Company Quick10K Filing
Creative Realities
Price1.78 EPS49
Shares0 P/E0
MCap0 P/FCF0
Net Debt4 EBIT1
TEV4 TEV/EBIT3
TTM 2019-09-30, in MM, except price, ratios
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CREX 10Q Quarterly Report

Part 1. Financial Information
Item 1. Financial Statements
Note 1: Nature of Organization and Operations
Note 2: Summary of Significant Accounting Policies
Note 3: Recently Issued Accounting Pronouncements
Note 4: Revenue Recognition
Note 5: Fair Value Measurement
Note 6: Supplemental Cash Flow Statement Information
Note 7: Intangible Assets, Including Goodwill
Note 8: Loans Payable
Note 9: Commitments and Contingencies
Note 10: Related Party Transactions
Note 11: Income Taxes
Note 12: Warrants
Note 13: Stock - Based Compensation
Note 14: Significant Customers/Vendors
Note 15: Leases
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward - Looking Statements
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
EX-31.1 f10q0320ex31-1_creative.htm
EX-31.2 f10q0320ex31-2_creative.htm
EX-32.1 f10q0320ex32-1_creative.htm
EX-32.2 f10q0320ex32-2_creative.htm
EX-99.1 f10q0320ex99-1_creative.htm

Creative Realities Earnings 2020-03-31

Balance SheetIncome StatementCash Flow
0.10.10.0-0.0-0.1-0.12012201420172020
Assets, Equity
0.10.10.0-0.0-0.1-0.12012201420172020
Rev, G Profit, Net Income
0.10.10.0-0.0-0.1-0.12012201420172020
Ops, Inv, Fin

10-Q 1 f10q0320_creativerealities.htm QUARTERLY REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2020

 

or

 

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

 

For the transition period from ___________ to ___________

 

Commission File Number 001-33169

 

 

 

Creative Realities, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Minnesota   41-1967918

State or Other Jurisdiction of

Incorporation or Organization

  I.R.S. Employer
Identification No.
     
13100 Magisterial Drive, Suite 100, Louisville KY   40223
Address of Principal Executive Offices   Zip Code

 

(502) 791-8800

Registrant’s Telephone Number, Including Area Code

 

 

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

 

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

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, par value $0.001 per share   CREX   The Nasdaq Stock Market LLC
Warrants to purchase Common Stock   CREXW   The Nasdaq Stock Market LLC

 

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

 

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

 

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

 

  Large accelerated filer ☐ Accelerated filer ☐
  Non-accelerated filer ☐ Smaller reporting company ☒
    Emerging growth company ☐  

 

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

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

As of May 14, 2020, the registrant had 9,827,023 shares of common stock outstanding.

 

 

 

 

 

  

PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

   March 31,   December 31, 
   2020   2019 
   (unaudited)     
ASSETS        
CURRENT ASSETS        
Cash and cash equivalents  $2,141   $2,534 
Accounts receivable, net of allowance of $945 and $617, respectively   3,293    4,663 
Unbilled receivables   72    86 
Work-in-process and inventories, net of reserve of $136 and $134, respectively   714    379 
Prepaid expenses and other current assets   460    320 
Total current assets   6,680    7,982 
           
Operating lease right-of-use assets   1,599    1,728 
Property and equipment, net   1,614    1,553 
Intangibles, net   4,248    4,407 
Goodwill   7,525    18,171 
Other assets   126    135 
TOTAL ASSETS  $21,792   $33,976 
LIABILITIES AND SHAREHOLDERS’ EQUITY          
CURRENT LIABILITIES          
Short-term seller note payable   1,637    1,637 
Short-term related party convertible loans payable, at fair value   2,171    2,000 
Accounts payable   2,002    1,849 
Accrued expenses   2,298    2,751 
Deferred revenues   1,453    772 
Customer deposits   1,350    755 
Current maturities of operating leases   649    646 
Current maturities of finance leases   16    21 
Total current liabilities   11,576    10,431 
Long-term related party loans payable, net of $422 and $507 discount, respectively   3,869    3,757 
Long-term obligations under operating leases   970    1,100 
Deferred tax liabilities   -      175 
Other long-term liabilities   2    5 
TOTAL LIABILITIES   16,417    15,468 
SHAREHOLDERS’ EQUITY          
Common stock, $.01 par value, 200,000 shares authorized; 9,795 and 9,775 shares issued and outstanding, respectively   98    98 
Additional paid-in capital   54,102    54,052 
Accumulated deficit   (48,825)   (35,642)
Total shareholders’ equity   5,375    18,508 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $21,792   $33,976 

