10-Q 1 f10q0916_creativerealities.htm QUARTERLY REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

 

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

 

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

 

Commission File Number 001-33169

 

 

 

Creative Realities, Inc.

(Exact name of registrant as specified in its charter)

 

Minnesota   41-1967918

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

 

13100 Magisterial Drive, Suite 100, Louisville, KY 40223

(Address of principal executive offices, including zip code)

 

(502) 791-8800

(Registrant’s telephone number, including area code)

 

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 month (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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☐  No ☒

 

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

 

  Large accelerated filer ☐ Accelerated filer ☐
  Non-accelerated filer ☐ Smaller reporting company ☒
  (Do not check if a smaller reporting company)      

 

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

 

As of November 5, 2016, the registrant had 66,232,284 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)

 

   September 30,   December 31, 
   2016   2015 
ASSETS  (unaudited)     
CURRENT ASSETS        
Cash and cash equivalents  $976   $1,361 
Accounts receivable, net of allowance of $44 and $0, respectively   1,682    884 
Unbilled receivables   398    81 
Work-in-process and inventories   588    82 
Prepaid expenses and other current assets   200    348 
Total current assets   3,844    2,756 
Property and equipment, net   874    892 
Intangibles, net   2,357    4,831 
Goodwill   14,989    14,354 
Other assets   191    203 
TOTAL ASSETS  $22,255   $23,036 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
CURRENT LIABILITIES          
Loans payable, net of discount of $757 and $0, respectively  $6,632   $150 
Accounts payable   3,093    3,601 
Accrued expenses   1,388    2,318 
Deferred revenues   799    1,213 
Customer deposits   238    - 
Dividends payable   114    - 
Total current liabilities   12,264    7,282 
Loans payable, net of discount of $0 and $909, respectively   -    2,280 
Warrant liability   1,581    1,649 
Deferred tax liabilities   539    358 
Other liabilities   115    96 
TOTAL LIABILITIES   14,499    11,665 
           
COMMITMENTS AND CONTINGENCIES          
Convertible preferred stock, net of discount (liquidation preference of $7,706 and $5,495, respectively)   3,829    3,769 
           
SHAREHOLDERS' EQUITY          
Common stock, $.01 per value, 200,000 shares authorized; 66,132 and 64,224 shares issued and outstanding, respectively   661    642 
Additional paid-in capital   21,763    21,574 
Accumulated deficit   (18,497)   (14,614)
Total shareholders' equity   3,927    7,602 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $22,255   $23,036 

 

See accompanying notes to condensed consolidated financial statements

 

Page 1 of 31

 

 

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

   For the Three Months Ended
September 30,		   For the Nine Months Ended September 30, 
    2016   2015   2016   2015 
Sales                
Hardware  $856   $962   $2,536   $2,557 
Services and other   1,852    2,407    5,636    5,640 
Total sales   2,708    3,369    8,172    8,197 
Cost of sales                    
Hardware   785    861    2,144    2,313 
Services and other   602    997    1,844    3,236 
Total cost of sales (exclusive of depreciation and amortization shown below)   1,387    1,858    3,988    5,549 
Gross profit   1,321    1,511    4,184    2,648 
                     
Operating expenses:                    
Sales and marketing expenses   280    247    753    921 
Research and development expenses   218    25    736    510 
General and administrative expenses   1,562    1,479    4,751    5,397 
Depreciation and amortization expense   540    439    1,614    1,296 
Loss on lease termination   -    638    -    638 
Impairment loss on intangible assets   1,065    -    1,065    - 
Total operating expenses   3,665    2,828    8,919    8,762 
Operating loss   (2,344)   (1,317)   (4,735)   (6,114)
                     
Other income (expenses):                    
Interest expense   (494)   (302)   (1,296)   (529)
Change in fair value of warrant liability   (433)   (15)   602    797 
Gain on settlement of debt   547    -    953    - 
Other income/(expense)   140    (60)   140    (69)
Total other income/(expense)   (240)   (377)   399    199 
Loss before income taxes   (2,584)   (1,694)   (4,336)   (5,915)
(Provision)/benefit from income taxes   (62)   -    453    - 
Net loss from operations   (2,646)   (1,694)   (3,883)   (5,915)
Dividends on preferred stock   (114)   (81)   (339)   (277)
Net loss attributable to common shareholders  $(2,760)  $(1,775)  $(4,222)  $(6,192)
Basic and diluted loss per common share  $(0.04)  $(0.04)  $(0.06)  $(0.13)
Weighted average shares outstanding - basic and diluted   66,001    46,218    65,179    46,218 

 

See accompanying notes to condensed consolidated financial statements.

 

Page 2 of 31

 

 

CREATIVE REALITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   Nine Months Ended
September 30,		 
   2016   2015 
Operating Activities:        
Net loss  $(3,883)  $(5,915)
Adjustments to reconcile net loss to net cash used in operating activities          
Depreciation and amortization   1,741    1,296 
Amortization of debt discount   739    411 
Stock-based compensation   204    174 
Change in warrant liability   (602)   (797)
Deferred tax provision   (454)   - 
Provision for doubtful accounts   44    104 
Write-off of leasehold improvements   -    227 
Warrant issued for services   20    - 
Noncash interest added to promissory notes   80    - 
Impairment of intangible assets   1,065    - 
Gain on debt settlement   (953)   - 
Changes to operating assets and liabilities:          
Accounts receivable and unbilled revenues   (1,159)   1,586 
Inventories   (506)   490 
Prepaid expenses and other current assets   148    138 
Other assets   12    66 
Accounts payable   733    (338)
Deferred revenue   (414)   (388)
Accrued expenses   (810)   993 
Other non-current liabilities   257    - 
Net cash used in operating activities   (3,738)   (1,953)
Investing activities          
Purchases of property and equipment   (314)   (585)
Net cash used in investing activities   (314)   (585)
Financing activities          
Issuance of convertible preferred stock and warrants   514    1,299 
Debt issuance costs   -    (16)
Issuance of loans payable and warrants, net of discount   3,263    946 
Issuance of common stock   178    - 
Payments on promissory notes   (288)   - 
Net cash provided by financing activities   3,667    2,229 
Decrease in Cash and Cash Equivalents   (385)   (309)
Cash and Cash Equivalents, beginning of period   1,361    573 
Cash and Cash Equivalents, end of period   976    264 

 

See accompanying notes to condensed consolidated financial statements.

 

Page 3 of 31

 

  

CREATIVE REALITIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)

(unaudited)

All currency is rounded to the nearest thousand except share and per share amounts

 

NOTE 1: NATURE OF OPERATIONS AND GOING CONCERN UNCERTAINTY

 

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.  

 

Basis of Presentation

 

We have prepared the condensed consolidated financial statements included herein, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). The condensed consolidated financial statements include the Company’s wholly owned subsidiaries. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed in the accompanying condensed consolidated financial statements. The accompanying year-end condensed consolidated balance sheet was derived from the audited financial statements included in the annual financial statements but does not include all disclosures required by U.S. GAAP. The accompanying interim financial statements are unaudited, and reflect all adjustments that in the opinion of management are necessary for a fair presentation of the Company’s condensed consolidated financial position, results of operations, and cash flows for the periods presented. Unless otherwise noted, all such adjustments are of a normal, recurring nature. All intercompany transactions and balances have been eliminated in consolidation. The Company’s results of operations and cash flows for the interim periods are not necessarily indicative of the results of operations and cash flows that it may achieve in future periods. Nevertheless, we believe that the disclosures are adequate to ensure the information presented is not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with our audited financial statements and the notes thereto for the year ended December 31, 2015 included in the Company’s 10-K filed with the SEC on April 4, 2016.

 

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. We have 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.

 

Going Concern Uncertainty

 

We have incurred net losses and negative cash flows from operating activities for the three and nine months ended September 30, 2016 and the years ended December 31, 2015 and 2014. As of September 30, 2016, we had cash and cash equivalents of $976 and a working capital deficit of $(8,420). These factors raise substantial doubt about our ability to continue as a going concern. Management believes that despite our losses to date and while we can provide no assurance that our ongoing integration efforts will be successful, the operations of the consolidated Company resulting from the acquisition of ConeXus World Global, LLC and our restructuring actions will improve our sales, profit margin, scale and operating efficiencies. The Company entered into a Loan and Security Agreement on August 17, 2016, pursuant to which it has obtained financing, see Note: 8, Loans Payable.

 

The condensed consolidated financial statements do not include any adjustments to the recoverability and classifications of recorded assets and liabilities as a result of the above uncertainty.

 

Page 4 of 31

 

 

Acquisitions

 

Acquisition of ConeXus World Global

 

On October 15, 2015, we completed the acquisition of ConeXus World Global, LLC pursuant to an Agreement and Plan of Merger and Reorganization for 2,080,000 shares of Series A-1 Convertible Preferred Stock, and the conversion of $823 of ConeXus World Global debt into (i) 2,639,258 shares of our common stock, and (ii) $150 in principal amount of our convertible debt. As a result of the merger transaction, ConeXus World Global, LLC is now our wholly owned operating subsidiary. The merger was completed by the filing of articles of merger with the Kentucky Secretary of State.

