CREATIVE REALITIES, INC. - Quarter Report: 2019 September (Form 10-Q)

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 September 30, 2019

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)

(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:

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.

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 ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☐

APPLICABLE ONLY TO CORPORATE ISSUERS

As of November 7, 2019, the registrant had 9,774,546 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)

See accompanying notes to condensed consolidated financial statements

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

CREATIVE REALITIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands, except shares)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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 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 incurred a net loss for the year ended December 31, 2018 and had negative cash flows from operating activities as of December 31, 2018. For the three months ended September 30, 2019 and 2018 we have recognized/(incurred) net income/(losses) of $242 and ($878), respectively. For the nine months ended September 30, 2019 and 2018, we recognized/(incurred) net income/(losses) of $475 and ($3,728), respectively. As of September 30, 2019, we had cash and cash equivalents of $2,240 and working capital deficit of $3,486, which includes $640 representing current maturities of operating leases recorded January 1, 2019 upon adoption of Accounting Standards Update (“ASU”) 2016-02.

On November 9, 2018, Slipstream Communications, LLC, an Anguillan limited liability company, (“Slipstream”) a related party (see Note 9), extended the maturity date of our term loan and revolving loan to August 16, 2020. Our intent is to refinance our term loan and revolving loan with an unrelated third party during 2019. In conjunction with the extension of the maturity date of our term loan, we agreed that the cash portion of the interest rate would increase prospectively from 8.0% per annum to 10.0% per annum effective July 1, 2019.

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 revolver loan with the Secured Disbursed Escrow Promissory Note.

Management believes that, based on (i) the extension of the maturity date on our term loan and revolving loans and (ii) our operational forecast through 2020, we can continue as a going concern through at least November 8, 2020. However, given our historical net losses, cash used in operating activities and working capital deficit, we obtained a continued support letter from Slipstream through November 15, 2020. We can provide no assurance that our ongoing operational efforts will be successful which could have a material adverse effect on our results of operations and cash flows.

See Note 9 to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt obligations.

Acquisitions

Acquisition of Allure Global Solutions, Inc.

On September 20, 2018, we entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Christie Digital Systems, Inc. (“Seller”) to acquire the capital stock of Allure Global Solutions, Inc. (“Allure”), a wholly owned subsidiary of Seller (the “Allure Acquisition”). Allure is an enterprise software development company providing software solutions, a suite of complementary services, and ongoing support for an array of digital media and POS solutions. Allure provides a wide range of products for the theatre, restaurant, convenience store, theme park, and retail spaces and works to create, develop, deploy, and maintain enterprise software solutions including those designed specifically to integrate, manage, and power ambient client-owned networks. Those networks manage data and marketing content that has been designed and proven to influence consumer purchase behavior. The Allure Acquisition closed on November 20, 2018.

Subject to the terms and conditions of the Purchase Agreement, upon the closing of the Allure Acquisition, we acquired ownership of all of Allure’s issued and outstanding capital shares in consideration for a total purchase price of approximately $8,450, subject to a post-closing working capital adjustment. Of this purchase price amount, we paid $6,300 in cash. Of the remaining purchase price amount, approximately $1,250 is to be paid to former management of Allure, and approximately $900 is due from Allure to Seller, under an existing Seller note which was amended and restated for this reduced amount (as so amended and restated, the “Amended and Restated Seller Note”). The Amended and Restated Seller Note accrues interest at 3.5% per annum and requires us to make quarterly payments of interest only through February 19, 2020, on which date the Amended and Restated Seller Note will mature and all remaining amounts owing thereunder will be due. We are able to prepay in whole or in part amounts owing under the Amended and Restated Seller Note, without penalty, at our option, at any time and from time to time.

On May 10, 2019, we reached a settlement agreement with Seller on, among other things, the final net working capital as of the acquisition date resulting in (i) a payment to us from Seller in the amount of $210, and (ii) a reduction of the amount due under the Amended and Restated Seller Note of $168 of cash collected by the Company which had been previously designated for payment on the Amended and Restated Seller Note but was not ultimately remitted to the Seller and (b) $20 of unpaid accrued interest. In addition to this net working capital settlement, Seller accepted collection risk for one acquired receivable in the amount of $666, which was net settled through the Amended and Restated Seller Note. As a result, our condensed consolidated balance sheet reflects a reduction in both accounts receivable and the Amended and Restated Seller Note of $666 as of June 30, 2019. The outstanding principal balance of the Amended and Restated Seller Note as of September 30, 2019 is $1,637.

The Amended and Restated Seller Note is convertible into shares of our common stock at Seller’s option on or after May 19, 2019, at an initial conversion price of $8.40 per share, subject to customary equitable adjustments. Conversion of all amounts owing under the Amended and Restated Seller Note will be mandatory if the 30-day volume-weighted average price of our common stock exceeds 200% of the common stock trading price at the closing of the Allure Acquisition. We will grant Seller customary registration rights for the shares of our common stock issuable upon conversion of the Amended and Restated Seller Note.

The Purchase Agreement contemplates additional consideration of $2,000 to be paid by us to Seller in the event that Allure’s revenue exceeds $13,000, provided that revenues from one specifically-named customer is capped at 70% of their gross revenue as part of the aggregate revenue calculation, for any of (i) the 12-month period ending December 31, 2019, or (ii) any of the next following trailing 12-month periods ending on each of March 31, June 30, September 30 and December 31, 2020.

See Note 5 to the Condensed Consolidated Financial Statements for further discussion of the Company’s Allure Acquisition.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.  Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the 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, 2018, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2019.

The results of operations for the interim periods are not necessarily indicative of results of operations for a full year. It is the opinion of management that all necessary adjustments for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein.

2.  Revenue Recognition

We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, which we adopted effective January 1, 2018, using the modified retrospective method. See further discussion of the impact of adoption and our revenue recognition policy in Note 4.

3. Inventories

Inventories are stated at the lower of cost or market (net realizable value), determined by the first-in, first-out (FIFO) method, and consist of the following:

4. Impairment of Long-Lived Assets

We review the carrying value of all long-lived assets, including property and equipment, for impairment in accordance with ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets. Under ASC 360, impairment losses are recorded whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable.

If the impairment tests indicate that the carrying value of the asset is greater than the expected undiscounted cash flows to be generated by such asset, an impairment loss would be recognized. The impairment loss is determined as the amount by which the carrying value of such asset exceeds its fair value. We generally measure fair value by considering sale prices for similar assets or by discounting estimated future cash flows from such assets using an appropriate discount rate. Assets to be disposed of are carried at the lower of their carrying value or fair value less costs to sell. Considerable management judgment is necessary to estimate the fair value of assets, and accordingly, actual results could vary significantly from such estimates.

5. Basic and Diluted Income/(Loss) per Common Share

Basic and diluted income/(loss) per common share for all periods presented is computed using the weighted average number of common shares outstanding. Basic weighted average shares outstanding includes only outstanding common shares. Diluted weighted average shares outstanding includes outstanding common shares and potential dilutive common shares outstanding in accordance with the treasury stock method. All of the shares reserved for outstanding stock options and warrants totaling approximately 5,021,888 and 1,787,029 at September 30, 2019 and 2018, respectively, were excluded from the computation of income/(loss) per share as they are anti-dilutive. Net income/(loss) attributable to common shareholders for the three months ended September 30, 2019 and 2018 is after dividends on convertible preferred stock of $0 and $105, respectively. Net income/(loss) attributable to common shareholders for the nine months ended September 30, 2019 and 2018 is after dividends on convertible preferred stock of $0 and $345, respectively.