 

  

See accompanying notes to condensed consolidated financial statements

 

1

 

 

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

   For the Three Months Ended 
   March 31, 
   2020   2019 
Sales        
Hardware  $1,367   $1,641 
Services and other   2,337    7,843 
Total sales   3,704    9,484 
Cost of sales          
Hardware   983    1,405 
Services and other   1,114    4,398 
Total cost of sales   2,097    5,803 
Gross profit   1,607    3,681 
Operating expenses:          
Sales and marketing   427    697 
Research and development   313    373 
General and administrative   2,856    2,290 
Depreciation and amortization   366    286 
Goodwill impairment   10,646    -   
Total operating expenses   14,608    3,646 
Operating income/(loss)   (13,001)   35 
           
Other income (expenses):          
Interest expense   (227)   (204)
Gain on settlement of obligations   40    7 
Change in fair value of Special Loan   (151)   -   
Other income/(expense)   1    (1)
Total other income/(expense)   (337)   (198)
Income/(loss) before income taxes   

(13,338

)   (163)
Benefit from / (provision for) income taxes   155    (21)
Net income/(loss)  $(13,183)  $(184)
Basic earnings/(loss) per common share  $(1.35)  $(0.02)
Diluted earnings/(loss) per common share  $(1.35)  $(0.02)
Weighted average shares outstanding - basic   9,794    9,725 
Weighted average shares outstanding - diluted   9,794    9,725 

 

  

See accompanying notes to condensed consolidated financial statements.

 

2

 

 

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   Three Months Ended 
   March 31, 
   2020   2019 
Operating Activities:        
Net income/(loss)  $(13,183)  $(184)
Adjustments to reconcile net income/(loss) to net cash used in operating activities          
Depreciation and amortization   366    277 
Amortization of debt discount   85    156 
Stock-based compensation   50    41 
Change in warrant liability   -      1 
Change in fair value of Special Loan   151    -   
Deferred tax provision   (175)   19 
Allowance for doubtful accounts   328    68 
Increase in notes due to in-kind interest   47    -   
Loss on goodwill impairment   10,646      
Gain on settlement of obligations   (40)   (7)
Changes to operating assets and liabilities:          
Accounts receivable and unbilled receivables   1,056    (556)
Inventories   (335)   (286)
Prepaid expenses and other current assets   (140)   623 
Operating lease right-of-use assets, net   129    141 
Other assets   9    9 
Accounts payable   193    402 
Deferred revenue   681    (1,024)
Accrued expenses   (453)   1,419 
Deposits   595    (1,196)
Other liabilities   (127)   (135)
Net cash used in operating activities   (117)   (232)
Investing activities          
Purchases of property and equipment   (268)   (230)
Net cash used in investing activities   (268)   (230)
Financing activities          
Principal payments on finance leases   (8)   (8)
Net cash used in financing activities   (8)   (8)
Increase/(decrease) in Cash and Cash Equivalents   (393)   (470)
Cash and Cash Equivalents, beginning of period   2,534    2,718 
Cash and Cash Equivalents, end of period  $2,141   $2,248 

   

See accompanying notes to condensed consolidated financial statements.

 

3

 

 

CREATIVE REALITIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands, except shares)

 

                Additional              
    Common Stock     paid in     Accumulated        
    Shares     Amount     capital     (Deficit)     Total  
Balance as of December 31, 2019     9,774,546     $ 98     $ 54,052     $ (35,642 )   $ 18,508  
Stock-based compensation     -       -       19       -       19  
Shares issued to directors as compensation     20,425       -       31       -       31  
Net loss     -       -       -       (13,183 )     (13,183 )
Balance as of March 31, 2020     9,794,971     $ 98     $ 54,102     $ (48,825 )   $ 5,375  

 

  

           Additional         
   Common Stock   paid in   Accumulated     
   Shares   Amount   capital   (Deficit)   Total 
Balance as of December 31, 2018   9,724,826   $97   $53,575   $(36,851)  $16,821 
Adoption of ASU 2016-02   -    -    -    171    171 
Stock-based compensation   -    -    41    -    41 
Net loss   -    -    -    (184)   (184)
Balance as of March 31, 2019   9,724,826   $97   $53,616   $(36,864)  $16,849 

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

 

CREATIVE REALITIES, INC.