 

The debtholders and members of ConeXus received a total of 1,664,000 shares of Series A-1 Convertible Preferred Stock, par value $1.00, and 16,000,000 shares of our common stock, par value $0.01. In accordance with the terms of the amendment to the agreement and plan of merger and reorganization, an additional 416,000 shares of Series A-1 Convertible Preferred Stock and 4,000,000 shares of common stock were to be issued upon the reorganization of the capital structure of a Belgian affiliate of ConeXus. As of the date of this Quarterly Report on Form 10-Q, this reorganization has not occurred and the Company will not be acquiring the ConeXus Belgian affiliate. Therefore, no liability has been recorded for these additional shares, the consideration has not been included in the purchase price allocation and the financial results of the Belgian affiliate have not been included in the condensed consolidated financial statements.

 

Note 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

A summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:

 

1.  Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of Creative Realities, Inc., our wholly owned subsidiaries ConeXus World Global LLC, Creative Realities, LLC, Broadcast International, Inc., and Wireless Ronin Technologies Canada, Inc. All inter-company balances and transactions have been eliminated in consolidation, as applicable.

 

2.  Foreign Currency

 

For the Company’s Canadian operations, the local currency has been determined to be the functional currency. The results of its non-U.S. dollar based operations are translated to U.S. dollars at the average exchange rates during the period. Assets and liabilities are translated at the rate of exchange prevailing on the balance sheet date. Equity is translated at the prevailing rate of exchange at the date of the equity transaction. The effects of converting non-functional currency assets and liabilities into the functional currency are recorded as general and administrative expenses in the condensed consolidated statements of operations. Translation adjustments, which are considered immaterial to date, have been recorded as general and administrative expenses in the condensed consolidated statements of operations.

 

3.  Revenue Recognition

 

We recognize revenue primarily from these sources:

 

  ●

Hardware:

System hardware sales

  ●

Services and Other:

Professional and implementation services

   

Software design and development services

Software and software license sales

Maintenance and support services

 

We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 910, Contractors-Construction, ASC 605, Revenue Recognition, ASC 605-25, Accounting for Revenue Arrangements with Multiple Deliverables and ASC subtopic 985-605, Software. In the event of a multiple-element arrangement, we evaluate each element of the transaction to determine if it represents a separate unit of accounting, taking into account all factors following the guidelines set forth in FASB ASC 985-605-25-5:

 

(i)persuasive evidence of an arrangement exists;
(ii)delivery has occurred, which is when product title transfers to the customer, or services have been rendered;
(iii)customer payments are fixed or determinable and free of contingencies and significant uncertainties; and
(iv)collection is reasonably assured. If it is determined that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment, revenues are reported on a gross basis.

 

Page 5 of 31

 

  

We enter into arrangements with customers that could include a combination of software products, system hardware, maintenance and support, or installation and training services. We allocate the total arrangement fee among the various elements of the arrangement based on the relative fair value of each of the undelivered elements determined by vendor-specific objective evidence (VSOE). In software arrangements for which we do not have VSOE of fair value for all elements, revenue is deferred until the earlier of when VSOE is determined for the undelivered elements (residual method) or when all elements for which we do not have VSOE of fair value have been delivered. We have determined the VSOE of fair value for each of the Company’s products and services.

 

The VSOE for maintenance and support services is based upon the renewal rate for continued service arrangements. The VSOE for installation and training services is established based upon pricing for the services. The VSOE for software and licenses is based on the normal pricing and discounting for the product when sold separately.

 

Each element of our multiple-element arrangements qualifies for separate accounting. Nevertheless, when a sale includes both software and maintenance, we defer revenue under the residual method of accounting. Under this method, the undelivered maintenance and support fees included in the price of software is amortized ratably over the period the services are provided. We defer maintenance and support fees based upon the customer’s renewal rate for these services.

 

System hardware sales

 

Included in “hardware” are system hardware sales whereby revenue is recognized generally upon shipment of the product or customer acceptance depending upon contractual arrangements with the customer. Shipping charges billed to customers are included in sales and the related shipping costs are included in cost of sales. Total hardware sales were $856 and $962 for the three months ended September 30, 2016 and 2015, respectively and $2,536 and $2,557 for the nine months ended September 30, 2016 and 2015, respectively.

 

Services and Other

 

Included in “services and other” revenue is professional and implementation services, software design and development services, software and software license sales and maintenance and support services revenue. Total services and other revenue was $1,852 and $2,407 for the three months ended September 30, 2016 and 2015, respectively and $5,636 and $5,640 for the nine months ended September 30, 2016 and 2015, respectively.

 

Professional and implementation services

 

Professional services revenue is derived primarily from consulting services related to the design and development of various marketing experiences, and content development and management. The majority of professional services and accompanying agreements qualify for separate accounting.

 

Implementation services revenue is derived from implementation, maintenance and support contracts, content development, software development and training.

 

These services are bid either on a fixed-fee basis, time-and-materials basis or both. For time-and-materials contracts, we recognize revenue as services are performed. For fixed-fee contracts, we recognize revenue upon completion of specific contractual milestones, or by using the percentage-of-completion method.

 

Software design and development services

 

Software design and development services includes revenue from contracts for technology integration consulting services where we design/redesign, build and implement new or enhanced systems applications and related processes for clients recognized on the percentage-of-completion method. The percentage-of-completion accounting involves calculating the percentage of services provided during the reporting period compared to the total estimated services to be provided over the duration of the contract. Estimated revenues from applying the percentage-of-completion method include estimated incentives for which achievement of defined goals is deemed probable. Contract costs include all direct material, labor, subcontractors, certain indirect costs, such as indirect labor, equipment costs, supplies, tools and depreciation costs. This method is followed where reasonably dependable estimates of revenues and costs can be made. We measure progress for completion based on either the hours worked as a percentage of the total number of hours of the project or by delivery and customer acceptance of specific milestones as outlined per the terms of the agreement with the customer. Estimates of total contract revenue and costs are continuously monitored during the term of the contract, and recorded revenue and costs are subject to revision as the contract progresses. Such revisions may result in increases or decreases to revenue and income and are reflected in the financial statements in the periods in which they are first identified. If estimates indicate that a contract loss will occur, a loss provision is recorded in the period in which the loss first becomes probable and reasonably estimable. Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenue that will be generated by the contract and are included in cost of sales and classified in accrued expenses in the balance sheet. Selling, general and administrative costs are charged to expense as incurred. Our presentation of revenue recognized on a contract completion basis has been consistently applied for all periods presented.

 

Page 6 of 31

 

  

Software and software license sales

 

Software and software license sales are revenue when a fixed fee order has been received and delivery has occurred to the customer. We assess whether the fee is fixed or determinable and free of contingencies based upon signed agreements received from the customer confirming terms of the transaction. Software is delivered to customers electronically or on a CD-ROM, and license files are delivered electronically.

 

Maintenance and support services

 

Maintenance and support services revenue consists of software updates and various forms of support services. Software updates provide customers with rights to unspecified software product upgrades and maintenance releases and patches released during the term of the support period. Support includes access to technical support personnel for software and hardware issues. We also offer 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. This revenue is recognized ratably over the term of the contract, which is typically one to three years. Maintenance and support is 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. Support agreement fees are based on the level of service provided to its 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.

 

Costs and estimated earnings recognized in excess of billings on uncompleted contracts are recorded as unbilled services and are included in work-in-process on the balance sheet. Billings in excess of costs and estimated earnings on uncompleted contracts are recorded as deferred revenue until revenue recognition criteria are met. Unbilled receivables are a normal part of our business as some receivables are invoiced in the month following shipment or completion of services. Our policy is to present any taxes imposed on revenue-producing transactions on a net basis.

 

4.  Cash and Cash Equivalents

 

Cash equivalents consist of commercial paper and all other liquid investments with original maturities of three months or less when purchased. As of September 30, 2016 and December 31, 2015, the Company had substantially all cash invested in commercial banks. The balances are insured by the Federal Deposit Insurance Corporation up to $250.

 

5. Accounts Receivable and Allowance for Doubtful Accounts

 

Our unsecured accounts receivable are customer obligations due under normal trade terms, carried at their face value less an allowance for doubtful accounts. As discussed in Note 4, we had a factoring arrangement with Allied Affiliated Funding for our accounts receivable with recourse up until August 17, 2016 when it was terminated. None of our receivables are factored at this time. We determine our allowance for doubtful accounts based on the evaluation of the aging of our accounts receivable and on a customer-by-customer analysis of high-risk customers. Our reserves contemplate our historical loss rate on receivables, specific customer situations and the economic environments in which we operate. We determine past-due accounts receivable on a customer-by-customer basis. Accounts receivable are written off after all reasonable collection efforts have failed. There is an immaterial amount of reserve for doubtful accounts at September 30, 2016 and December 31, 2015.