6. Income Taxes

Deferred income taxes are recognized in the financial statements for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates. Temporary differences arise from net operating losses, differences in basis of intangibles, stock-based compensation, reserves for uncollectible accounts receivable and inventory, differences in depreciation methods, and accrued expenses. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company accounts for uncertain tax positions utilizing an established recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We had no uncertain tax positions as of September 30, 2019 and December 31, 2018.

7. Goodwill and Definite-Lived Intangible Assets

We follow the provisions of ASC 350, Goodwill and Other Intangible Assets. Pursuant to ASC 350, goodwill acquired in a purchase business combination is not amortized, but instead tested for impairment at least annually. The Company uses a measurement date of September 30. There was no impairment loss recognized on goodwill or definite-lived intangible assets during the nine months ended September 30, 2019 and 2018 (see Note 8).

8. Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our significant estimates include: the allowance for doubtful accounts, recognition of revenue, right-of-use assets and related lease liabilities, deferred taxes, deferred revenue, the fair value of acquired assets and liabilities, valuation of warrants and other stock-based compensation and other assumptions and estimates used to evaluate the recoverability of long-lived assets, goodwill and other intangible assets and the related amortization methods and periods. Actual results could differ from those estimates.

9. Business Combinations

Accounting for acquisitions requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. Refer to Note 5, “Business Combination” for a discussion of the accounting for the Allure Acquisition.

10. Leases

On January 1, 2019, we adopted ASU No. 2016-02, Leases (Topic 842), as amended, which supersedes the lease accounting guidance under ASC 840, and generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use (“ROU”) assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We adopted the new guidance using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged. For information regarding the impact of Topic 842 adoption, see Note 17— Leases.

Lease accounting results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under Topic 842, while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under Topic 840.

We elected the package of practical expedients permitted under the transition guidance, which allowed us to carryforward our historical lease classification, our assessment on whether a contract was or contains a lease, and our initial direct costs for any leases that existed prior to January 1, 2019. We also elected to combine our lease and non-lease components. We have no leases with an initial term of 12 months or less.

Upon adoption, we recognized total ROU assets of $2,319, with corresponding liabilities of $2,319 on the condensed consolidated balance sheets. This included $54 of pre-existing finance lease ROU assets previously reported in computer equipment within property and equipment, net. The ROU assets include adjustments for prepayments and accrued lease payments. The net effect of the adoption resulted in an insignificant cumulative effect adjustment to retained earnings on January 1, 2019 but did not impact our prior year consolidated statements of operations, statements of cash flows, or statements of shareholders’ equity.

Under Topic 842, we determine if an arrangement is a lease at inception. ROU assets and liabilities are recognized at commencement date based on the present value of remaining lease payments over the lease term. For this purpose, we consider only payments that are fixed and determinable at the time of commencement. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be. The ROU asset also includes any lease payments made prior to commencement and is recorded net of any lease incentives received. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options.

Operating leases are included in operating lease right-of-use assets, current maturities of operating leases, and long-term obligations under operating leases on our condensed consolidated balance sheets. Finance leases are included in property and equipment, net, current maturities of financing leases, and long-term obligations under financing leases on our condensed consolidated balance sheets.

NOTE 3: RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Recently adopted

On January 1, 2019, we adopted ASU No. 2016-02, Leases (Topic 842), as amended. For information regarding the impact of Topic 842 adoption, see Note 2 – Summary of Significant Accounting Policies and Note 17— Leases.

On January 1, 2019, we adopted ASU No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (Topic 718) to simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. The new guidance expanded the scope of ASC 718 to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in an entity’s own operations. The adoption had no impact to the Company’s consolidated financial statements.

In October 2018, the FASB issued ASU No. 2018-16 (“ASU 2018-16”), Derivatives and Hedging. ASU 2018-16 expands the permissible benchmark interest rates to include the Secured Overnight Financing Rate (SOFR) to be eligible as a U.S. benchmark interest rate for purposes of applying hedge accounting under Topic 815, Derivatives and Hedging. The Company adopted this ASU effective January 1, 2019 on a prospective basis for qualifying or redesignated hedging relationships entered on or after the date of adoption. As we previously adopted the amendments in Update 2017-12, and as the benchmark rate on our term loan debt does not utilize the SOFR, the adoption of this amendment had no effect on the Company’s results of operations, financial position and cash flows.

On January 1, 2019, we adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, which amended certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. We have updated our Condensed Consolidated Financial Statements to include a reconciliation of the beginning balance to the ending balance of stockholders’ equity for each period for which a statement of comprehensive income is filed.

On January 1, 2019, we adopted ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment which aimed to address concerns over the cost and complexity of the two-step goodwill impairment test by removing the second step of the test. Prior to adoption, an entity was required to perform a two-step test to determine the amount, if any, of goodwill impairment. In Step 1, an entity compared the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the entity performed Step 2 by comparing the implied fair value of goodwill with the carrying amount of that goodwill for that reporting unit. An impairment charge equal to the amount by which the carrying amount of goodwill for the reporting unit exceeds the implied fair value of that goodwill is recorded, limited to the amount of goodwill allocated to that reporting unit. As a result of adoption, in completing our annual impairment testing of goodwill as of September 30, 2019, we applied a one-step quantitative test and would have recorded the amount of goodwill impairment, if any, as the excess of a reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. There was no impact on our condensed consolidated financial statements as the result of adoption.

Not yet adopted

In August 2018, the FASB issued ASU 2018-15 Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. The amendments in this update provide guidance on evaluating the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption of the amendments in this ASU is permitted, including adoption in any interim period, for all entities. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This standard modifies the disclosure requirements for fair value measurements by removing the requirements to disclose: (i) amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) timing of recognizing transfers between levels within the fair value hierarchy; and (iii) valuation processes used for Level 3 fair value measurements. Additionally, the standard now requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level 3 fair value measurements held at the end of each reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity is permitted to early adopt all of the disclosure changes or early adopt only the removed disclosure requirements and delay adoption of the additional disclosures until the effective date of this amendment. We are currently evaluating the disclosure requirements related to adopting this guidance.

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

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts not completed as of the date of adoption. Results for reporting periods beginning on or after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. Under this method, we concluded that the cumulative effect of applying this guidance was not material to the financial statements and no adjustment to the opening balance of accumulated deficit was required on the adoption date.

Under ASC 606, the Company accounts for revenue using the following steps:

The Company combines contracts with the same customer into a single contract for accounting purposes when the contracts are entered into at or near the same time and the contracts are negotiated as a single commercial package, consideration in one contract depends on the other contract, or the services are considered a single performance obligation. If an arrangement involves multiple performance obligations, the items are analyzed to determine the separate units of accounting, whether the items have value on a standalone basis and whether there is objective and reliable evidence of their standalone selling price. The total contract transaction price is allocated to the identified performance obligations based upon the relative standalone selling prices of the performance obligations. The standalone selling price is based on an observable price for services sold to other comparable customers, when available, or an estimated selling price using a cost plus margin approach.

The Company estimates the amount of total contract consideration it expects to receive for variable arrangements by determining the most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide and the contractual pricing based on those quantities. The Company only includes some or a portion of variable consideration in the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. The Company considers the sensitivity of the estimate, its relationship and experience with the client and variable services being performed, the range of possible revenue amounts and the magnitude of the variable consideration to the overall arrangement. The Company receives variable consideration in very few instances.

As discussed in more detail below, revenue is recognized when a customer obtains control of promised goods or services under the terms of a contract and is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing services. The Company does not have any material extended payment terms as payment is due at or shortly after the time of the sale. Observable prices are used to determine the standalone selling price of separate performance obligations or a cost plus margin approach when one is not available. Sales, value-added and other taxes collected concurrently with revenue producing activities are excluded from revenue.