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 three months ended March 31, 2020. For the three months ended March 31, 2020 and 2019, we have incurred net losses of $13,183 and $184, respectively. As of March 31, 2020, we had cash and cash equivalents of $2,141 and working capital deficit of $4,896, which includes $649 representing current maturities of operating leases that were initially recognized January 1, 2019 upon adoption of Accounting Standards Update (“ASU”) 2016-02, and for which no corresponding current asset is recorded.

 

5

 

 

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 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 has caused the projected incoming cash to be delayed, and consequently cash flows have been 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 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;

 

6

 

 

  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 the Company’s term, revolving and special 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) the extension of the maturity date on our term loan and revolving loans to June 30, 2021, (ii) our receipt of approximately $1,551 of funding through the Payroll Protection Program on April 27, 2020, (iii) our operational forecast through 2021, and (iv) support from Slipstream through June 30, 2021, we can continue as a going concern through at least May 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 three months ended March 31, 2020, we can provide no assurance that our ongoing operational efforts will be successful, particularly in consideration of the business interruptions and uncertainty generated as a result of the COVID-19 pandemic which could have a material adverse effect on 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.

 

7

 

 

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:

 

   March 31,   December 31, 
   2020   2019 
Raw materials, net of reserve of $136 and $134, respectively  $241   $200 
Work-in-process   473    179 
Total inventories  $714   $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 March 31, 2020 and concluded there were none.

 

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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 5,035,518 and 5,320,162 at March 31, 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 months ended March 31, 2020, in accordance with ASC 260 Earnings per share, we included 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 March 31, 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.

 

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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 months ended March 31, 2020 and 2019:

 

(in thousands)  Three Months
Ended
March 31,
2020
   Three Months
Ended
March 31,
2019
 
Hardware  $1,367   $1,641 
           
Services:          
Installation Services   869    2,372 
Software Development Services   142    3,976 
Managed Services   1,326    1,495 
Total Services   2,337    7,843 
           
Total Hardware and Services  $3,704   $9,484 

 

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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, 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.

 

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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 March 31, 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 March 31, 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 $151 loss during the period 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

 

   Three Months Ended 
   March 31, 
   2020   2019 
Supplemental Cash Flow Information          
Non-cash Investing and Financing Activities          
Cash paid during the period for:          
Interest  $107   $80 
Income taxes, net  $1   $- 

 

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NOTE 7: INTANGIBLE ASSETS, INCLUDING GOODWILL

 

Intangible Assets

 

Intangible assets consisted of the following at March 31, 2020 and December 31, 2019: 

 

   March 31,   December 31, 
   2020   2019 
   Gross       Gross     
   Carrying   Accumulated   Carrying   Accumulated 
   Amount   Amortization   Amount   Amortization 
Technology platform  $4,635    3,210   $4,635    3,147 
Customer relationships   5,330    2,727    5,330    2,679 
Trademarks and trade names   1,020    800    1,020    752 
    10,985    6,737    10,985    6,578 
Accumulated amortization   6,737         6,578      
Net book value of amortizable intangible assets  $4,248        $4,407      

 

For the three months ended March 31, 2020 and 2019, amortization of intangible assets charged to operations was $159 and $156, 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 March 31, 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 indicate that an impairment loss may have been incurred during the period. 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.

 

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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 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.

 

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 (1)
B   1/16/2018     1,007     6/30/2021     61,729      10.0% interest (2)
C   8/17/2016     3,020     6/30/2021     588,236      10.0% interest (2)
D   11/19/2018     1,637     2/15/2020     -      3.5% interest (3)
E   12/30/2019     2,171     6/30/2021(4)     -      10.0% interest (4)
    Total debt, gross     8,099           649,965      
    Debt discount     (422 )                
    Total debt, net   $ 7,677                  
    Less current maturities     (3,808 )                
    Long term debt     3,869                  

 

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

 

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(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.

 

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 the Company’s term, revolving and special 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.

 

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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. As of March 31, 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 $151 loss during the period 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.

 

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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 $29 in accrued expenses in the Condensed Consolidated Financial Statements as of March 31, 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 is in the early stages of litigation 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.

 

The Company is not party to any other material legal proceedings, other than ordinary routine litigation incidental to the business, as of May 7, 2020, and there were no other such proceedings pending during the period covered by this Report.

 

Termination benefits

 

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.

 

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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 is included in accrued expenses on the Condensed Consolidated Balance Sheet. 