 

6. Work-In-Process and Inventories

 

Our work-in-process and inventories are recorded using the lower of cost or market on a first-in, first-out (FIFO) method. Inventory is net of an allowance for obsolescence of $10 and $28 as of September 30, 2016 and December 31, 2015, respectively.

 

7. Fair Value of Financial Instruments

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Inputs are broadly defined as assumptions market participants would use in pricing an asset or liability.

 

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FASB ASC 820-10, Fair Value Measurements and Disclosures, requires disclosure of the estimated fair value of an entity's financial instruments. Such disclosures, which pertain to our financial instruments, do not purport to represent our aggregate net fair value. The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate fair value because of the short maturity of those instruments. The fair value of the loan payable approximates carrying value based on the interest rates in the agreement compared to current market interest rates. The fair value of the warrant liabilities is calculated using a Black-Scholes model, which approximates a binomial model due to probability factors used to determine the fair value. The calculation of this liability is based on Level 3 inputs. See Notes 5 and 13 for further discussion on the valuation of warrant liabilities.

 

8.  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 360-10-05-4, Accounting for the Impairment or Disposal of Long-Lived Assets. Under ASC 360-10-05-4, 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.

 

9. Property and Equipment

 

Property and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over the estimated service lives, principally using straight-line methods. Leasehold improvements are amortized over the shorter of the life of the improvement or the lease term, using the straight-line method.

 

 Depreciation and amortization expense was $70 and $81 for the three months ended September 30, 2016 and 2015 and $205 and $200 for the nine months ended September 30, 2016 and 2015, respectively.

 

10. Research and Development and Software Development Costs

 

Research and development expenses consist primarily of development personnel and non-employee contractor costs related to the development of new products and services, enhancement of existing products and services, quality assurance and testing. Effective April 2015, the Company began capitalizing its costs for additional functionality to its internal software. The Company capitalized approximately $88 and $166 for the three months ended September 30, 2016 and 2015 and approximately $164 and $388 for the nine months ended September 30, 2016 and 2015, respectively. These software development costs include both enhancements and upgrades of our client based systems including functionality of our internal information systems to aid in our productivity, profitability and customer relationship management. The Company amortizes these costs over 5 years once the new projects are finished and placed in service. These costs are included in property and equipment, net on the condensed consolidated balance sheets.

 

11. Basic and Diluted Loss per Common Share

 

Basic and diluted loss per common share for all periods presented is computed using the weighted average number of common shares outstanding. Basic weighted average shares outstanding include only outstanding common shares. Diluted net loss per common share is computed by dividing net loss by the weighted average common and potential dilutive common shares outstanding in accordance with the treasury stock method. Shares reserved for outstanding stock options and warrants totaling approximately 34.7 and 20.0 million at September 30, 2016 and 2015, respectively, were excluded from the computation of loss per share as well as the potential common shares issuable upon conversion of convertible preferred stock and convertible promissory notes as their effect was antidilutive due to our net loss. Net loss attributable to common shareholders for the three months ended September 30, 2016 is after dividends on convertible preferred stock of $114. Net loss attributable to common shareholders for the nine months ended September 30, 2016 is after dividends on convertible preferred stock of $339 and for the three and nine months ended September 30, 2015 is after dividends on convertible preferred stock of $81 and $277, and amortization of the beneficial conversion feature of $34.

 

12. Deferred Income Taxes

 

The calculation of our income tax provision involves dealing with uncertainties in the application of complex tax regulations.  We recognize tax liabilities for uncertain income tax positions based on management’s estimate of whether it is more likely than not that additional taxes will be required.  We had no uncertain tax positions as of September 30, 2016 and December 31, 2015.

 

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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 (other than goodwill), 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.

 

13. Accounting for Stock-Based Compensation

 

The Company accounts for stock-based compensation in accordance with ASC 718-10, Stock Compensation, that requires the 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 value. For purposes of determining estimated fair value under ASC 718-10-30, the Company computes the estimated fair values of stock options using the Black-Scholes option-pricing model. Stock-based compensation expense to employees of $69 and $39 was charged to expense during the three months ended September 30, 2016 and 2015 and $204 and $174 for the nine months ended September 30, 2016 and 2015, respectively. 

 

14. Goodwill and Indefinite-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 (see Note 7). An impairment loss on intangible assets of $1,065 was charged to expense during the three and nine months ended September 30, 2016 and no impairment loss on intangible assets was charged to expense during the three and nine months ended September 30, 2015. There was no impairment loss recognized on goodwill during the three and nine months ended September 30, 2016 (see Note 7).

 

15. Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our significant estimates are: the allowance for doubtful accounts, recognition of revenue under fixed price contracts, deferred tax assets, deferred revenue, depreciable lives and depreciation methods for property and equipment, 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.

 

16. Recently Issued Accounting Pronouncements

 

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, which provides guidance on the classification of certain cash receipts and cash payments in the statement of cash flows, including those related to debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance, and distributions received from equity method investees. This guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. Early adoption is permitted, including the adoption in an interim period. If an entity adopts the guidance in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that intgerim period. The guidance must be adopted on a retrospective basis and must be applied to all periods presented, but may be applied prospectively if retrospective application would be impracticable. We are currently evaluating the impact, if any, that the adoption of this guidance will have on our consolidated statement of cash flows.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides guidance with respect to measuring credit losses on financial instruments, including trade receivables. This guidance eliminates the probable initial recognition threshold that was previously required prior to recognizing a credit loss on financial instruments. The credit loss estimate can now reflect an entity’s current estimate of all future expected credit losses. Under the previous guidance, an entity only considered past events and current conditions. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the impact, if any that the adoptions of this guidance will have on our consolidated financial statements.

 

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In November 2015, the FASB issued ASU 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes, which provides guidance simplifying the balance sheet classification of deferred taxes. The new guidance requires that all deferred taxes be presented as noncurrent, rather than separated into current and noncurrent amounts. The guidance is effective for reporting periods beginning after December 15, 2016 and early adoption is permitted. In addition, the adoption of this guidance can be applied either prospectively or retrospectively to all periods presented. We are currently evaluating the impact, if any, that the adoption of this will have on our consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, to clarify the principles used to recognize revenue for all entities. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, which further clarifies the implementation guidance on principal versus agent considerations”, and in April 2016, the FASB issued ASU 2016-10, Revenue from contracts with customers (Topic 606): Identifying performance obligations and licensing, an update on identifying performance obligations and accounting for licenses of intellectual property. Additionally, in May 2016, the FASB issued ASU 2016-12, Revenue from contracts with customers (Topic 606): Narrow-scope improvements and practical expedients, which includes amendments for enhanced clarification of the guidance. This guidance is effective for fiscal years beginning on or after December 15, 2017, including interim periods within those fiscal years and early adoption is permitted. We are evaluating the impact that adoption of this guidance will have on our condensed consolidated financial statements. 

 

In March 2016, the FASB issued ASU 2016-09, Stock Compensation, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases, which amended guidance for lease arrangements in order to increase transparency and comparability by providing additional information to users of financial statements regarding an entity's leasing activities. The revised guidance seeks to achieve this objective by requiring reporting entities to recognize lease assets and lease liabilities on the balance sheet for substantially all lease arrangements. The guidance, which is required to be adopted in the first quarter of 2019, will be applied on a modified retrospective basis beginning with the earliest period presented. Early adoption is permitted. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

 

In July 2015, FASB issued ASU 2015-11, Inventory (Topic 330) Related to Simplifying the Measurement of Inventory applies to all inventory except that which is measured using last-in, first-out (LIFO) or the retail inventory method. Inventory measured using first-in, first-out (FIFO) or average cost is included in the new amendments. Inventory within the scope of the new guidance should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments will take effect for public business entities for fiscal years beginning after December 15, 2016, including interim periods thereafter. The new guidance should be applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. We are evaluating the impact of the standard on the consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern, which states management should evaluate whether there are conditions or events, considered in the aggregate, that raise a substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued.  Management’s evaluation should be based on relevant conditions and events that are known and likely to occur at the date that the financial statements are issued.  The standard update will be effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, however, early application is permitted.  The Company is evaluating the effect that ASU 2014-15 will have on its consolidated financial statements and related disclosures, but does not anticipate a material impact.

 

17. Reclassifications

 

Certain reclassifications were made to the 2015 consolidated financial statements to conform to the 2016 presentation with no effect on net loss or shareholders’ equity.