The Company recognizes contract assets or unbilled receivables related to revenue recognized for services completed but not yet invoiced to the clients. Unbilled receivables are recorded as accounts receivable when the Company has an unconditional right to contract consideration. A contract liability is recognized as deferred revenue when the Company invoices clients in advance of performing the related services under the terms of a contract. Deferred revenue is recognized as revenue when the Company has satisfied the related performance obligation.

Deferred contract acquisition costs were evaluated for inclusion in other assets; however, the Company elected to use the practical expedient for recording an immediate expense for those incremental costs of obtaining contracts, including certain design/engineering services, commissions, incentives and payroll taxes, as these incremental and recoverable costs have terms that do not exceed one year.

The Company provides innovative digital marketing technology and solutions to retail companies, individual retail brands, enterprises and organizations throughout the United States and in certain international markets. The Company’s technology and solutions include: digital merchandising systems and omni-channel customer engagement systems, interactive digital shopping assistants, advisors and kiosks, and other interactive marketing technologies such as mobile, social media, point-of-sale transactions, beaconing and web-based media that enable our customers to transform how they engage with consumers.

We typically generate revenue through the following sources:

The following table disaggregates the Company’s revenue by major source for the three and nine months ended September 30, 2019:

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 September 30, 2019 were $1,428. We expect to recognize $1,428 during the three months ended December 31, 2019.

Software design and development services

Software and software license sales are revenue when a fixed fee order has been received and delivery has occurred to the customer. Revenue is recognized generally upon customer acceptance (point-in-time) of the software product and verification that it meets the required specifications. Software is delivered to customers electronically. Software design and development revenues are classified as “Software Development Services” within our disaggregated revenue.

Software as a service

Software as a service includes revenue from software licensing and delivery in which software is licensed on a subscription basis and is centrally hosted. These services often include software updates which provide customers with rights to unspecified software product upgrades and maintenance releases and patches released during the term of the support period. Contracts for these services are generally 12-36 months in length. We account for revenue from these services in accordance with ASC 985-20-15-5 and recognize revenue ratably over the performance period. Software as a service revenues are classified as “Managed Services” within our disaggregated revenue.

Maintenance and support services

The Company sells support services which include access to technical support personnel for software and hardware troubleshooting. The Company offers a hosting service through our network operations center, or NOC, allowing the ability to monitor and support its customers’ networks 7 days a week, 24 hours a day. These contracts are generally 12-36 months in length. Revenue is recognized over the term of the agreement in proportion to the costs incurred in fulfilling performance obligations under the contract. Maintenance and Support revenues are classified as “Managed Services” within our disaggregated revenue.

Maintenance and support fees are based on the level of service provided to end customers, which can range from monitoring the health of a customer’s network to supporting a sophisticated web-portal to managing the end-to-end hardware and software of a digital marketing system. These agreements are renewable by the customer. Rates for maintenance and support, including subsequent renewal rates, are typically established based upon a fee per location, per device, or a specified percentage of net software license fees as set forth in the arrangement. These contracts are generally 12-36 months in length. Revenue is recognized ratably and evenly over the service period.

The Company also performs time and materials-based maintenance and repair work for customers. Revenue is recognized at a point in time when the performance obligation has been fully satisfied.

In addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification of certain costs relating to revenue arrangements with customers. As a result of our analysis, we did not identify any components of our revenue transactions which required reclassification between gross and net presentation.

NOTE 5: BUSINESS COMBINATION

On November 20, 2018, the Company completed the Allure Acquisition. Pursuant to the Purchase Agreement, the total purchase price was $8,450, which was primarily funded using cash from the Company’s public offering closed on November 19, 2018.

On May 10, 2019, the Company entered a settlement agreement with Seller finalizing the opening balance sheet net working capital in accordance with the Purchase Agreement. The reconciliation of final net working capital compared to the estimated net working capital at the date of the acquisition resulted in a final net working capital below the estimated net working capital by $398. The $398 net working capital deficit was settled via cash payment from Seller to the Company in the amount of $210, net of past due interest on the Amended and Restated Seller Note of $20 and $168 collected by the Company on certain acquired accounts receivable which, in accordance with the Purchase Agreement, were required to be utilized to pay down the Amended and Restated Seller Note. The preliminary purchase price and related allocation of the purchase price has been updated to reflect the cash settlement. The difference between the total purchase price and the net consideration transferred is driven by the cash acquired in the acquisition. The purchase price allocation remains preliminary as of September 30, 2019 as the Company continues to evaluate certain acquired assets and liabilities.

The revised preliminary purchase price of Allure consisted of the following items:

The Company accounted for the Allure Acquisition using the acquisition method of accounting. The revised preliminary allocation of the purchase price is based on estimates of the fair value of assets acquired and liabilities assumed as of November 20, 2018. The Company is continuing to obtain information to determine the acquired assets and liabilities, including tax assets, liabilities and other attributes. The components of the preliminary purchase price allocation are as follows:

The preliminary fair value of the customer relationship intangible asset has been estimated using the income approach through a discounted cash flow analysis with the cash flow projections discounted using a rate of 26.0%. The cash flows are based on estimates used to price the Allure Acquisition, and the discount rates applied were benchmarked with reference to the implied rate of return from the Company’s pricing model and the weighted average cost of capital.

The definite-lived trade name represents the Allure brand name as marketed primarily in the sports & entertainment, large venue and quick service restaurant verticals of the digital signage industry. The Company applied the income approach through an excess earnings analysis to determine the preliminary fair value of the trade name asset. The Company identified this asset as definite-lived as opposed to indefinite-lived as the Company plans to utilize the Allure trade name as a product name as opposed to go-to-market company name. The Company applied the income approach through a relief-from-royalty analysis to determine the preliminary fair value of this asset.

The developed technology assets are primarily comprised of know-how and functionality embedded in Allure’s proprietary content management application which drives currently marketed products and services. The Company applied the income approach through a relief-from-royalty analysis to determine the preliminary fair value of this asset.

The Company is amortizing the identifiable intangible assets on a straight-line basis over the weighted average lives ranging from 5 to 15 years.

The table below sets forth the preliminary valuation and amortization period of identifiable intangible assets:

The Company estimated the preliminary fair value of the acquired property, plant and equipment using a combination of the cost and market approaches, depending on the component. The preliminary fair value of property, plant and equipment is $177.

The excess of the purchase price over the preliminary estimated fair value of the tangible net assets and identifiable intangible assets acquired was recorded as goodwill and is subject to change upon final valuation. The factors contributing to the recognition of the amount of goodwill are based on several strategic and synergistic benefits that are expected to be realized from the Allure Acquisition. These benefits include a comprehensive portfolio of iconic customer brands, complementary product offerings, enhanced national footprint, and attractive synergy opportunities and value creation. None of the goodwill is expected to be deductible for income tax purposes.

The following unaudited pro forma information for the nine months ended September 30, 2018 presents the combined financial results for the Company and Allure, adjusted for Allure’s fiscal year ended March 31, as if the Allure Acquisition had been completed January 1, 2017. Prior to the Allure Acquisition, Allure had a fiscal year reporting from April 1 to March 31 annually. The pro forma financial information set forth below for the nine months ended September 30, 2018 includes Allure’s pro forma information for the nine month period January 1, 2018 through September 30, 2018. The unaudited information set forth below for the nine months ended September 30, 2019 represents the Company’s consolidated results for that period.

NOTE 6: FAIR VALUE MEASUREMENT

We measure certain financial assets, including cash equivalents, at fair value on a recurring basis. In accordance with ASC 820-10-30, fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820-10-35 establishes a three-level hierarchy that prioritizes the inputs used in measuring fair value. The three hierarchy levels are defined as follows:

Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets.