 

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 months ended March 31, 2020 and 2019, the Company had sales to 33 Degrees of $500, or 13.5%, and $195, or 2.1%, respectively, of consolidated revenue. Accounts receivable due from 33 Degrees was $211, or 5.0%, and $1, or 0.0% of consolidated accounts receivable at March 31, 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 months ended March 31, 2020, we reported tax benefit of $155. As of March 31, 2020, the net deferred tax assets totaled $0 after valuation allowance, as compared to $175 at December 31, 2019. As discussed above, this 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   -    -    - 
Warrants expired   (11,318)   12.20    - 
Balance March 31, 2020   4,815,047   $4.81    3.17 

 

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NOTE 13: 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 
$0.01 - $5.39   25,000    9.61   $1.88    0   $1.88 
$5.40 - $7.50   203,997    6.24   $6.91    166,913   $6.73 
$7.51 - $160.50   84,812    4.65    12.43    84,812   $12.43 
    313,809    6.08   $8.00    251,725      

 

   Options   Weighted Average Exercise 
   Outstanding   Price 
Balance, December 31, 2019   313,860   $8.06 
Granted   -    - 
Exercised   -    - 
Forfeited or expired   51    368 
Balance, March 31, 2020   313,809   $8.00 

 

The weighted average remaining contractual life for options exercisable is 5.4 years as of March 31, 2020.

 

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 years three months ended March 31, 2020 and 2019 of $50 and $41, 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 March 31, 2020, there was approximately $155 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.

 

NOTE 14: SIGNIFICANT CUSTOMERS/VENDORS

 

Significant Customers

 

We had two (2) and one (1) customers that in the aggregate accounted for 24% and 18.5% of accounts receivable as of March 31, 2020 and December 31, 2019, respectively, which includes transactions with 33 Degrees for both periods.

 

We had 3 and 2 customers that accounted for 39% and 42% of revenue for the three months ended March 31, 2020 and 2019, respectively, of which 33 Degrees represented 13.6% and 2.1% for the same periods, respectively.

 

Significant Vendors

 

We had two (2) and one (1) vendors that accounted for 41% and 50% of outstanding accounts payable at March 31, 2020 and December 31, 2019, respectively.

 

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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)  Three Months Ended
March 31,
2020
   Three Months Ended
March 31,
2019
 
Finance lease cost        
Amortization of right-of-use assets  $7   $8 
Interest   1    2 
Operating lease cost   172    197 
Total lease cost  $180   $207 
           
Weighted Average Remaining Lease Term          
Operating leases   3.2 years    4.0 years 
Finance leases   1.1 years    1.6 years 
           
Weighted Average Discount Rate          
Operating leases   10.0%   10.0%
Finance leases   13.8%   13.3%

 

The following is a schedule, by years, of maturities of lease liabilities as of March 31, 2020:

 

(in thousands)  Operating
Leases
   Finance
Leases
 
The remainder of 2020  $513   $15 
2021   630    4 
2022   377    1 
2023   375    - 
Thereafter   -    - 
Total undiscounted cash flows   1,895    20 
Less imputed interest   (277)  $(2)
Present value of lease liabilities  $1,619   $18 

  

Supplemental cash flow information related to leases are as follows:

 

(in thousands)  Three Months Ended
March 31,
2020
   Three Months Ended
March 31,
2019
 
Cash paid for amounts included in the measurement of lease liabilities:          
Operating cash flows from operating leases  $170   $191 
Operating cash flows from finance leases   1    1 
Financing cash flows from finance leases   7    8 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements

 

The following discussion contains various forward-looking statements within the meaning of Section 21E of the Exchange Act. Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. When used in the following discussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates,” “projects,” should,” “may,” “propose,” and similar expressions (or the negative versions of such words or expressions), as they relate to us or our management, are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those anticipated, and many of which are beyond our control. Factors that could cause actual results to differ materially from those anticipated are set forth under the caption “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission on March 13, 2020, and this Report under Part II, Item 1A.

 

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking statements. Accordingly, we cannot be certain that any of the events anticipated by forward-looking statements will occur or, if any of them do occur, what impact they will have on us. We caution you to keep in mind the cautions and risks described in this document and to refrain from attributing undue certainty to any forward-looking statements, which speak only as of the date of the document in which they appear. We do not undertake to update any forward-looking statement.

 

Overview

 

Creative Realities, Inc. is a Minnesota corporation that provides innovative digital marketing technology solutions to a broad range of companies, individual brands, enterprises, and organizations throughout the United States and in certain international markets. We have expertise in a broad range of existing and emerging digital marketing technologies across 18 vertical markets, as well as the related media management and distribution software platforms and networks, device and content 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; content creation, production and scheduling programs and systems; a comprehensive series of recurring maintenance, support, and field service offerings; 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.