 

NOTE 3: ACQUISITIONS

 

Acquisition of ConeXus World Global

 

On October 15, 2015, we completed the acquisition of ConeXus World Global, LLC for 2,080,000 shares of Series A-1 Convertible Preferred Stock, and the conversion of $823 of ConeXus World Global debt into (i) 2,639,258 shares of our common stock, and (ii) $150 in principal amount of our convertible debt and a warrant to purchase 267,857 shares of common stock.

 

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The debtholders and members of ConeXus received a total of 1,664,000 shares of Series A-1 Convertible Preferred Stock, par value $1.00, and 16,000,000 shares of our common stock, par value $0.01. In accordance with the terms of the amendment to the agreement and plan of merger and reorganization, an additional 416,000 shares of Series A-1 Convertible Preferred Stock and 4,000,000 shares of common stock were to be issued upon the reorganization of the capital structure of a Belgian affiliate of ConeXus. As of the date of this report, this reorganization has not occurred and the Company will not be acquiring the ConeXus Belgian affiliate. Therefore, no liability has been recorded for these additional shares, the consideration has not been included in the purchase price allocation and the financial results of the Belgian affiliate have not been included in the condensed consolidated financial statements.

 

In our Quarterly Report on Form 10-Q for the period ended March 31, 2016, filed with the SEC on May 13, 2016, we disclosed the preliminary estimate of the consideration transferred to effect the merger. The following is the consideration actually transferred to effect the merger:

 

     
Issuance of common shares to ConeXus  shareholders  $3,520 
Issuance of preferred shares to ConeXus shareholders   1,664 
Issuance of convertible promissory note with warrants   150 
Total consideration  $5,334 

 

The fair value of the warrants is based on the Black-Scholes valuation model, using the CRI, Inc. share price on the merger date as an input.

 

The following assumptions were applied in determining the grant date fair value of the (for accounting purposes only) warrant award: 

 

Risk-free interest rate  1.71
Expected term  5.0 years
Expected price volatility  60.47%
Dividend yield  -

 

Our computation of expected volatility is based on historical volatility. The expected warrant term was the life of the warrant. The risk free interest rate of the award is based on the U.S. Treasury yield curve in effect at the time of the merger and having a term consistent with the expected term of the award.

 

Under the acquisition method of accounting, the total purchase price is allocated to the identifiable tangible and intangible assets and liabilities of ConeXus World Global, LLC acquired in the merger, based on their fair values at the merger date. The estimated fair values are based on the information that was available as of the merger date or became available during the measurement period. We believe that the information provides a reasonable basis for estimating the fair values. The fair value of goodwill and other liabilities was updated to reflect a measurement period adjustment. A tax benefit of $635 was recognized for the three months ended June 30, 2016 and the nine months ended September 30, 2016, respectively, on the Company’s condensed consolidated statements of operations and would have been recorded for the year ended December 31, 2015 if the adjustment to the provisional amounts had been recognized as of the acquisition date. See Note 12: Income Taxes. We believe that the information provides a reasonable basis for estimating the fair values. The allocation of the purchase price has been allocated to assets acquired and liabilities assumed as follows:

 

Current assets  $1,187 
Property and equipment   47 
Goodwill   4,629 
Identifiable intangible assets   1,750 
Other assets   13 
Total assets   7,626 
      
Current liabilities   1,657 
Deferred tax liabilities   635 
Total liabilities   2,292 
      
Total allocated purchase price  $5,334 

 

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The estimated fair value of amortizable intangible assets of approximately $1.8 million is amortized on a straight-line basis over the weighted average estimated useful life. The purchase price allocation to identifiable intangible assets and related amortization lives are as follows: 

 

       Useful lives
   Amounts   (years)
Customer relationships  $1,370   3
    Trademark   380   5
Total  $1,750    

  

The fair values of the customer relationship were estimated using a discounted present value income approach. Under the income approach, an intangible asset’s fair value is equal to the present value of future economic benefits to be derived from ownership of the asset. Indications of value are determined by discounting future net cash flows to their present value at market-based rates of return. The useful life of the intangible assets for amortization purposes was determined considering the period of expected cash flows used to measure the fair value of the intangible assets adjusted as appropriate for the entity-specific factors including legal, regulatory, contractual, competitive, economic or other factors that may limit the useful life of intangible assets.

 

The goodwill recognized as a result of the merger is attributable primarily to the strategic and synergistic opportunities across the marketing technology spectrum, expected corporate synergies and the assembled workforce.

 

We incurred approximately $0.2 million of acquisition-related costs that were expensed during the year ended December 31, 2015. These costs are included in selling, general and administrative costs in our condensed consolidated statements of operations. No such costs were incurred for the three and nine months ended September 30, 2016.

 

The following unaudited pro forma consolidated financial results have been prepared for illustrative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisitions of ConeXus (discussed above) occurred on the first day of the earliest period presented, or of future results of the consolidated entities.

 

The unaudited pro forma condensed consolidated financial information includes amortization expense from the acquired assets and transaction costs assuming the merger occurred on January 1, 2015. The unaudited pro forma condensed consolidated financial information does not reflect any operating efficiencies and cost savings that may be realized from the integration of the acquisition.

 

   Three months ended September 30,
2015		   Nine months ended September 30,
2015		 
Supplemental pro forma combined results of operations:        
         
Net sales           $5,582   $12,712 
Net loss  $(1,683)  $(6,347)

  

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NOTE 4: FINANCING ARRANGEMENTS

 

Factoring Agreement

 

On October 15, 2015, we entered into a Factoring Agreement with Allied Affiliated Funding, L.P. Under the Factoring Agreement, Allied Affiliated Funding, or “Allied,” was permitted, but not required to purchase approved receivables from the Company and its subsidiaries up to a maximum amount of $3.0 million. Upon receipt of any advance under the Factoring Agreement, the Company and its subsidiaries sold and assigned all of their rights in such receivables and all proceeds thereof to Allied, with recourse. The purchase price for receivables bought and sold under the Factoring Agreement was equal to their face amount less a 1.10% base discount. Added to the base discount is an additional .037% discount from the face value of a receivable for each day beyond 30 days that the receivable remained unpaid by the account debtor. The base discount was subject to adjustment in the event of changes in the prime lending rate as published by The Wall Street Journal. Allied provided advances under the Factoring Agreement net of an applicable reserve amount, as specified in the agreement. The obligations of the Company and its subsidiaries under the Factoring Agreement are secured by substantially all of the assets of the Company and its subsidiaries. Allied had the right under the Factoring Agreement to require the Company to repurchase any receivable earlier sold for a purchase price equal to the face value of the receivable. The Factoring Agreement had an initial term of one year, subject to potential one-year renewals thereafter, unless earlier terminated (or not renewed) in accordance with the agreement. The Company terminated the Factoring Agreement on August 17, 2016, upon payment to Allied of an early termination fee equal to $37.5. The table below provides an analysis of the accounts receivables factored at December 31, 2015. There were no receivables factored at September 30, 2016.

 

   December 31, 
   2015 
Accounts receivables assigned to factor     $1,218 
Advances from factor   (1,049)
Amounts due from factor      169 
Unfactored accounts receivable   715 
Total accounts receivable     $884 

 

NOTE 5: FAIR VALUE MEASUREMENT

 

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

 

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

 

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

 

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

 

The following table presents information about the Company's warrant liabilities that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques the Company used to determine such fair value. See Note 13 for the inputs used for the probability weighted Black Scholes valuations when the warrants were issued and during the nine-month period ending September 30, 2016.

 

       Quote Prices In Active Markets   Significant Other Observable Inputs   Significant Other Unobservable Inputs 
Description  Fair Value   (Level 1)   (Level 2)   (Level 3) 
Warrant liabilities at December 31, 2015  $1,649            -           -   $1,649 
Warrant liabilities at September 30, 2016  $1,581    -    -   $1,581 
                     
The change in level 3 fair value is as follows:                    
                     
Warrant liability as of December 31, 2015                 $1,649 
New warrant liabilities                  534 
Decrease in fair value of warrant liability                  (602)
Ending warrant liability as of September 30, 2016                 $1,581 

 

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NOTE 6: OTHER FINANCIAL STATEMENT INFORMATION

 

The following table provides details of selected financial statement items: 

 

Inventories

 

   September 30,   December 31, 
   2016   2015 
Finished goods  $12   $69 
Work-in-process   576    13 
Total inventories  $588   $82 

 

   Nine Months Ended 
   September 30, 
   2016   2015 
Supplemental Cash Flow Information        
Non-cash Investing and Financing Activities        
Noncash preferred stock dividends  $338   $274 
Issuance of notes in exchange for accounts payable     $288   $- 
Issuance of stock upon conversion of preferred stock  $176   $- 
Issuance of stock in exchange for accounts payable     $86   $- 

 

NOTE 7: GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill

 

Changes in goodwill for the period from December 31, 2015 to September 30, 2016 are as follows:

 

Goodwill at December 31, 2015  $14,354 
Adjustment to ConeXus purchase accounting   635 
Goodwill at September 30, 2016  $14,989 

 

Other Intangible Assets

 

Other intangible assets consisted of the following at September 30, 2016 and December 31, 2015: 

 

   September 30,   December 31, 
   2016   2015 
   Gross       Gross     
   Carrying   Accumulated   Carrying   Accumulated 
   Amount   Amortization   Amount   Amortization 
Technology platform   4,190    2,335    4,190    1,598 
Customer relationships   2,460    1,199    2,460    584 
Trademarks and trade names   680    374    680    317 
    7,330    3,908    7,330    2,499 
Accumulated amortization   3,908         2,499      
Impairment loss on technology platform   1,065         -      
Net book value of amortizable intangible assets   2,357         4,831      

  

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For the three months ended September 30, 2016 and 2015, amortization of intangible assets charged to operations was $470 and $364, and for the nine months ended September 30, 2016 and 2015 amortization of intangible assets charged to operations was $1,409 and $1,096, respectively. 

