distributed as of June 30, 2018 were the equivalent of 3,822
Series A Preferred Stock, which represents 12,369 equivalent common shares based on the volume-weighted adjusted price utilized
for conversion. The fair value of these shares are reflected at fair value as a dividend on preferred stock in the condensed consolidated
statement of operations and do not impact net loss for the period. During the quarter ended March 31, 2018, there were no conversions
of Convertible Preferred Stock into common stock.
NOTE
14: WARRANTS
On
January 16, 2018, we entered into the Third Amendment to the Loan and Security Agreement with Slipstream, under which we obtained
a $1.0 million revolving loan, with interest thereon at 8% per annum, maturing on January 16, 2019 (subsequently extended to August
2020). In connection with the loan, we issued the lender a five-year warrant to purchase up to 61,729 shares of Creative Realities’
common stock at a per share price of $8.10 (subject to adjustment and subsequently adjusted to $6.09 in November 2018). The fair
value of the warrants on the issuance date was $266, which is accounted for as an additional debt discount and amortized over
the remaining life of the loan.
Listed
below are the inputs used for the probability weighted Black Scholes option pricing model valuation for warrants issued during
the three months ended March 31, 2019 and 2018.
Issuance Date
|
|
Expected Term at
Issuance
Date
|
|
|
Risk Free Interest Rate at Date of Issuance
|
|
|
Volatility at
Date of Issuance
|
|
|
Stock Price at Date
of Issuance
|
|
1/16/2018
|
|
|
5.00
|
|
|
|
2.36
|
%
|
|
|
65.07
|
%
|
|
$
|
7.80
|
|
Listed
below are the inputs used for the probability weighted Black Scholes option pricing model valuation for those warrants classified
in the condensed consolidated balance sheet as liabilities as of March 31, 2019.
Remaining Expected
Term at
March 31, 2019 (Years)
|
|
|
Risk Free Interest
Rate at March 31,
2019
|
|
|
Volatility at
March 31,
2019
|
|
|
Stock Price at
March 31,
2019
|
|
|
0.39
|
|
|
|
2.42
|
%
|
|
|
120.11
|
%
|
|
$
|
2.71
|
|
A
summary of outstanding liability and equity warrants is included below:
|
|
Warrants (Equity)
|
|
|
|
|
|
Warrants (Liability)
|
|
|
|
|
|
|
Amount
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life
|
|
|
Amount
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life
|
|
Balance January 1, 2019
|
|
|
4,815,047
|
|
|
$
|
4.90
|
|
|
|
4.34
|
|
|
|
216,255
|
|
|
$
|
7.34
|
|
|
|
0.64
|
|
Warrants issued
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Warrants expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance March 31, 2019
|
|
|
4,815,047
|
|
|
$
|
4.90
|
|
|
|
4.09
|
|
|
|
216,255
|
|
|
$
|
7.34
|
|
|
|
0.39
|
|
NOTE
15: STOCK-BASED COMPENSATION
A
summary of outstanding options is included below:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Range of Exercise
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Options
|
|
|
Exercise
|
|
Prices between
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
$5.40 - $19.50
|
|
|
287,341
|
|
|
|
6.79
|
|
|
$
|
8.35
|
|
|
|
215,048
|
|
|
$
|
8.66
|
|
$19.51 - $23.70
|
|
|
1,000
|
|
|
|
4.79
|
|
|
|
23.70
|
|
|
|
1,000
|
|
|
$
|
23.70
|
|
$23.71 - $367.50
|
|
|
519
|
|
|
|
3.33
|
|
|
|
112.30
|
|
|
|
519
|
|
|
$
|
112.30
|
|
|
|
|
288,860
|
|
|
|
6.78
|
|
|
$
|
8.59
|
|
|
|
216,567
|
|
|
|
|
|
|
|
Options
|
|
|
Weighted Average Exercise
|
|
|
|
Outstanding
|
|
|
Price
|
|
Balance, December 31, 2018
|
|
|
288,860
|
|
|
$
|
8.59
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Forfeited or expired
|
|
|
-
|
|
|
|
-
|
|
Balance, March 31, 2019
|
|
|
288,860
|
|
|
$
|
8.59
|
|
The weighted average remaining contractual
life for options exercisable is 6.26 years as of March 31, 2019.
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. There are 276,674 options outstanding under the 2014 Stock Incentive Plan.