 

Our main operations are conducted directly through Creative Realities, Inc. and 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.

 

We generate revenue in our business by:

 

  consulting with our customers to determine the technologies and solutions required to achieve their specific goals, strategies and objectives;

 

  designing our customers’ digital marketing experiences, content and interfaces;

 

  engineering the systems architecture delivering the digital marketing experiences we design – both software and hardware – and integrating those systems into a customized, reliable and effective digital marketing experience;

 

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  managing the efficient, timely and cost-effective deployment of our digital marketing technology solutions for our customers;

 

  delivering and updating the content of our digital marketing technology solutions using a suite of advanced media, content and network management software products; and

 

  maintaining our customers’ digital marketing technology solutions by: providing content production and related services; creating additional software-based features and functionality; hosting the solutions; monitoring solution service levels; and responding to and/or managing remote or onsite field service maintenance, troubleshooting and support calls.

 

These activities generate revenue through: bundled-solution sales; consulting services, experience design, content development and production, software development, engineering, implementation, and field services; software license fees; and maintenance and support services related to our software, managed systems and solutions.

 

Recent Developments

 

In January 2020, an outbreak of a new strain of coronavirus, COVID-19, was identified in Wuhan, China. Through the first quarter of 2020, the disease became widespread around the world, and on March 11, 2020, the World Health Organization declared a pandemic. Thereafter, state and local authorities in the United States and worldwide have forced many businesses to temporarily reduce or cease operations to slow the spread of the COVID-19 pandemic.

 

As a result of the COVID-19 pandemic, we have experienced rapid and immediate deterioration in our business in each of our key vertical markets. The elective and forced closures of, and implementation of social distancing policies on, businesses across the United States has resulted in materially reduced demand for our services by our customers, as our customers purchase our products and services to engage with their end customers in a physical space through digital technology, particularly in our theater, sports arena and large entertainment markets. The reduced demand has resulted in customer orders being delayed. These conditions have resulted in downward revisions of our internal forecasts on current and future projected earnings and cash flows, resulting in a non-cash impairment loss of $10,646 recording during the period, and reduced liquidity as described below.

 

While we are experiencing an intense curtail in current customer demand, our long-term outlook for the digital signage industry remains strong. We believe that the digital signage industry will experience rapid consolidation, adding scale and enhancing profitability to those companies that emerge as the enterprise-level providers within our industry after the COVID-19 pandemic and consolidations. We believe that one byproduct of the COVID-19 pandemic may be the acceleration of industry consolidation as smaller providers may be unwilling or unable to continue business over the course of 2020.

 

Given the uncertainty around the extent and timing of the potential future spread or mitigation of the COVID-19 pandemic and around the imposition or relaxation of protective measures, we cannot reasonably estimate the impact to our future results of operations, cash flows, or financial condition at this time.

 

See “Termination Benefits” under Note 9 Commitments and Contingencies for a discussion of the Company’s cost-control measures, including employment compensation reductions designed to achieve preliminary cost savings in light of the significant economic uncertainty caused by the COVID-19 pandemic.

 

Our Sources of Revenue

 

We generate revenue through digital marketing solution sales, which include system hardware, professional and implementation services, software design and development, software licensing, deployment, and maintenance and support services.

 

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We currently market and sell our technology and solutions primarily through our sales and business development personnel, but we also utilize agents, strategic partners, and lead generators who provide us with access to additional sales, business development and licensing opportunities.

 

Our Expenses

 

Our expenses are primarily comprised of three categories: sales and marketing, research and development, and general and administrative. Sales and marketing expenses include salaries and benefits for our sales, business development, solution management and marketing personnel, and commissions paid on sales. This category also includes amounts spent on marketing networking events, promotional materials, hardware and software to prospective new customers, including those expenses incurred in trade shows and product demonstrations, and other related expenses. Our research and development expenses represent the salaries and benefits of those individuals who develop and maintain our proprietary software platforms and other software applications we design and sell to our customers. Our general and administrative expenses consist of corporate overhead, including administrative salaries, real property lease payments, salaries and benefits for our corporate officers and other expenses such as legal and accounting fees.