 

The Company has made comprehensive upgrades to its technology platform. Due to these upgrades, the Company evaluated the recoverability of the carrying amount of the original technology platform intangible asset at September 30, 2016. Based upon this evaluation, the Company determined that the technology platform intangible asset was impaired as its value was not recoverable and exceeded its fair value. The Company recognized an impairment loss of $1,065.

 

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.

 

The Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. The Company performed its annual goodwill impairment test at September 30, 2016.

 

Utilizing the two-step impairment test, the Company first 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, considerations for purchase orders expected to be completed in the fourth quarter of 2016 and orders actively being negotiated for fiscal 2017. We also used these same expectations in a number of valuation models in addition to discounted cash flows, including, leveraged buy-out, trading comps and market capitalization, and ultimately determined an estimated fair value of our reporting unit based on weighted average calculations from these models. 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, 2016.

 

The Company recognizes that any changes in our actual fourth quarter 2016 or projected 2017 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.

 

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NOTE 8: LOANS PAYABLE

 

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

 

Issuance Date  Original Principal   Additional Principal   Total Principal   Maturity Date  Warrants   `
8/17/2016  $3,000   $-   $3,000   8/17/2017   5,882,352   8.0% interest
6/29/2016   50    -    50   4/15/2017   89,286   14% interest - 12% cash,  2% added to principal
6/13/2016   200    13    213   4/15/2017   357,143   14% interest - 12% cash,  2% added to principal
6/13/2016   250    8    258   4/15/2017   446,429   14% interest - 12% cash,  2% added to principal
5/3/2016   500    4    504   4/15/2017   892,857   14% interest - 12% cash,  2% added to principal
12/28/2015   150    2    152   4/15/2017   267,857   14% interest - 12% cash,  2% added to principal
12/28/2015   500    8    508   4/15/2017   892,857   14% interest - 12% cash,  2% added to principal
12/28/2015   600    9    609   4/15/2017   1,071,429   14% interest - 12% cash,  2% added to principal
10/26/2015   300    5    305   4/26/2017   535,714   14% interest - 12% cash,  2% added to principal
10/15/2015   150    2    152   4/15/2017   267,857   14% interest - 12% cash,  2% added to principal
10/15/2015   500    9    509   4/15/2017   892,857   14% interest - 12% cash,  2% added to principal
6/23/2015   400    10    410   4/15/2017   640,000   14% interest - 12% cash,  2% added to principal
6/23/2015   119    15    134   4/15/2017   935,210   Refinanced May 20, 2015 debt, 14% interest - 12% cash,  2% added to principal
5/20/2015   465         465   4/15/2017   762,295   14% cash interest
   $7,184   $85   $7,269       13,934,143    
Debt discount             (757)           
Unpaid interest             120            
Total convertible promissory notes  $7,184        $6,632            

 

Obligations under the secured convertible promissory notes are secured by a grant of collateral security in all of the tangible assets of the co-makers pursuant to the terms of an amended and restated security agreement.

 

On August 17, 2016, we entered into a Loan and Security Agreement with Slipstream Communications, LLC, a related party (see Note 11), under which we obtained a $3.0 million term loan, with interest thereon at 8% per annum, maturing on August 17, 2017 (with a one-year option for us to extend that maturity, so long as we are not then in default and we deliver additional warrants to the lender). The term loan contains certain customary restrictions including, but not limited to, restrictions on mergers and consolidations with other entities, cancellation of any debt or incurring new debt (subject to certain exceptions), and other customary restrictions. In connection with the loan, we issued the lender a five-year warrant to purchase up to 5,882,352 shares of common stock. The proceeds from the loan were used to (i) satisfy the obligations owed to Allied Affiliated Lending, L.P. under the Factoring Agreement (see Note 4), (ii) pay off certain obligations under settlement arrangements in effect as of the date hereof (see Note 9), and (iii) obtain working capital. The Loan and Security Agreement permits the lender to make additional advances of up to an additional $1.0 million. In connection with this financing transaction, we terminated the Factoring Agreement with Allied Affiliated Lending. Our principal subsidiaries — Creative Realities, Inc., Creative Realities, LLC, Conexus World Global, LLC, and Broadcast International, Inc. — were also parties to the securities purchase agreement and are co-makers of the secured convertible promissory notes. The fair value of the warrants on the issuance date was $361. See Note 13 for the Black Scholes inputs used to calculate the fair value of the warrants.

 

On June 29, 2016, we offered and sold to an accredited investor a secured convertible promissory note in the principal amount of $50,000 and five-year warrants to purchase up to 89,286 shares of Creative Realities’ common stock at a per-share price of $0.28 (subject to adjustment), all pursuant to a securities purchase agreement. Our principal subsidiaries — Creative Realities, LLC, Wireless Ronin Technologies Canada, Inc., and Conexus World Global, LLC — were also parties to the securities purchase agreement and are co-makers of the secured convertible promissory notes. The fair value of the warrants on the issuance date was $6. See Note 13, for the Black Scholes inputs used to calculate the fair value of the warrants.

 

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On June 13, 2016, upon receipt of an additional $300 of principal, we exchanged two short term notes totaling $150 for two secured convertible promissory notes totaling a principal amount of $450 and five-year warrants to purchase up to 803,572 shares of Creative Realities’ common stock at a per-share price of $0.28 (subject to adjustment), all pursuant to a securities purchase agreement. Our principal subsidiaries — Creative Realities, LLC, Wireless Ronin Technologies Canada, Inc., and Conexus World Global, LLC — were also parties to the securities purchase agreement and are co-makers of the secured convertible promissory notes. This exchange is accounted for as a modification of the debt. The fair value of the warrants on the issuance date was $57. See Note 13, for the Black Scholes inputs used to calculate the fair value of the warrants.

 

On or about May 3, 2016, we offered and sold to an accredited investor a secured convertible promissory note in the principal amount of $500,000 and five-year warrants to purchase up to 892,857 shares of Creative Realities’ common stock at a per-share price of $0.28 (subject to adjustment), all pursuant to a securities purchase agreement. Our principal subsidiaries — Creative Realities, LLC, Wireless Ronin Technologies Canada, Inc., and Conexus World Global, LLC — were also parties to the securities purchase agreement and are co-makers of the secured convertible promissory notes. In connection with the offer and sale of the above-described secured convertible promissory note, we incurred commissions to a placement agent aggregating $25. The fair value of the warrants on the issuance date was $89. See Note 13, for the Black Scholes inputs used to calculate the fair value of the warrants.

 

The secured promissory notes mature on April 15, 2017, unless the holder of a note elects to extend the maturity date for an additional six-month period in which case such note will mature on October 15, 2017. At any time prior to the maturity date, the investors may convert the outstanding principal and accrued and unpaid interest into Creative Realities’ common stock at a conversion price equal to $0.28 per-share (subject to adjustment).

 

The Company and the investors entered into registration rights agreements requiring Creative Realities to register under the Securities Act of 1933 the resale of the shares of common stock issuable upon conversion of the secured notes and upon exercise of the warrants. The Company filed a registration statement on Form S-1/A on May 13, 2016 registering 23,272,184 shares of common stock and that registration statement became effective on June 1, 2016.

 

NOTE 9: STRUCTURED SETTLEMENT PROGRAM

 

In March 2016, the Company issued 8.00% nonconvertible promissory notes in favor of certain general unsecured creditors in the aggregate principal amount of $288 to settle an aggregate amount of $839 of accounts payable, accrued expenses and other liabilities. The aggregate amount of payables, accrued expenses and other liabilities was subsequently revised to $796. In September 2016, the amounts previously settled with nonconvertible promissory notes were paid in cash of $249 resulting in a gain on the debt settlement of $547. No gain was not previously recorded.

 

In June 2016, the Company settled debt of $614 for $123 cash payment and the issuance of 409,347 shares of the Company’s restricted common stock, fair value at conversion date of $85, and recognized a gain on debt restructuring of $406. In conjunction with this debt settlement, an additional 809,842 shares of restricted common stock were issued to investors for cash to facilitate the settlement of a portion of the $614 debt.