Compensation
expense recognized for the issuance of stock options for the three months ended March 31, 2019 and 2018 was as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2019
|
|
|
2018
|
|
Stock-based compensation costs included in:
|
|
|
|
Costs of sales
|
|
$
|
-
|
|
|
$
|
(6
|
)
|
Sales and marketing expense
|
|
|
-
|
|
|
|
6
|
|
General and administrative expense
|
|
|
41
|
|
|
|
64
|
|
Total stock-based compensation expense
|
|
$
|
41
|
|
|
$
|
64
|
|
At
March 31, 2019, there was approximately $488 of total unrecognized compensation expense related to unvested share-based awards.
Generally, this expense will be recognized over the next three years and will be adjusted for any future forfeitures as they occur.
Stock-based
compensation expense is based on awards ultimately expected to vest. ASC 718-10-55 allows companies to either estimate forfeitures
at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates or elect
to account for forfeitures as they occur by reversing compensation cost when the award is forfeited. Our accounting policy is
to account for forfeitures as they occur by recording a cumulative-effect adjustment in the period in which forfeitures occur.
On
September 20, 2018, the Compensation Committee of the Board of Directors proposed, and the Board of Directors approved, an aggregate
award of 166,667 shares of common stock to our current CEO in light of performance and growth of certain key customer relationships.
Of those shares granted, 133,334 were deemed to be awarded and fully vested as of such date, with the remaining 33,333 shares
restricted to vest upon the Company’s recognition in accordance with GAAP of approximately $6,200 of revenue which is currently
deferred on the Company’s balance sheet. During the three-months ended September 30, 2018, the Company recorded compensation
expense for those vested awards based on the grant-date close price of the Company’s common stock, or $7.50, resulting in
a non-cash, non-recurring compensation expense in the period of $1,000. The remaining expense to be recognized upon vesting of
the restricted shares is $250. The conditions have not been met as of March 31, 2019 for those remaining shares to vest and no
compensation expense has been recorded.
NOTE
16: SIGNIFICANT CUSTOMERS
Major
Customers
We
had 3 customers that in the aggregate accounted for 44% and 40% of accounts receivable as of March 31, 2019 and December
31, 2018, respectively, which includes transactions with 33 Degrees for both periods.
We
had 2 and 4 customers that accounted for 42% and 66% of revenue for the three months ended March 31, 2019 and 2018, respectively,
of which 33 Degrees represented 2.1% and 10.3% for the same periods, respectively.
NOTE
17: 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 2019 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)
|
|
Three Months Ended March 31, 2019
|
|
Finance lease cost
|
|
|
|
Amortization of right-of-use assets
|
|
$
|
8
|
|
Interest
|
|
|
2
|
|
Operating lease cost
|
|
|
197
|
|
Total lease cost
|
|
$
|
207
|
|
|
|
|
|
|
Weighted Average Remaining Lease Term
|
|
|
|
|
Operating leases
|
|
|
4.0 years
|
|
Finance leases
|
|
|
1.6 years
|
|
|
|
|
|
|
Weighted Average Discount Rate
|
|
|
|
|
Operating leases
|
|
|
10.0
|
%
|
Finance leases
|
|
|
13.3
|
%
|
The
following is a schedule, by years, of maturities of lease liabilities as of March 31, 2019:
(in thousands)
|
|
Operating Leases
|
|
|
Finance Leases
|
|
The remainder of 2019
|
|
$
|
528
|
|
|
$
|
27
|
|
2020
|
|
|
681
|
|
|
|
22
|
|
2021
|
|
|
630
|
|
|
|
3
|
|
2022
|
|
|
377
|
|
|
|
-
|
|
2023
|
|
|
375
|
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
|
|
-
|
|
Total undiscounted cash flows
|
|
|
2,591
|
|
|
|
52
|
|
Less imputed interest
|
|
|
(463
|
)
|
|
$
|
(5
|
)
|
Present value of lease liabilities
|
|
$
|
2,128
|
|
|
$
|
47
|
|
Supplemental
cash flow information related to leases are as follows:
|
|
Three Months
Ended March 31,
2019
|
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
191
|
|
Operating cash flows from finance leases
|
|
$
|
1
|
|
Financing cash flows from finance leases
|
|
$
|
8
|
|
|
|
|
|
|
Lease liabilities arising from obtaining right-of-use assets:
|
|
|
|
|
Operating leases
|
|
$
|
-
|
|
Finance leases
|
|
$
|
-
|
|