 

Critical Accounting Policies and Estimates

 

The Company’s significant accounting policies are described in Note 2 Summary of Significant Accounting Policies of the Company’s Condensed Consolidated Financial Statements included elsewhere in this filing. The Company’s Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States. Certain accounting policies involve significant judgments, assumptions, and estimates by management that could have a material impact on the carrying value of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Our actual results could differ from those estimates. 

 

Results of Operations

 

Note: All dollar amounts reported in Results of Operations are in thousands, except per-share information.

 

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019 

 

The tables presented below compare our results of operations and present the results for each period and the change in those results from one period to another in both dollars and percentage change.

 

    For the three months
ended March 31,
    Change  
    2020     2019     Dollars     %  
Sales   $ 3,704     $ 9,484     $ (5,780 )     -61 %
Cost of sales     2,097       5,803       (3,706 )     -64 %
Gross profit     1,607       3,681       (2,074 )     -56 %
Sales and marketing expenses     427       697       (270 )     -39 %
Research and development expenses     313       373       (60 )     -16 %
General and administrative expenses     2,856       2,290       566       25 %
Depreciation and amortization expense     366       286       80       28 %
Loss on goodwill impairment     10,646       -       10,646       100 %
Total operating expenses     14,608       3,646       10,962       301 %
Operating income/(loss)     (13,001 )     35       (13,036 )     -37,246 %
Other income/(expenses):                                
Interest expense     (227 )     (204 )     23       11 %
Change in fair value of warrant liability     -       (1 )     1       -100 %
Change in fair value of Special Loan     (151 )     -       (151 )     -100 %
Gain on settlement of obligations     40       7       33       471 %
Other income/(expense)     1       -       1       100 %
Total other income/(expense)     (337 )     (198 )     (139 )     70 %
Net loss before income taxes     (13,338 )     (163 )     (13,175 )     8,083 %
Provision from income taxes     155       (21 )     176       -838 %
Net loss   $ (13,183 )   $ (184 )   $ (13,154 )     7,065 %

 

   

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Sales

 

Sales decreased by $5,780, or 61%, in the three months ended March 31, 2020 as compared to the same period in 2019 due to (i) non-recurrence of a $2,083 software development project completed in the three months ended March 31, 2019, (ii) non-recurrence of $1,802 revenue recognized from a single sales transaction of software licenses which were sold in 2018 but initially recorded as deferred revenue and ultimately recognized as revenue in the three months ended March 31, 2019, and (iii) a general reduction in both sales and installation activity, highlighted by a significant increase in suspended, delayed, and cancelled customer projects, initiatives, and capital expenditures during the three months ended March 31, 2020 as a direct result of COVID-19.

 

Gross Profit

 

Gross profit decreased $2,074 in absolute dollars from $3,681 to $1,607, or 56%, primarily as a result of the decrease in sales, partially offset by an increase in gross profit margin. Gross profit margin increased to 43.4% in 2020 from 38.8% in 2019 during the same period. The increase in gross profit margin is the result of sales mix during the period, with managed services, including our recurring revenue, representing a higher percentage of total revenue in part as the result of a reduction in hardware and installation services revenue. Gross profit margin from services revenues increased to 52.3% from 43.9% driven by the increase in managed services revenue as a percentage of total services revenue.

 

Sales and Marketing Expenses

 

Sales and marketing expenses generally include the salaries, taxes, and benefits of our sales and marketing personnel, as well as trade show activities, travel, and other related sales and marketing costs. Sales and marketing expenses decreased by $270, or 39%, in 2020 compared to 2019. The decrease was there result of reduced personnel costs, combined with reduced spend on trade show activity and related travel costs following the cancellation of several key industry events as a result of COVID-19. We anticipate that our sales and marketing expenses will continue to be significantly lower than those incurred in 2019 as trade shows and industry events planned for the remainder of 2020 have already been suspended, delayed, or completely cancelled. We further anticipate our sales personnel will reduce travel costs during the extended pandemic period and utilize virtual meeting technology more commonly moving forward.

  

Research and Development Expenses

 

Research and development expenses decreased by $60, or 16%, in 2020 compared to 2019 as the result of a reduction in personnel costs during the period.