 

NOTE 10: COMMITMENTS AND CONTINGENCIES

 

Litigation

 

In February 2016, a former vendor alleging our failure to pay outstanding invoices for approximately $335, which is included in accounts payable in the accompanying condensed consolidated balance sheets, initiated a breach-of-contract lawsuit against us. It is our objective that we reach a negotiated settlement with the vendor. At this time, we do not believe this matter individually is likely to have a material adverse impact on the Company.

 

In February 2016, a former vendor alleging our failure to pay outstanding invoices for approximately $70, which is included in accounts payable in the accompanying condensed consolidated balance sheets, filed a motion for summary judgment against us. We have filed an opposition motion to the request for summary judgment, and have initiated a counter-claim in the same venue. It is our objective that we reach a negotiated settlement with the vendor. At this time, we do not believe this matter individually is likely to have a material adverse impact on the Company.

 

Page 17 of 31

 

 

NOTE 11: RELATED PARTY TRANSACTIONS

 

On August 17, 2016, we entered into a Loan and Security Agreement with Slipstream Communications, LLC, a related party investor, under which we obtained a $3.0 million term loan, with interest thereon at 8% per annum, maturing on August 17, 2017 (with a one-year option for us to extend that maturity, so long as we are not then in default and we deliver additional warrants to the lender). In connection with the loan, we issued the lender a five-year warrant to purchase up to 5,882,352 shares of Creative Realities’ common stock at a per share price of $0.28 (subject to adjustment).

 

For the three and nine months ended September 30, 2016, the Company had sales with a related party entity that is 24% owned by a member of senior management. Sales were $614 and $990 for the three and nine months ended September 30, 2016, respectively. Accounts receivable due from the related party was $296 at September 30, 2016.

 

In December 2015, in connection with the offer and sale of the December 28, 2015 secured convertible promissory notes, the Company issued to related party investors five-year warrants to purchase up to 1,750,000 shares of Creative Realities’ common stock at a per share price of $0.28 (subject to adjustment) in consideration of additional covenants and facilitating the financing. The note matures on April 15, 2017.

 

In connection with the ConeXus acquisition in October 2015, the Company entered into a Securities Purchase Agreement with our CEO under which it offered and sold a secured $150 - 14% interest convertible promissory note with an immediately exercisable five-year warrant to purchase up to 267,857 shares of the Company’s common stock at a per-share price of $0.28 (subject to adjustment). The note matures on April 15, 2017.

 

In July 2015, the Company obtained two 1% demand promissory notes in the amounts of $100 and $50 from related party investors.  The Company obtained cash of $300 from these related parties and converted the demand promissory notes to convertible promissory notes on June 13, 2016 of $200 and $250, with five year warrants immediately exercisable to purchase up to 357,143 and 446,429, respectively, at a per share price of $0.28 (subject to adjustment). The secured promissory notes include accrued interest from July 2015 to June 13, 2016 at 14% on original principle amounts of $12 and $6, respectively. The notes mature on April 15, 2017.

 

In May 2015, the Company entered into a Securities Purchase Agreement with a related party investor under which it offered and sold a secured $465 14% interest convertible promissory note with a five-year warrant immediately exercisable to purchase up to 762,295 shares of common stock at a per-share price of $0.31. On June 23, 2015, this secured convertible promissory note together with accrued but unpaid interest and a 25% conversion premium was converted into a $585 - 14% convertible promissory note, maturing on August 18, 2016, with new five-year warrants to purchase up to 935,210 shares of common stock at a price of $0.30 per share, in a private placement exempt from registration under the Securities Act of 1933. The interest is payable 12% in cash and 2% as additional principal amount to the note. In connection with the offer and sale of the October 26, 2015 secured convertible promissory note, we entered into extension agreements with the holders of this secured convertible promissory to primarily extend the maturity date to April 15, 2017 in exchange for 109,688 shares of common stock valued at $24. This change was accounted for as a modification of the debt. The $24 is recognized as additional debt discount that will be amortized over the remaining life of the debt.

 

In February 2015, the Company entered into an agreement with a related party investor to purchase 50,000 shares of convertible preferred stock with an immediately exercisable five-year warrant to purchase up to 62,500 shares of the Company’s common stock at the as adjusted per-share price of $0.36 for $50.

 

In February 2015, the Company entered into an agreement with a related party investor to purchase 175,000 shares of convertible preferred stock with an immediately exercisable five-year warrant to purchase up to 218,750 shares of the Company’s common stock at the as adjusted per-share price of $0.36 in exchange for a previously outstanding convertible promissory note in the amount of $175.

 

NOTE 12: INCOME TAXES

 

Our deferred tax assets are primarily related to net federal and state operating loss carryforwards (NOLs). We have substantial NOLs that are limited in its usage by IRC Section 382. IRC Section 382 generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership within a statutory testing period. We have performed a preliminary analysis of the annual NOL carryforwards and limitations that are available to be used against taxable income. The estimated NOL carryforward for federal purposes is $18.6 million and foreign NOL carryforward is $5.9 million as of September 30, 2016. Based on the losses of the Company, there continues to be a full valuation allowance against the net deferred tax assets of the Company.

 

For the three months and the nine months ended September 30, 2016, we reported a deferred tax expense/(benefit) of $62 and $(453), respectively.  The tax benefit is primarily attributable to a measurement period adjustment for the reduction of the valuation allowance for a liability booked for amortizable intangible assets in connection with the acquisition of ConeXus as governed by ASC 805.  This reduction of the valuation allowance also resulted in an increase in goodwill of ConeXus for $635.

 

Page 18 of 31

 

 

The net deferred liability at September 30, 2016 of $539 represents the liability relating to indefinite lived assets, which is not more likely than not to be offset by the company’s deferred tax assets.

 

NOTE 13: CONVERTIBLE PREFERRED STOCK AND WARRANTS

 

On August 17, 2016, the Company issued a warrant to purchase 5,882,352 shares of common stock at the per share price of $0.28 (subject to adjustment) pursuant to a securities purchase agreement as more fully described in Note 8, Loans Payable.

 

On June 29, 2016, the Company issued a warrant to purchase 89,286 shares of common stock at the per share price of $0.28 (subject to adjustment) pursuant to a securities purchase agreement as more fully described in Note 8, Loans Payable.

 

On June 13, 2016, the Company issued a warrant to purchase 803,572 shares of common stock at the per share price of $0.28 (subject to adjustment) pursuant to a securities purchase agreement as more fully described in Note 8, Loans Payable.

 

On May 3, 2016, the Company issued a warrant to purchase 892,857 shares common stock at the per share price of $0.28 (subject to adjustment) pursuant to a securities purchase agreement as more fully described in Note 8, Loans Payable.

 

On January 15, 2016, the Company issued a warrant to purchase 250,000 shares of the Company’s common stock at the per share price of $0.28 (subject to adjustment) in exchange for services rendered related to the issuance of debt on December 28, 2015. The fair value of the warrants on the issuance date was $20. The warrants were recorded as a liability with a discount to the debt issued, which will be amortized over the life of the debt.

 

Listed below are the range of inputs used for the probability weighted Black Scholes option pricing model valuations when the warrants were issued and at September 30, 2016.

 

Date  Expected Term at Issuance
Date		   Risk Free Interest Rate at Date of Issuance   Volatility at Date of Issuance   Stock Price at Date of
Issuance		 
Issued 8/20/2014   5.00    1.50%   96.00%  $0.63 
Issued 2/13/2015   5.00    1.28%   100.00%  $0.34 
Issued 5/22/2015   5.00    1.28%   107.58%  $0.29 
Issued 10/15/2015   5.00    1.71%   58.48%  $0.22 
Issued 10/26/2015   5.00    1.71%   60.47%  $0.21 
Issued 12/21/2015   5.00    1.75%   58.48%  $0.21 
Issued 12/28/2015   5.00    1.75%   58.48%  $0.16 
Issued 1/15/2016   5.00    1.76%   58.48%  $0.17 
Issued 5/3/2016   5.00    1.25%   51.15%  $0.21 
Issued 6/13/2016   5.00    1.14%   51.12%  $0.17 
Issued 6/29/2016   5.00    1.01%   48.84%  $0.17 
Issued 8/17/2016   5.00    1.15%   51.55%  $0.15 

 

   Expected Term at September 30, 2016  Risk Free Interest
Rate at September 30, 2016		   Volatility at September 30, 2016   Stock Price at September 30, 2016 
  2.89-4.88   1.14%   48.51%  $0.20 

 

Page 19 of 31

 

 

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

 

   Warrants (Equity)       Warrants (Liability)     
   Amount   Weighted Average Exercise
Price		   Weighted Average Remaining Contractual Life   Amount   Weighted Average Exercise
Price		   Weighted Average Remaining Contractual
Life		 
Balance, January 1, 2016   6,165,786    3.64    3.85    13,787,241    0.33    4.23 
Warrants issued to financial advisors   -    -    -    250,000    0.28    4.55 
Warrants issued with promissory notes   -    -    -    1,785,715    0.28    4.65 
Warrants issued with term loan   -    -    -    5,882,352    0.28    4.88 
Balance September 30, 2016   6,165,786    3.64    3.10    21,705,308    0.31    3.96 

 

NOTE 14: STOCKHOLDERS’ EQUITY

 

In June 2016, in conjunction with the structured settlement program, the Company issued 409,347 shares of its restricted common stock to creditors and 809,842 shares of stock were issued to investors.