Level 2 — Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.

Level 3 — Valuations based on inputs that are unobservable and involve management judgment and the reporting entity’s own assumptions about market participants and pricing.

The Company previously recorded warrant liabilities that were measured at fair value on a recurring basis using a binomial option pricing model. The warrant liabilities were classified as Level 3 and were determined to have a fair value of $21 as of December 31, 2018. The warrant liabilities had been previously 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 Seller in the event that acquiree revenue exceeds $13,000, as defined in the underlying agreement, for any of the trailing twelve-month periods measured as of December 31, 2019, March 31, 2020, June 30, 2020, September 30, 2020 and December 31, 2020. The fair value of the earnout liability was determined to be $250 at the time of acquisition. There were no changes to the assumptions nor adjustments recorded to the fair value of the earnout liability as of September 30, 2019 given limited passage of time in the measurement period and performance in-line with those estimates utilized in developing the initial estimate. 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.

NOTE 7: SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION

NOTE 8: INTANGIBLE ASSETS AND GOODWILL

Intangible Assets

Intangible assets consisted of the following at September 30, 2019 and December 31, 2018:

For the three months ended September 30, 2019 and 2018, amortization of intangible assets charged to operations was $147 and $232, respectively. For the nine months ended September 30, 2019 and 2018 amortization of intangible assets charged to operations was $451 and $696, respectively.

Goodwill

The following is a rollforward of the Company’s goodwill since December 31, 2018:

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.

On January 1, 2019, we adopted ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment which aimed to address concerns over the cost and complexity of the two-step goodwill impairment test by removing the second step of the test. The Company performed its annual goodwill impairment test at September 30, 2019.

The Company assessed the carrying value of goodwill at the reporting unit level based on an estimate of the fair value of the respective reporting unit. Fair value of the reporting unit was estimated using a discounted cash flow analyses consisting of various assumptions, including expectations of future cash flows based on projections or forecasts derived from analysis of business prospects and economic or market trends that may occur, specifically, the Company gave significant consideration to actual historic financial results, including revenue growth rates in the preceding three years. Based on the Company’s assessment, we determined that the fair value of our reporting unit exceeds its carrying value, and accordingly, the goodwill associated with the reporting unit is not considered to be impaired at September 30, 2019.

The Company recognizes that any changes in our actual fourth quarter 2019 or 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 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 9: LOANS PAYABLE

The outstanding debt with detachable warrants, as applicable, are shown in the table below. Further discussion of the notes follows.

A – Secured Disbursed Escrow Promissory Note with related party

B – Revolving Loan with related party

C – Term Loan with related party

D – Amended and Restated Seller Note from the Allure Acquisition

(1) 0.0% interest per annum when total borrowings under the term and revolver loans, in aggregate, are below $4,000 in principal (disregarding paid-in-kind (“PIK”) interest); 10.0% cash, when total borrowing under the term and revolver loans, in aggregate, exceed $4,000 in principal (disregarding PIK interest)

(2) 10.0% cash interest per annum when total borrowings under the term and revolver loans, in aggregate, are below $4,000 in principal (disregarding PIK interest); 10.0% cash, 2.0% PIK when total borrowing under the term and revolver loans, in aggregate, exceed $4,000 in principal (disregarding PIK interest).

(3) 3.5% simple cash interest per annum; interest payable quarterly with the first payment due on December 31, 2018 with payments of accrued interest continuing quarterly thereafter until the maturity date of February 20, 2020.

The foregoing obligations are secured by all of the tangible assets of the co-makers pursuant to the terms of an amended and restated security agreement.

Term Notes and Secured Disbursed Escrow Promissory Note

On August 17, 2016, we entered into a Loan and Security Agreement (the “Loan Agreement”) with Slipstream Communications, LLC, an Anguillan limited liability company (“Slipstream”), and obtained a $3.0 million term loan (the “Term Loan”), with interest thereon at 8% per annum. The Term Loan contains certain customary restrictions including, but not limited to, restrictions on mergers and consolidations with other entities, cancellation of any debt or incurring new debt (subject to certain exceptions).

On January 16, 2018, we entered into the Third Amendment to the Loan and Security Agreement with Slipstream and obtained a $1.0 million revolving loan (the “Revolving Loan”), with interest thereon at 8% per annum, maturing on January 16, 2019. In connection with the Revolving Loan, we issued Slipstream a five-year warrant to purchase up to 61,729 shares of Creative Realities’ common stock at a per share price of $8.10 (subject to adjustment and subsequently adjusted to $8.09 in April 2018). The fair value of the warrants was $266, which was accounted for as an additional debt discount and is being amortized over the remaining life of the Revolving Loan.

On April 27, 2018, we entered into the Fourth Amendment to the Loan and Security Agreement with Slipstream, under which we obtained a $1.1 million Revolving Loan, with interest thereon at 8% per annum, provided, however, at all times when the aggregate outstanding principal amount of the Term Loan and the Revolving Loan (excluding the additional principal added pursuant to this proviso) exceeds $4,000 then interest rate shall be 10%, of which eight percent 8% shall be payable in cash and 2% shall be paid by the issuance of and treated as additional principal of the Term Loan (“PIK”); provided, further, no interest accrues on any portion of the outstanding Disbursed Escrow Loan. The Revolving Loan was originally set to mature on January 16, 2019, which was amended to August 16, 2020 in conjunction with the Fifth Amendment to the Loan and Security Agreement. In connection with the Revolving Loan, we issued the lender a five-year warrant to purchase up to 143,791 shares of Creative Realities’ common stock at a per share price of $7.65 (subject to adjustment). The fair value of the warrants was $543, which was accounted for as an additional debt discount and is being amortized over the remaining life of the Revolving Loan.

The Fourth Amendment also included our issuance to Slipstream a Secured Disbursed Escrow Promissory Note (the “Disbursed Escrow Note”), and, effective June 30, 2018 we drew $264 thereon in conjunction with our exit from a previously leased operating facility. The principal amount of the Disbursed Escrow Note bears simple interest at the 8%; provided, that the Disbursed Escrow Note accrues no interest when the aggregate outstanding principal amount of the Term Loan and the Revolving Loan (excluding the additional principal added pursuant to this proviso) is at or below $4,000.

On November 19, 2018, we used proceeds from our public offering to repay Slipstream $1,283, inclusive of $125 of accrued interest, to reduce borrowings under the Loan Agreement to an aggregate of $4,264, comprised of $3,000 Term Loan, $1,000 Revolving Loan and $264 Disbursed Escrow Note. The condensed consolidated balance sheet includes $33 of accrued interest as of September 30, 2019 representing one month’s interest at 8.0% on the $4,000 outstanding balance.

On November 9, 2018, Slipstream extended the maturity date of the Term Loan and Revolver Loan to August 16, 2020 through the Fifth Amendment to the Loan and Security Agreement. Our current intent is to refinance our Term Loan with an unrelated third party during 2019. In conjunction with the extension of the maturity date of our Term Loan, the cash portion of the interest rate increased from 8.0% per annum to 10.0% per annum effective July 1, 2019.

On November 6, 2019, Slipstream extended the maturity date of the Term Loan and Revolver Loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement, aligning their maturity date with that of the Disbursed Escrow Note.

See Note 14 for the Black Scholes inputs used to calculate the fair value of the warrants.