  

General and Administrative Expenses

 

Total general and administrative expenses increased by $566, or 25%, in 2020 compared to 2019 driven by recording an incremental reserve for bad debts of $344 in the three months ended March 31, 2020, an increase of $282, or 462%, versus the same period in the prior year, in response the changes in customer payment activity during the period and the age of our accounts receivable beyond standard payment terms. The Company also incurred legal expense of $120 in the three months ended March 31, 2020, an increase of $72, or 148%, versus the same period in the prior year driven by those legal actions outlined within Note 10 Commitments and Contingencies. The Company has also experienced continued pressure on both health and commercial insurance rates, including specifically rates related to a tightening market for director and officer insurance, resulting in an increase of $36, or 77%, in insurance-related costs in the three months ended March 31, 2020 versus the same period in 2019. Total general and administrative employee-related expenses, including salaries, benefits, payroll taxes, bonuses, and travel and entertainment expenses, increased approximately 5%, or $69, in the three months ended March 31, 2020 versus the same period in 2019. We expect a reduction in these employee-related expenses in future periods as a result of the actions outlined within Note 10 Commitments and Contingencies.

 

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Depreciation and Amortization Expenses

 

Depreciation and amortization expenses increased by $80, or 28%, in 2020 compared to 2019. This increase was primarily driven by increased depreciation expense related to increasing spend on capitalized software since the acquisition of Allure.

 

Goodwill impairment

 

See Note 7 Intangible Assets, Including Goodwill to the Condensed Consolidated Financial Statements for a discussion of the Company’s interim impairment test and the non-cash impairment charge recorded.

 

Interest Expense

 

See Note 8 Loans Payable to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt and related interest expense obligations.

 

Change in fair value of Special Loan

 

As of March 31, 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 $151 loss during the period from the change in fair value of the liability

 

Summary Unaudited Quarterly Financial Information

 

The following represents unaudited financial information derived from the Company’s quarterly financial statements: 

 

   March 31,   December 31,   September 30,   June 30,   March 31, 
Quarters ended  2020   2019   2019   2019   2019 
Net sales  $3,704   $6,077   $6,723   $9,314   $9,484 
Cost of sales   2,097    3,553    3,417    5,086    5,803 
Gross profit   1,607    2,524    3,306    4,228    3,681 
Operating expenses, inclusive of one-time lease termination expense, excluding depreciation and amortization   3,596    2,872    2,942    3,425    3,360 
Goodwill impairment   10,646    -    -    -    - 
Depreciation/amortization   366    378    278    308    286 
Operating (loss)/income   (13,001)   (726)   86    495    35 
Other expenses/(income)   (182)   (1,289)   (156)   78    219 
Net (loss)/income  $(13,183)  $563   $242   $417   $(184)

 

Supplemental Operating Results on a Non-GAAP Basis

 

The following non-GAAP data, which adjusts for the categories of expenses described below, is a non-GAAP financial measure. Our management believes that this non-GAAP financial measure is useful information for investors, shareholders and other stakeholders of our company in gauging our results of operations on an ongoing basis. We believe that EBITDA is a performance measure and not a liquidity measure, and therefore a reconciliation between net loss/income and EBITDA and Adjusted EBITDA has been provided. EBITDA should not be considered as an alternative to net loss/income as an indicator of performance or as an alternative to cash flows from operating activities as an indicator of cash flows, in each case as determined in accordance with GAAP, or as a measure of liquidity. In addition, EBITDA does not take into account changes in certain assets and liabilities as well as interest and income taxes that can affect cash flows. We do not intend the presentation of these non-GAAP measures to be considered in isolation or as a substitute for results prepared in accordance with GAAP. These non-GAAP measures should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP.

 

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   March 31,   December 31,   September 30,   June 30,   March 31, 
Quarters ended  2020   2019   2019   2019   2019 
GAAP net loss  $(13,183)  $563   $242   $417   $(184)
Interest expense:                         
Amortization of debt discount   85    105    105    158    156 
Other interest, net   142    109    94    55    48 
Depreciation/amortization   366    378    278    308    286 
Income tax expense/(benefit)   (155)   128    51    (107)   21 
EBITDA  $(12,745)  $1,283   $770   $831   $327 
Adjustments                         
Change in warrant liability   -      -      -      (22)   1 
Change in fair value of Special Loan   151    -      -      -      -   
Gain on settlement of obligations   (40)   (1,632)   (406)   (6)   (7)
Gain on earnout liability   -      (250)   -      -      -   
Loss on goodwill impairment   10,646    -      -      -      -   
Stock-based compensation   50    52    62    291    42 
Adjusted EBITDA  $(1,938)  $(547)  $426   $1,094   $363 

 

 

Liquidity and Capital Resources

 

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 three months ended March 31, 2020. For the three months ended March 31, 2020 and 2019 we have incurred net losses of $13,183 and $184, respectively. As of March 31, 2020, we had cash and cash equivalents of $2,141 and working capital deficit of $4,896, which includes $649 representing current maturities of operating leases which were initially recognized January 1, 2019 upon adoption of Accounting Standards Update (“ASU”) 2016-02, and for which no corresponding current asset is recorded.