 

On May 4, 2016, 409,347 shares of the Company’s common stock were issued to certain creditors of the Company in settlement of outstanding accounts payable aggregating $163 pursuant to agreements entered into in March 2016. The Company recognized a gain on debt extinguishment of $78 on the date the stock was issued.

 

A summary of outstanding options is included below:

 

       Weighted             
       Average   Weighted       Weighted 
       Remaining   Average       Average 
Range of Exercise  Number   Contractual   Exercise   Options   Exercise 
Prices between  Outstanding   Life   Price   Exercisable   Price 
$0.19 - $0.65   7,019,999    8.73   $0.28    2,440,721   $1.36 
$0.66 - $0.79   30,000    7.29    0.79    30,000   $0.79 
$0.80 - $12.25   15,500    5.84    3.73    15,500   $3.73 
    7,065,499    8.72   $0.29           

 

   Options   Weighted Average 
   Outstanding   Exercise Price 
Balance, December 31, 2015   7,898,578   $0.33 
Granted   300,000    0.19 
Exercised   -    - 
Forfeited or expired   (1,133,079)   0.52 
Balance, September 30, 2016   7,065,499   $0.29 

 

On May 25, 2016, the Company granted 10-year options to purchase 300,000 shares of its common stock to an employee. The options vest over 4 years and have an exercise price of $0.19. The fair value of the options on the grant date was $0.12 and was determined using the Black-Sholes model. The following inputs were used:

 

Risk-free interest rate   1.24%
Expected term   6.25 years 
Expected price volatility   51.12%
Dividend yield   - 

 

The weighted average remaining contractual life for options exercisable is 8.72 years as of September 30, 2016.

 

Page 20 of 31

 

 

NOTE 15: STOCK-BASED COMPENSATION

 

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 365,500 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. There are 6,699,999 options outstanding under the 2014 Stock Incentive Plan.

 

Compensation expense recognized for the issuance of stock options for the three and nine months ended September 30, 2016 and 2015 was as follows:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2016   2015   2016   2015 
Stock-based compensation costs included in:        
Costs of sales   -    3    -    3 
Sales and marketing expense   19    1    55    4 
General and administrative expense   50    35    149    167 
Total stock-based compensation expense  $69   $39   $204   $174 

  

At September 30, 2016, there was approximately $882 of total unrecognized compensation expense related to unvested share-based awards. Generally, this expense will be recognized over the next 4.0 years and will be adjusted for any future changes in estimated forfeitures. 

 

Stock-based compensation expense is based on awards ultimately expected to vest and is reduced for estimated forfeitures. ASC 718-10-55 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company applied a pre-vesting forfeiture rate of 10% based on upon actual historical experience for employee option awards of the registrant.

 

On October 15, 2015, our current CEO was awarded 4,951,557 performance shares with a grant date to be determined upon certain conditions being satisfied.

 

NOTE 16: SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS

 

Segment Information

 

We currently operate in one reportable segment, marketing technology solutions. Substantially all property and equipment is located at our offices in the United States, and a data center located in the United States. All sales for the three and nine months ended September 30, 2016 and 2015 were in the United States and Canada.

 

Major Customers

 

We had 3 customers that in the aggregate accounted for 57% and 53% of accounts receivable as of September 30, 2016 and December 31, 2015, respectively. In 2015, we were no longer doing business with our largest customer that accounted for 16% of 2015 sales.

 

The Company had 3 and 4 customers that accounted for 64% and 57% of revenue for the three months and the nine months ended September 30, 2016, respectively.

 

Page 21 of 31

 

 

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, 2015 as filed with the Securities and Exchange Commission on April 4, 2016.

 

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 retailers, brand marketers, venue-operators, enterprises, non-profits and other organizations throughout the United States and a growing number of international markets. Our technology and solutions include: digital merchandising systems, interactive digital shopping assistants and kiosks, mobile digital marketing platforms, digital way-finding platforms, digital menu board systems, dynamic signage, and other digital marketing technologies. We enable our clients’ engagement with consumers by using combinations of our technology and solutions that interact with mobile, social media, point-of-sale, wireless networks and web-based platforms. 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 digital marketing technology companies focused on helping retailers and brands use the latest technologies to create better shopping experiences.

 

Our main operations are conducted directly through Creative Realities, Inc. and under our wholly owned subsidiaries Creative Realities, LLC, a Delaware limited liability company, Wireless Ronin Technologies Canada, Inc., a Canadian corporation, and ConeXus World Global, LLC, a Kentucky limited liability company.

 

We generate revenue in this business by:

 

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

 

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

 

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

 

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

 

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

 

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

 

Page 22 of 31

 

 

These activities generate revenue through: bundled-solution sales; service fees for consulting, 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.

 

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 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. 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, 2016 Compared to Three Months Ended September 30, 2015 

 

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

 

For the three months ended September 30, 2015, the financial results of ConeXus are not included as the acquisition date was October 15, 2015. As a result of this merger, the results of operations may not be entirely comparable and the variances are explained in more detail in the analysis below.

 

Page 23 of 31

 

 

The columns present the following:

 

  ● The first two data columns in the table show the dollar results for each period presented.
     
  ● The column entitled “Change - Dollars” show the change in results, in dollars. The column entitled “Change - %” show the change in percentages.  

 

   For the three months ended  September 30,   Change 
   2016   2015   Dollars   % 
Sales   $2,708   $3,369   $(661)   -20%
Cost of sales (exclusive of depreciation and amortization shown below)   1,387    1,858    (471)   -25%
Gross profit   1,321    1,511    (190)   -13%
Sales and marketing expenses   280    247    33    13%
Research and development expenses   218    25    193    NM 
General and administrative expenses   1,562    1,479    83    6%
Depreciation and amortization expense   540    439    101    23%
Loss on lease termination   -    638    (638)   NM 
Impairment loss on intangible assets   1,065    -    1,065    NM 
Total operating expenses   3,665    2,828    837    30%
Operating loss   (2,344))   (1,317)   (1,027)   78%
Other income/(expenses):                    
Interest expense   (494))   (302)   (192)   64%
Change in fair value of warrant liability   (433)   (15)   (418)   NM 
Gain on settlement of debt   547    -    547    NM 
Other income/(expense)   140)   (60)   200    -333%
Total other income/(expense)   (240)   (377)   137    -36%
Net loss before income taxes   (2,584)   (1,694)   (890)   53%
Provision/(benefit) from income taxes   (62)   -    (62)   NM 
Net income/(loss)  $(2,646)  $(1,694)  $(952)   56%

 

NM - not meaningful

 

 Sales

 

Sales decreased by $661 or 20% in 2016 compared to 2015. During 2015, the Company made a significant realignment and reorganization of its sales, account management, and business development personnel, which resulted in a significantly reduced sales pipeline. The Company terminated a customer relationship in August 2015 in connection with this initiative. This decrease was offset by approximately $1.6 million of additional revenue from ConeXus, which we merged with on October 15, 2015.

 

Gross Profit

 

Gross profit margin on a percentage basis increased to 49% in 2016 from 45% in 2015, and decreased by $190 in absolute dollars during the same period. The increase in gross profit margin is the result of our acquisition of ConeXus, the improved mix of higher margin services, a reduction of traditionally lower margin hardware sales as a percentage of total sales, as well the winding down, termination or renewal of certain customer relationships with modified business terms as a result of our business realignment, integration and restructuring initiative.

 

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. Total sales and marketing expenses on increased 13% to $280 in 2016 from $247 in 2015. The increase is primarily due to an increase in payroll and related trade show expenses.

 

Page 24 of 31

 

 

Research and Development Expenses

 

Research and development expenses increased to $218 in 2016 compared to $25 in 2015. The increase is attributable to the payroll related expenses of our software development personnel and consultants responsible for maintaining, supporting and enhancing our proprietary content management system platforms.

 

General and Administrative Expenses

 

Total general and administrative expenses increased 6% or $83 to $1,562 in 2016 from $1,479 in 2015. The increases were primarily due to an increase in related information technology infrastructure costs and travel, offset by a decrease in payroll expenses.

 

Depreciation and Amortization Expenses

 

Depreciation and amortization expenses increased 23% to $540 in 2016 from $439 in 2015 primarily due to the amortization of intangible assets acquired in the ConeXus merger transaction.