Convertible Promissory Notes

On October 29, 2018, Slipstream, the holder of convertible promissory notes, agreed to convert $4,955 of outstanding principal, including paid-in-kind interest and all accrued interest thereon into shares of our common stock and warrants at a conversion price equal to the lower of $7.65, or 80% of the price at which shares of common stock were sold in the Public Offering. The conversion was contingent upon (i) the conversion of the Company’s Series A Preferred Stock, and (ii) the successful completion of a Public Offering of at least $10 million, each of which were successfully completed on November 19, 2018. In exchange for participation in the Public Offering, subject to a minimum participation requirement as agreed between the underwriters and the Company, and Slipstream’s execution of a lock-up agreement, Slipstream received, as a one-time incentive, additional common stock and warrants in such number that decreased the effective conversion price of the convertible notes to 70% of the lowest of those scenarios outlined above. Upon completion of the Company’s Public Offering on November 19, 2018, the convertible promissory notes were converted into shares of the Company’s common stock. The Company issued 653,062 shares of common stock at the stated conversion rate and an additional 1,386,090 shares of common stock in exchange for conversion of the convertible promissory notes as a result of the one-time incentive. The lock-up agreement applied to all shares of common stock and warrants issued to Slipstream.

Amended and Restated Seller Note from the Allure Acquisition

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 through the Purchase Agreement as part of the Allure Acquisition. The Amended and Restated Seller Note accrues interest at 3.5% per annum and requires us to make quarterly payments of interest only through February 19, 2020, on which date the Amended and Restated Seller Note will mature and all remaining amounts owing thereunder will be due. The condensed consolidated balance sheet includes $14 of accrued interest as of September 30, 2019 representing all interest accrued under the Amended and Restated Seller Note since close of the Allure Acquisition. We are able to prepay in whole or in part amounts owing under the Amended and Restated Seller Note, without penalty, at our option, at any time and from time to time.

The Amended and Restated Seller Note is convertible into shares of Creative Realities common stock, at Seller’s option on or after May 19, 2019, at an initial conversion price of $8.40 per share, subject to customary equitable adjustments. Conversion of all amounts owing under the Amended and Restated Seller 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 Seller customary registration rights for the shares of our common stock issuable upon conversion of the promissory note.

NOTE 10: COMMITMENTS AND CONTINGENCIES

Lease termination

On August 10, 2017, we announced the planned closure of our office facilities located at 22 Audrey Place, Fairfield, New Jersey 07004 which housed our previous operations center and ceased use of the facilities in February 2018. In ceasing use of these facilities, we recorded a one-time non-cash charge of $474 to accrue for the remaining rent under the lease term, net of anticipated subtenant rental income. Effective June 30, 2018, we entered into a settlement agreement to exit this lease agreement, resulting in the Company recording a gain on settlement of $39 in the three months ended June 30, 2018.

Settlement of obligations

During the three and nine months ended September 30, 2019, through settlements of liabilities no longer deemed valid, the Company wrote off obligations and recognized a gain of $406 and $419, respectively. During the three and nine months ended September 30, 2018, the Company wrote off obligations and recognized a gain of $169 and $208, respectively.

Litigation

(a) 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. As of the date of this filing, no formal legal action had been taken by the customer against the Company and, as a result, the outcome of this matter is unclear, so the Company is unable to reasonably estimate the possible loss, or range of loss, if any.

The Company has notified its insurance company and Seller 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.

(b) The Company is involved in various other legal and administrative proceedings incidental to the operations of its business. The Company believes that the outcome of all such other pending proceedings in the aggregate will not have a material adverse effect on its business, financial condition, liquidity, or operating results.

Termination benefits

On December 21, 2018, the Company announced certain restructuring activities following completion of its acquisition of Allure and accrued one-time termination benefits related to severance to the affected employees of $386, $31 of which was paid prior to the year-end date. During the three and nine months ended September 30, 2019, cash payments for termination benefits of $84 and $295 were paid and a liability of $60 remains included in accrued expenses on the condensed consolidated balance sheet.

NOTE 11: RELATED PARTY TRANSACTIONS

In addition to the financing transactions with Slipstream, a related party, discussed in Note 9, we have the following related party transactions.

On August 14, 2018, we entered into a payment agreement with 33 Degrees Convenience Connect, Inc., a related party that is approximately 17.5% owned by a member of our senior management (“33 Degrees”), outlining terms for repayment of $2,567 of aged accounts receivable as of that date. The payment agreement stipulates a simple interest rate of 12% on aged accounts receivable to be paid on the tenth day of each month through the maturity date of December 31, 2019. Remaining payments due under the agreement as of September 30, 2019 were $417, $300 of which has been paid subsequent to the reporting date as of the date of this filing. Remaining payments of $117 are to be paid on December 1, 2019. All amounts under this note are included in accounts receivable in current assets, as all amounts are expected to be collected within one year of the balance sheet date. Since inception of this agreement up to and through the filing date, all payments due under this agreement have been received from 33 Degrees timely, including monthly interest payments and payments for ongoing services.

Since the Company entered into the payment agreement with 33 Degrees, 33 Degrees has continued to purchase additional hardware and services from the Company, on a prepaid basis, in addition to making payments under the payment agreement. On March 12, 2019, the Company entered into a security agreement and promissory note with 33 Degrees Menu Services, LLC, a subsidiary of 33 Degrees, providing a line of credit of $300 for hardware, installation and SaaS services. Under the agreement, product will be shipped and installed by the Company upon evidence of a valid purchase order from the ultimate payer being provided as collateral.

For the three and nine months ended September 30, 2019, the Company had sales to 33 Degrees of $279, or 4.2%, and $750, or 2.9%, respectively, of consolidated revenue. For the three and nine months ended September 30, 2018, the Company had sales to 33 Degrees of $235, or 3.9%, and $1,265, or 7.3%, respectively, of consolidated revenue.

Accounts receivable due from 33 Degrees was $517, or 9.1%, and $1,933, or 30.0% of consolidated accounts receivable at September 30, 2019 and December 31, 2018, respectively.

On November 6, 2019, Slipstream extended the maturity date of the Term Loan and Revolving Loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement, aligning the maturity date of such loans with the maturity date of the Disbursed Escrow Note. See Note 9 for additional information regarding the loans.

NOTE 12: INCOME TAXES

Our deferred tax assets are primarily related to net federal and state operating loss carryforwards (NOLs). We have substantial NOLs that are limited in usage by IRC Section 382. IRC Section 382 generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership within a statutory testing period. We have performed a preliminary analysis of the annual NOL carryforwards and limitations that are available to be used against taxable income. Based on the history of losses of the Company, there continues to be a full valuation allowance against the net deferred tax assets of the Company with a definite life.

For the three and nine months ended September 30, 2019, we reported a tax expense/(benefit) of $51 and ($35), respectively. The net deferred tax liability at September 30, 2019 of $99 represents the liability relating to indefinite lived assets. This indefinite lived deferred tax liability may be considered a source of taxable income and reduced by certain indefinite lived deferred tax assets that will never expire, subject to statutory limitations.

NOTE 13: CONVERTIBLE PREFERRED STOCK

Our Series A Convertible Preferred Stock (the “preferred stock”) entitled its holders to a 6% dividend, payable semi-annually in cash or in kind through the three-year anniversary of the original issue date, and from and after such three-year anniversary, payable in shares of common stock. The three-year anniversary of the initial investment date occurred during the second half of 2017 for $5,200 and the first quarter of 2018 for the remaining $300 originally issued preferred stock and therefore dividends on those investments will be paid via issuance of common shares at all future dividend dates.

On November 5, 2018, the shareholders of preferred stock agreed to convert the entire class of preferred stock into common stock at an exchange ratio of $7.65 per share. The conversion was contingent upon a successful Public Offering of at least $10 million, which the Company completed on November 19, 2018.