 

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 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 has caused the projected incoming cash to be delayed, and consequently cash flows have been 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 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.

 

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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.

 

Management believes that, based on (i) the extension of the maturity date on our term loan and revolving loans to June 30, 2021, (ii) our receipt of approximately $1,551 of funding through the Payroll Protection Program on April 27, 2020, (iii) our operational forecast through 2021, and (iv) support from Slipstream through June 30, 2021, we can continue as a going concern through at least May 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 three months ended March 31, 2020, we can provide no assurance that our ongoing operational efforts will be successful, particularly in consideration of the business interruptions and uncertainty generated as a result of the COVID-19 pandemic which could have a material adverse effect on 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.

 

Operating Activities

 

As of December 31, 2019, we had an accumulated deficit of $35,642. The cash flows used in operating activities was $117 and $232 for the three months ended March 31, 2020 and 2019, respectively. The cash flows used in operating activities was driven by the Company’s net loss partially offset by a non-cash charge for fair value of our Special Loan, a non-cash impairment charge related to goodwill combined with increases in customer deposits and deferred revenue, each representing advance cash collections on future performance obligations, and a reduction in accounts receivable.

 

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Investing Activities

 

Net cash used in investing activities during the three months ended March 31, 2020 was $268 compared to $230 during the same period in 2019. The use of cash in both periods represents acquisition of capital assets, primarily related to the capitalization of software costs. We currently do not have any material commitments for capital expenditures as of March 31, 2020, nor do we anticipate capital expenditures in excess of our historical trends throughout the balance of the year.

  

Financing Activities

 

Net cash used in financing activities during the three months ended March 31, 2020 was $8 compared to $8 for the same period in 2019, each driven by principal payments on finance leases following the adoption of ASC 842 Leases.

 

Contractual Obligations

 

We have no material commitments for capital expenditures, and we do not anticipate any significant capital expenditures for the remainder of 2020.

 

Off-Balance Sheet Arrangements

 

During the three months ended March 31, 2020, we did not engage in any off-balance sheet arrangements set forth in Item 303(a) (4) of Regulation S-K.

  

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of March 31, 2020, and designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

On February 20, 2020, the Company and Allure filed a demand for arbitration against Seller (Christie Digital Systems, Inc.) 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. 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. We continue to assert the offset right under the Allure Purchase Agreement and Amended and Reseller Note.

 

Information regarding legal proceeding can be found in Note 9 Commitments and Contingencies to the Company’s Condensed Consolidated Financial Statements.

 

Item 1A. Risk Factors

 

As a smaller reporting company, we are not required to provide the information required by this Item; however, the discussion of our business and operations should be read together with the Risk Factors set forth in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 13, 2020. Such risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flow, strategies or prospects in a material and adverse manner. In addition, below are additional risks to consider.

 

The launch of our new Thermal Mirror product may not be successful.

 

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, 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. First, we are investing significant time and resources that take away the attention of management that would otherwise be available for ongoing development of our existing business or to respond to new opportunities. We also have limited cash and we are spending significant costs in the launch, which may ultimately not be successful. This cash could have been used to support our other proven business lines. In addition, we currently have sold limited quantities of the Thermal Mirror as we remain in the pilot phase with numerous potential customers, and we face significant competition from other COVID-19 related workplace safety solutions, and our competitors have more capital resources than we do. The failure to successfully manage these risks in the development and marketing of Thermal Mirror could have a material, adverse effect on the Company’s business, financial condition, and results of operations.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

None.

 

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Item 6. Exhibits

 

Exhibit No.   Description
     
31.1   Chief Executive Officer Certification pursuant to Exchange Act Rule 13a-14(a).
     
31.2   Chief Financial Officer Certification pursuant to Exchange Act Rule 13a-14(a).
     
32.1   Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350.
     
32.2   Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350.
     
99.1   Press release dated May 14, 2020
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase
     
101.LAB   XBRL Taxonomy Extension Label Linkbase
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase

 

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SIGNATURES

 

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

 

  Creative Realities, Inc.
     
Date: May 14, 2020 By  /s/ Richard Mills
    Richard Mills
    Chief Executive Officer

 

  By  /s/ Will Logan
    Will Logan
    Chief Financial Officer

 

 

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