 

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

 

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

 

For the nine months ended September 30, 2015, the financial results of ConeXus are not included as the acquisition date was October 15, 2015. As a result of this merger, the results of operations may not be entirely comparable and the variances are explained in more detail in the analysis below.

 

Page 25 of 31

 

 

The columns present the following:

 

  ● The first two data columns in each table show the dollar results for each period presented

 

  ● The columns entitled “Change - Dollars” and “Change - %” show the change in results, both in dollars and percentages. For example, when net sales increase from one period to the next that change is shown as a positive.  When net sales decrease from one period to the next, that change is shown as a negative in both columns.

 

   For the nine months ended September 30,   Change 
   2016   2015   Dollars   % 
Sales   $8,172   $8,197   $(25)   -0.3%
Cost of sales (exclusive of depreciation and amortization shown separately below)   3,988    5,549    (1,561)   -28%
Gross profit   4,184    2,648    1,536    58%
Sales and marketing expenses   753    921    (168)   -18%
Research and development expenses   736    510    226    44%
General and administrative expenses   4,751    5,397    (646)   -12%
Depreciation and amortization expense   1,614    1,296    318    25%
Loss on lease termination   -    638    (638)   NM 
Impairment loss on intangible assets   1,065    -    1,065    NM 
Total operating expenses   8,919    8,762    157    2%
Operating loss   (4,735))   (6,114)   1,379    -23%
Other income (expenses):                    
Interest expense   (1,296))   (529)   (767)   145%
Change in fair value of warrant liability   602    797    (195)   -24%
Restructuring of debt   953    -    953    100%
Other income/(expense)   140)   (69)   209    -303%
Total other expense   399    199    200    101%
Net loss before income taxes   (4,336)   (5,915)   1,579    -27%
Provision/(benefit) from income taxes   453    -    453    100%
Net loss  $(3,883)  $(5,915)  $2,032    -34%

 

NM - not meaningful                

 

 Sales

 

Sales decreased by $25 or 0.3% in 2016 compared to 2015. During 2015, the Company made significant realignment and reorganization of its sales, account management, and business development personnel, which resulted in a significantly reduced sales pipeline. The Company terminated a customer relationship in August 2015 in connection with this initiative. This decrease was offset by approximately $4.8 million of additional revenue from ConeXus, which we merged with on October 15, 2015.

 

Gross Profit

 

Gross profit margin on a percentage basis increased to 51% in 2016 from 32% in 2015, and increased by $1,536 in absolute dollars during the same period. The increase in gross profit margin and increase in absolute dollars are the result of our acquisition of ConeXus, the improved mix of higher margin services, a reduction of traditionally lower margin hardware sales as a percentage of total sales, as well the winding down, termination or renewal of certain customer relationships with modified business terms as a result of our business realignment, integration and restructuring initiative.

 

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. Total sales and marketing expenses decreased 18% to $753 in 2016 from $921 in 2015. The decrease is primarily due to a decrease in marketing and related trade show expenses.

 

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Research and Development Expenses

 

Research and development expenses increased to $736 in 2016 compared to $510 in 2015. The increase is attributable to the payroll related expenses of our software development personnel and consultants responsible for maintaining, supporting and enhancing our proprietary content management system platforms.

 

General and Administrative Expenses

 

Total general and administrative expenses decreased 12% or $(646) to $4,751 in 2016 from $5,397 in 2015. The decreases were primarily due to a decrease in payroll of $476 as the company recorded severance to a former executive of $464 in the second quarter 2015.

 

Depreciation and Amortization Expenses

 

Depreciation and amortization expenses increased 25% to $1,614 in 2016 from $1,296 in 2015 primarily due to the amortization of intangible assets acquired in the ConeXus merger transaction.

 

Liquidity and Capital Resources 

 

We incurred net losses and negative cash flows from operating activities for the three and nine months ended September 30, 2016. At September 30, 2016, we had cash and cash equivalents of $976 and a working capital deficit of $(8,420). Cash used in operating activities for the nine months ended September 30, 2016 was $3,738. These factors raise substantial doubt about our ability to continue as a going concern. Management believes that, despite our losses to date and while we can provide no assurance that our ongoing integration efforts will be successful, the operations of the combined Company resulting from the completed acquisitions and related restructuring actions will provide greater sales, margin, scale and operating efficiencies, all of which we believe will ultimately lead to operating profitability and positive cash flows from operations. Additionally, the Company has entered into a Loan and Security Agreement in August 2016 to raise additional financing which has lowered and will continue to reduce our interest expense in the future.

 

See Note 8 to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt obligations.

 

Operating Activities

 

We do not currently generate positive cash flow. Our operational costs have been greater than sales generated to date. As of September 30, 2016, we had an accumulated deficit of $(18,497). The cash flow used in operating activities was $(3,738) and (1,953) for the nine months ended September 30, 2016 and 2015, respectively. The majority of the cash consumed by operations for both periods was attributed to our net losses of $(3,883) and $(5,915) for the nine months ended September 30, 2016 and 2015, respectively. Included in our net losses were non-cash charges totaling $1,884 and $1,415 for the nine months ended September 30, 2016 and 2015, respectively.

 

Investing Activities

 

Net cash used in investing activities during the nine months ended September 30, 2016 was $(314) compared to $(585) during 2015. The increase in cash used in investing activities is primarily related to the capitalization of software costs. We currently do not have any material commitments for capital expenditures as of September 30, 2016, nor do we anticipate any significant expenditures in 2016.

  

Financing Activities

 

Net cash provided by financing activities during the nine months ended September 30, 2016 was $3,667 compared to $2,229 in 2015. The decrease was primarily related to less loans payable.

 

Contractual Obligations

 

We have no material commitments for capital expenditures, and we do not anticipate any significant capital expenditures for the remainder of 2016.

 

Off-Balance Sheet Arrangements

 

During the nine months ended September 30, 2016, we did not engage in any off-balance sheet arrangements set forth in Item 303(a) (4) of Regulation S-K.

 

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Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, as appropriate, to allow timely decisions regarding required disclosures. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, and Board of Directors, as appropriate, to allow timely decisions regarding required disclosure.

 

Under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and VP, Corporate Controller, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, we concluded as of September 30, 2016 that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below.

 

Management’s Report on Internal Control Over Financial Reporting 

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

The Company identified that, while certain improvements did occur in the Company’s internal control over financial reporting for the nine months ended September 30, 2016, internal control over financial reporting was not effective as of September 30, 2016 and that material weaknesses exist including: a deficient process to close the monthly consolidated financial statements and prepare comprehensive and timely account analysis, and adequately document cost estimates in support of revenue recognition under percentage of completion. In addition, Creative Realities, Inc. currently does not have an independent financial expert on its Board of Directors.

 

A material weakness is a control deficiency (within the meaning of Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5) or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Management has already implemented certain practices and procedures during 2016 to address the foregoing material weaknesses, plans to expand the scope of its assessment of the effectiveness of its internal controls over financial reporting at the consolidated Company in 2016, and develop a plan to complete the remediation of the foregoing deficiencies.

 

In completing its assessment of internal control over financial reporting, management has used and anticipates to continue using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—2013 Integrated Framework.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 5. Other Information

 

On May 2, 2016, Eric J. Bertrand was appointed to the Board of Directors of Creative Realities, Inc.  Mr. Bertrand possesses voting and investment power over shares beneficially held by Lincoln Road Media Partners LLC, which is the holder of a convertible promissory note and warrant issued in a private placement transaction on April 14, 2016.  See Note 8 to the Condensed Consolidated Financial Statements for additional information.  Mr. Bertrand was appointed to the board in connection with Lincoln Road Media’s investment in the convertible note and warrant.

 

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SIGNATURES

 

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

 

  Creative Realities, Inc.
     
 Date:  November 21, 2016 By  /s/ Richard Mills
  Richard Mills
  Chief Executive Officer

  

  By /s/ John Walpuck
  John Walpuck
 

Chief Financial Officer and

Chief Operating Officer

 

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EXHIBITS INDEX

 

Exhibit No.   Description
     
10.1   Loan and Security Agreement with Slipstream Communications, LLC, dated as of  August 17, 2016 (filed herewith).
     
10.2   Warrant to Purchase Common Stock issued to Slipstream Communications on August 17, 2016 (filed herewith)
     
10.3   Secured Term Promissory Note issued in favor of Slipstream Communications, LLC, in principal amount of up to $4,000,000, dated as of August 17, 2016 (filed herewith)
     
31.1   Chief Executive Officer Certification pursuant to Exchange Act Rule 13a-14(a).
31.2   Chief Financial Officer Certification pursuant to Exchange Act Rule 13a-14(a).
32.1   Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350.
32.2   Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350.
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase
     
101.LAB   XBRL Taxonomy Extension Label Linkbase
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase

 

 

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