Holders of preferred stock received common stock at the stated conversion rate of $7.65 per share, or 723,561 shares of common stock. Those holders of preferred stock who executed a customary lock-up agreement for a period continuing for 90 days after the consummation of the public offering were issued, as a one-time incentive, additional common stock and warrants, in such number as defined in underlying agreements. The Company issued an additional 1,123,367 shares of common stock in exchange for execution of such lock-up agreements. The lock-up agreements applied to all shares of common stock issued to convert the holder’s preferred stock, and the additional shares of common stock and warrants, and underlying warrant shares, issued by the Company in exchange for the holder’s execution of the lock-up agreement and participation in the public offering. As a result of this conversion, there remained no Series A Preferred Stock outstanding as of December 31, 2018.

During the three and nine months ended September 30, 2018, accredited investors converted 124,985 shares of preferred stock for 16,339 shares of common stock.

NOTE 14: WARRANTS

On April 27, 2018, we entered into the Fourth Amendment to the Loan and Security Agreement with Slipstream, under which we issued the lender a five-year warrant to purchase up to 143,791 shares of Creative Realities’ common stock at a per share price of $7.65 (subject to adjustment and subsequently adjusted to $6.25 in November 2018). The fair value of the warrants was $543, which is accounted for as an additional debt discount and amortized over the remaining life of the loan.

On January 16, 2018, we entered into the Third Amendment to the Loan and Security Agreement with Slipstream, under which we issued the lender a five-year warrant to purchase up to 61,729 shares of Creative Realities’ common stock at a per share price of $8.10 (subject to adjustment and subsequently adjusted to $6.09 in November 2018). The fair value of the warrants on the issuance date was $266, which is accounted for as an additional debt discount and amortized over the remaining life of the loan.

Listed below are the inputs used for the probability weighted Black Scholes option pricing model valuation for warrants issued during the nine months ended September 30, 2019 and 2018.

A summary of outstanding liability and equity warrants is included below:

NOTE 15: STOCK-BASED COMPENSATION

A summary of outstanding options is included below:

The weighted average remaining contractual life for options exercisable is 5.88 years as of September 30, 2019.

Stock Compensation Expense Information

ASC 718-10, Stock Compensation, requires measurement and recognition of compensation expense for all stock-based payments including warrants, stock options, restricted stock grants and stock bonuses based on estimated fair values. Under the Amended and Restated 2006 Equity Incentive Plan, the Company reserved 1,720,000 shares for purchase by the Company’s employees and under the Amended and Restated 2006 Non-Employee Director Stock Option Plan the Company reserved 700,000 shares for purchase by the Company’s employees. There are 12,186 options outstanding under the 2006 Equity Incentive Plan.

In October 2014, the Company’s shareholders approved the 2014 Stock Incentive Plan, under which 7,390,355 shares were reserved for purchase by the Company’s employees. In August 2018, a special meeting of shareholders was held in which the shareholders voted to amend the Company’s 2014 Stock Incentive Plan to increase the reserve of shares authorized for issuance thereunder, from 7,390,355 shares to 18,000,000 shares. There are 276,674 options outstanding under the 2014 Stock Incentive Plan. 

Compensation expense recognized for the issuance of both stock options to employees and common stock to directors for the three and nine months ended September 30, 2019 and 2018 was as follows:

At September 30, 2019, there was approximately $166 of total unrecognized compensation expense related to unvested share-based awards. Generally, this expense will be recognized over the next three years and will be adjusted for any future forfeitures as they occur.

Stock-based compensation expense is based on awards ultimately expected to vest. ASC 718-10-55 allows companies to either estimate forfeitures at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates or elect to account for forfeitures as they occur by reversing compensation cost when the award is forfeited. Our accounting policy is to account for forfeitures as they occur by reversing compensation cost in the period in which forfeitures occur.

On September 20, 2018, the Compensation Committee of the Board of Directors proposed, and the Board of Directors approved, an aggregate award of 166,667 shares of common stock to our current CEO in light of performance and growth of certain key customer relationships. Of those shares granted, 133,334 were deemed to be awarded and fully vested as of such date, with the remaining 33,333 shares restricted to vest upon the Company’s recognition in accordance with GAAP of approximately $6,200 of revenue which is was deferred on the Company’s balance sheet. During the three-months ended September 30, 2018, the Company recorded compensation expense for those vested awards based on the grant-date close price of the Company’s common stock, or $7.50, resulting in a non-cash compensation expense in the period of $1,000. During the three months ended June 30, 2019, the conditions were met for those remaining shares to vest. During the three-months ended June 30, 2019, the Company recorded compensation expense for those vested awards based on the grant-date close price of the Company’s common stock, or $7.50, resulting in a non-cash compensation expense in the period of $250.

NOTE 16: SIGNIFICANT CUSTOMERS

Major Customers

We had 1 and 3 customers that in the aggregate accounted for 11% and 40% of accounts receivable as of September 30, 2019 and December 31, 2018, respectively, which includes transactions with 33 Degrees for both periods.

We had 1 and 2 customers that accounted for 13% and 56% of revenue for the three months ended September 30, 2019 and 2018, respectively. We had 1 and 2 customers that accounted for 23% and 56% of revenue for the nine months ended September 30, 2019 and 2018, respectively.

NOTE 17: LEASES

We have entered into various non-cancelable operating lease agreements for certain of our offices and office equipment. Our leases have original lease periods expiring between 2019 and 2023. Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease commencement. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

The components of lease costs, lease term and discount rate are as follows:

The following is a schedule, by years, of maturities of lease liabilities as of September 30, 2019:

Supplemental cash flow information related to leases are as follows:

NOTE 18: SUBSEQUENT EVENTS

Extension of Maturity Date of Debt

On November 6, 2019, Slipstream extended the maturity date of our Term Loan and Second Revolver Loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement, aligning the maturity date of those loans with that of the Disbursed Escrow Note.

Director Resignation; Election of Successor

Effective November 8, 2019, Alec Machiels is resigning as a member of the Company’s Board of Directors (the “Board”) and Chairman of the Board. The Board elected Dennis McGill as Mr. Machiels’ successor, effective November 8, 2019. The Board elected Mr. McGill to serve as the Company’s Chairman of the Board.

Consulting Agreement

On November 7, 2019, the Company and Dennis McGill executed a Consulting Agreement (the “Consulting Agreement”). The term of the Consulting Agreement is one year, and it automatically renews for successive one-year periods. Either party may terminate the Consulting Agreement at any time upon 30 days’ written notice. Under the Consulting Agreement, Mr. McGill will receive compensation of $5,000 per month in cash in exchange for general business and strategy consulting services to the Company.

Option Agreement

On November 7, 2019, the Company and Mr. McGill also executed an Option Agreement (the “Option Agreement”). Under the Option Agreement, Mr. McGill has the option to purchase 25,000 shares of the Company’s common stock under the Company’s 2014 Stock Incentive Plan. The options have an exercise price of $1.88 per share, which was the closing price of the Company’s common stock as reported on Nasdaq on the date prior to the date of the Option Agreement. The options vest in three equal annual installments beginning on the one-year anniversary of the date of the Option Agreement, provided that Mr. McGill must continue to serve as a director of the Company.

Executive Bonus

On November 6, 2019, the Board approved payment of a $150 cash bonus to Richard Mills, the Company’s Chief Executive Officer, for his significant contributions to the Company’s performance in 2018. 

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” and similar 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. Factors that could cause actual results to differ materially from those anticipated, certain of which are beyond our control, are set forth under the caption “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2018 as filed with the Securities and Exchange Commission on March 28, 2019.

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:

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.

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.

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 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 September 30, 2019 Compared to Three Months Ended September 30, 2018 

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. The Company acquired Allure Global Solutions, Inc. effective November 2018.

Sales

Sales increased by $722, or 12%, in the three months ended September 30, 2019 compared to the same period in 2018 driven by $1,248 from new customers in 2019 and $1,228 contributed by legacy Allure customers. During the three months ended September 30, 2018 the Company completed work on a single, material software development project with a longstanding client, for which approximately $2,375 was recognized in the three months ended September 30, 2018 and for which no similar project was completed in the same period in 2019.

Gross Profit

Gross profit decreased $435 in absolute dollars from $3,741 to $3,306, or 12%, primarily as a result of a single, material software development project which was recorded in the three months ended September 30, 2018 which had no equivalent in the current year. Excluding that project, the Company generated gross margin of approximately $2,316 during the three months ended September 30, 2018.

Gross profit margin decreased to 49.2% in the three months ended September 30, 2019 from 62.3% during the same period in 2018, primarily as a result of the material software development project recorded during the three months ended September 30, 2018.

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 increased by $98, or 23%, in the three months ended September 30, 2019 compared to the same period in 2018 a result of increased sales headcount following the Allure Acquisition and participation in an increased number of trade shows and customer-facing events.

Research and Development Expenses

Research and development expenses increased by $45, or 17%, in the three months ended September 30, 2019 compared to the same period in 2018 due to increased development headcount as a result of the Allure Acquisition.

General and Administrative Expenses

Total general and administrative expenses decreased by $1,120, or 35%, in the three months ended September 30, 2019 compared to the same period in 2018 as a result of (1) $1,000 reduction in compensation expense related to shares of common stock granted to our current CEO during the three months ended September 30, 2018 which did not recur in 2019, (2) $90 reduction in salaries, benefits and related taxes due to headcount reductions post-integration of the Allure Acquisition, and (3) $167 reduction in transaction/deal costs which were incurred during 2018 as part of the Allure Acquisition, partially offset by a (1) $144 increase in rent as a result of the Allure Acquisition and expansion of the Company’s headquarters, and (2) $142 increase in contractor spend.

Depreciation and Amortization Expenses

Depreciation and amortization expenses decreased by $52, or 16%, in the three months ended September 30, 2019 compared to the same period in 2018 due to certain property and intangible assets reaching the end of their useful lives, partially offset by the newly added assets as a result of the Allure Acquisition.

Interest Expense

See Note 9 to the condensed consolidated financial statements for a discussion of the Company’s debt and related interest expense obligations.

Change in Fair Value of Warrant Liability

See Note 6 to the condensed consolidated financial statements for a discussion of the Company’s non-cash change in warrant liability for the three months ended September 30, 2019, the methodology for which is consistent for the three months ended September 30, 2018. The change in the fair value of the warrant liability resulted in no gain or loss in the three months ended September 30, 2019. All warrants previously classified as liabilities within the balance sheet expired during the three months ended September 30, 2019.

Gain on Settlement of Obligations

During the three months ended September 30, 2019, the Company wrote off liabilities and recognized a gain of $406, primarily related to legacy accounts payable deemed to no longer be legal obligations to vendors.

In September 2018, the Company settled and/or wrote off debt of $219 for $50 cash payment and recognized a gain of $169. This debt included $30 of accrued wage labor liabilities no longer anticipated to be pursued against the Company.

Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

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. The Company acquired Allure Global Solutions, Inc. effective November 2018.

Sales

Sales increased by $8,275, or 48%, in the nine months ended September 30, 2019 compared to the same period in 2018 driven by $4,452 from customers new to the Company in 2019, $3,667 contributed by legacy Allure customers and the remainder through expansion and growth in the pre-existing customer base, partially offset by a reduction of $521 in sales to related parties.

Gross Profit

Gross profit increased $2,875 in absolute dollars from $8,340 to $11,209, or 34% during the nine months ended September 30, 2019 versus the same period in the prior year driven by an increase in sales, partially offset by a reduction in gross margin. Gross margin decreased from 48% for the nine months ended September 30, 2018 to 44% in 2019 during the same period.

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 increased by $364, or 25%, in the nine months ended September 30, 2019 compared to the same period in 2018 as a result of increased sales headcount following the Allure Acquisition and participation in an increased number of trade shows and customer-facing events.

Research and Development Expenses

Research and development expenses increased by $194, or 22%, in the nine months ended September 30, 2019 compared to the same period in 2018 due to increased development headcount as a result of the Allure Acquisition.

General and Administrative Expenses

Total general and administrative expenses decreased by $50, or 1%, in the nine months ended September 30, 2019 compared to the same period in 2018 as a result of (1) $881 reduction in compensation expense related to shares of common stock granted to our current CEO during the three months ended September 30, 2018 which did not recur in 2019, (2) $20 reduction in salaries, benefits and related taxes due to headcount reductions post-integration of the Allure Acquisition, and (3) $211 reduction in transaction/deal costs which were incurred during 2018 as part of the Allure Acquisition, partially offset by a (a) $623 increase in rent as a result of the Allure Acquisition and expansion of the Company’s headquarters, and (b) $523 increase in contractor spend.

Depreciation and Amortization Expenses

Depreciation and amortization expenses decreased by $109, or 11%, in the nine months ended September 30, 2019 compared to the same period in 2018 due to reduced amortization expense related to intangible assets, partially offset by increased depreciation of property and equipment acquired in the Allure Acquisition. Although we added intangible assets as a result of the Allure Acquisition, the amortization periods are longer than of those assets which became fully depreciated in 2018 and 2019.

Interest Expense

See Note 9 to the condensed consolidated financial statements for a discussion of the Company’s debt and related interest expense obligations.

Change in Fair Value of Warrant Liability

See Note 6 to the condensed consolidated financial statements for a discussion of the Company’s non-cash change in warrant liability for the nine months ended September 30, 2019, the methodology for which is consistent for the nine months ended September 30, 2019. The change in the fair value of the warrant liability resulted in a gain of $21 in the nine months ended September 30, 2019. All warrants previously classified as liabilities within the balance sheet expired during the three months ended September 30, 2019.

Gain on Settlement of Obligations

During the three months ended September 30, 2019, the Company wrote off liabilities and recognized a gain of $419, primarily related to legacy accounts payable deemed to no longer be legal obligations to vendors.

In September 2018, the Company settled and/or wrote off debt of $219 for $50 cash payment and recognized a gain of $169. This debt included $30 of accrued wage labor liabilities no longer anticipated to be pursued against the Company.

Summary Quarterly Financial Information

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

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 earnings before interest, tax, depreciation and amortization (“EBITDA”), which is a non-GAAP financial measure, is a performance measure and not a liquidity measure, and therefore a reconciliation between net income/(loss) and EBITDA and Adjusted EBITDA, which is a non-GAAP financial measure, has been provided. EBITDA and Adjusted 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 and Adjusted 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.

Liquidity and Capital Resources

We incurred a net loss for the year ended December 31, 2018 and had negative cash flows from operating activities as of December 31, 2018. For the three months ended September 30, 2019 and 2018 we have recognized/(incurred) net income/(losses) of $242 and ($878), respectively. For the nine months ended September 30, 2019 and 2018, we recognized/(incurred) net income/(losses) of $475 and ($3,728), respectively. As of September 30, 2019, we had cash and cash equivalents of $2,240 and working capital deficit of $3,486, which includes $640 representing current maturities of operating leases recorded January 1, 2019 upon adoption of Accounting Standards Update (“ASU”) 2016-02.

On November 9, 2018, Slipstream Communications, LLC, (“Slipstream”) a related party (see Note 9), extended the maturity date of our term loan and revolving loan to August 16, 2020. Our intent is to refinance our term loan and revolving loan with an unrelated third party in the first half of 2019. In conjunction with the extension of the maturity date of our term loan, we agreed that the cash portion of the interest rate would increase prospectively from 8.0% per annum to 10.0% per annum effective July 1, 2019.

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 revolver loan with the Secured Disbursed Escrow Promissory Note.

See Note 9 to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt obligations.

Operating Activities

As of December 31, 2018, we had an accumulated deficit of ($36,851). The cash flows provided by/(used in) operating activities was $456 and ($1,348) for the nine months ended September 30, 2019 and 2018, respectively. The cash provided by operating activities was driven by collections on accounts receivable of $1,739, utilization of prepaid assets of $1,295 and an increase in accrued expenses of $2,491, partially offset by the Company’s recognition of deferred revenue of $5,527.

Investing Activities

Net cash used in investing activities during the nine months ended September 30, 2019 was $442 compared to $255 during the same period in 2018. The use of cash in both periods represents acquisition of capital assets, primarily related to the capitalization of software costs, partially offset by cash received from a net working capital settlement of $210 in 2019. We currently do not have any material commitments for capital expenditures as of September 30, 2019, nor do we anticipate any significant expenditures for the remainder of 2019.

Financing Activities

Net cash (used in) / provided by financing activities during the nine months ended September 30, 2019 and 2018 was ($492) compared to $2,100. The decrease was related to debt proceeds of $2,100 in 2018 as compared to debt repayment of $498 in 2019.

Contractual Obligations

We have no material commitments for capital expenditures, and we do not anticipate any significant capital expenditures for the remainder of 2019.

Off-Balance Sheet Arrangements

During the nine months ended September 30, 2019, 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. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

As disclosed in Part II Item 9A Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, during the third quarter of fiscal 2014 we identified a material weakness in internal control related to a deficient process to close the monthly consolidated financial statements and prepare comprehensive and timely account analysis that support the Company’s financial reporting processes.

During 2019, management implemented our previously disclosed remediation plan that included: (i) addition of headcount in the accounting and finance function to support an adequate and timely close process; (ii) creation of a financial statement close checklist to document the timing, responsibilities and segregation of close duties within and between accounting and finance function personnel; (iii) documentation of a timeline for completion of the financial statement close process and adherence to the timeline in executing the financial statement close; (iv) performance of a Sarbanes-Oxley Section 404a self-assessment of internal controls over financial reporting in the financial statement close process which included identifying, documenting, performance of walk-throughs and testing of the identified internal controls; and (v) testing of the effectiveness of those identified and implemented internal controls.

During the third quarter of 2019, we completed our testing of the operating effectiveness of the implemented controls and found them to be effective. As a result, we have concluded the material weakness has been remediated as of September 30, 2019.

Changes in Internal Control over Financial Reporting

Except for the changes in connection with our implementation of the remediation plan discussed above, there have been no other changes in our internal control over financial reporting that occurred during the third quarter of 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

(a) 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. As of the date of this filing, no formal legal action had been taken by the customer against the Company and, as a result, the outcome of this matter is unclear, so the Company is unable to reasonably estimate the possible loss, or range of loss, if any.

The Company has notified its insurance company and Seller 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.

(b) The Company is not party to any other material legal proceedings, other than ordinary routine litigation incidental to the business, as of November 7, 2019, and there were no other such proceedings pending during the period covered by this Report.

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 28, 2019. 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.

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

(a) Director Resignation; Election of Successor

Effective November 8, 2019, Alec Machiels is resigning as a member of the Company’s Board of Directors (the “Board”) and Chairman of the Board. The Board elected Dennis McGill as Mr. Machiels’ successor, effective November 8, 2019. The Board elected Mr. McGill to serve as the Company’s Chairman of the Board.

Over the course of a forty-five-year career, Mr. McGill has served as a director, Chief Executive Officer or Chief Financial Officer of various public and private companies. From June 2015 to October 2017, Mr. McGill served as the President and CEO of ReCommunity Holdings II, Inc., the largest independent recycling processing company in the US, processing over 1.8 million tons of material annually and employing a team of 1,600 members. Mr. McGill served on the Board of Directors for Lighting Science Group Corp. (“LSGC”) from March 2015 to July 2017 while the company was publicly traded. Mr. McGill also served as the LSGC’s Interim Chief Operating Officer from June 2014 to September 2014 and as LSGC’s Interim Chief Financial Officer from July 2014 to December 2014. Mr. McGill joined Pegasus Capital as an operating advisor in December 2014 and remains in that capacity today. Since June 2014, Mr. McGill has also served on the board of directors of DGSE Companies, Inc., a company listed on the NYSE MKT that buys and sells jewelry, diamonds, fine watches, rare coins and currency (“DGSE”). Mr. McGill previously served on the board of directors of DGSE, ReCommunity Holdings, LP and Fiber Composites, LLC and served as the chairman of DGSE’s audit committee. From February 2013 to October 2013, Mr. McGill served as executive vice president and Chief Financial Officer of Heartland Automotive Services, Inc., where he actively participated with the senior management team to develop and roll-out a new business model. From September 2010 to February 2013, Mr. McGill served as executive vice president and Chief Financial Officer of Blockbuster LLC and was responsible for directing and managing various aspects of the Chapter 11 process. From March 2005 to July 2010, Mr. McGill served as executive vice president and Chief Financial Officer of Safety-Kleen Systems, Inc., during which time he led the company’s merger and acquisition efforts and grew the company from $0 to $160 million in EBITDA during his tenure. Mr. McGill holds a Bachelor of Science degree in Finance and Accounting and Master of Business Administration degree from the University of California, Berkeley and is a Certified Public Accountant in the state of California.

Consulting Agreement

On November 7, 2019, the Company and Dennis McGill executed a Consulting Agreement (the “Consulting Agreement”). The term of the Consulting Agreement is one year, and it automatically renews for successive one-year periods. Either party may terminate the Consulting Agreement at any time upon 30 days’ written notice. Under the Consulting Agreement, Mr. McGill will receive compensation of $5,000 per month in cash in exchange for general business and strategy consulting services to the Company.

The foregoing summary of the Consulting Agreement is qualified in all respects by the Consulting Agreement, a copy of which is attached hereto as Exhibit 10.1 and incorporated herein by this reference.

Option Agreement

On November 7, 2019, the Company and Mr. McGill also executed an Option Agreement (the “Option Agreement”). Under the Option Agreement, Mr. McGill has the option to purchase 25,000 shares of the Company’s common stock under the Company’s 2014 Stock Incentive Plan. The options have an exercise price of $1.88 per share, which was the closing price of the Company’s common stock as reported on Nasdaq on the date prior to the date of the Option Agreement. The options vest in three equal annual installments beginning on the one-year anniversary of the date of the Option Agreement, provided that Mr. McGill must continue to serve as a director of the Company. The foregoing summary of the Option Agreement is qualified in all respects by the Option Agreement, a copy of which is attached hereto as Exhibit 10.2 and incorporated herein by this reference.

Executive Bonus

On November 6, 2019, the Board approved payment of a $150 cash bonus to Richard Mills, the Company’s Chief Executive Officer, for his significant contributions to the Company’s performance in 2018. 

Extension of Maturity Date of Debt

On November 6, 2019, Slipstream extended the maturity date of our Term Loan and Second Revolver Loan to June 30, 2021 through the Sixth Amendment to the Loan and Security Agreement, aligning the maturity date of those loans with that of the Disbursed Escrow Note. The foregoing summary of the Sixth Amendment is qualified in all respects by the Sixth Amendment and Fourth Allonges, a copy of each is attached hereto as Exhibits 10.3-10.5 and incorporated herein by this reference.

(b) Not applicable.

Item 6. Exhibits 

SIGNATURES

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