Pursuant to the requirements of Section 13 or 15(d) 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.
March 30, 2023.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant, and in the capacities and on the date indicated.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
All currency is rounded to the nearest thousands except share and per share amounts. On March 27, 2023, the Company effectuated a l-for-3 reverse stock split of its outstanding common stock. These Notes to Consolidated Financial Statements and the accompanying Consolidated Financial Statements give retroactive effect to the reverse stock split for all periods presented. The shares of common stock retained a par value of $0.01 per share.
NOTE 1: NATURE OF ORGANIZATION AND OPERATIONS
Unless the context otherwise indicates, references in these Notes to the accompanying Consolidated Financial Statements to “we,” “us,” “our” and “the Company” refer to Creative Realities, Inc. and its subsidiaries.
Nature of the Company’s Business
Creative Realities, Inc. is a Minnesota corporation that provides innovative digital marketing technology and solutions to retail companies, individual retail brands, enterprises and organizations throughout the United States and in certain international markets. The Company has expertise in a broad range of existing and emerging digital marketing technologies, as well as the related media management and distribution software platforms and networks, device management, product management, customized software service layers, systems, experiences, workflows, and integrated solutions. Our technology and solutions include: digital merchandising systems and omni-channel customer engagement systems, interactive digital shopping assistants, advisors and kiosks, and other interactive marketing technologies such as mobile, social media, point-of-sale transactions, beaconing and web-based media that enable our customers to transform how they engage with consumers. We have expertise in a broad range of existing and emerging digital marketing technologies, as well as the following related aspects of our business: content, network management, and connected device software and firmware platforms; customized software service layers; hardware platforms; digital media workflows; and proprietary processes and automation tools.
Our main operations are conducted directly through Creative Realities, Inc., and under our wholly owned subsidiaries Allure Global Solutions, Inc., a Georgia corporation, Creative Realities Canada, Inc., a Canadian corporation, and Reflect Systems, Inc., a Delaware corporation.
Liquidity and Financial Condition
The accompanying Consolidated Financial Statements have been prepared on the basis of the realization of assets and the satisfaction of liabilities and commitments in the normal course of business and do not include any adjustments to the recoverability and classifications of recorded assets and liabilities as a result of uncertainties.
At December 31, 2022, we have an accumulated deficit of ($50,409), negative working capital of ($2,514) and cash of $1,633. For the year ended December 31, 2022, we incurred an operating loss of ($2,480) and cash outflows from operations of ($708). Our history of operating losses and near term cash obligations are indicators of substantial doubt about our ability to continue as a going concern. We obtained a continued support letter from Slipstream Communications, LLC ("Slipstream") through March 31, 2024, which alleviated the substantial doubt about our ability to continue as a going concern. We can provide no assurance that our ongoing operational efforts will be successful which could have a material adverse effect on our results of operations and cash flows.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in the preparation of the accompanying Consolidated Financial Statements follows:
1. Basis of Presentation
The accompanying Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-K and Article 8 of Regulation S-X and include all of the information and disclosures required by generally accepted accounting principles in the United States of America (“GAAP”) for annual financial reporting.
The Consolidated Financial Statements include the accounts of Creative Realities, Inc. and our wholly owned subsidiaries Allure, Creative Realities (Canada), Inc., and Reflect Systems, Inc. All intercompany balances and transactions have been eliminated in consolidation, as applicable.
2. Revenue Recognition
We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, applying the five-step model.
If an arrangement involves multiple performance obligations, the items are analyzed to determine the separate units of accounting, whether the items have value on a standalone basis and whether there is objective and reliable evidence of their standalone selling price. The total contract transaction price is allocated to the identified performance obligations based upon the relative standalone selling prices of the performance obligations. The standalone selling price is based on an observable price for services sold to other comparable customers, when available, or an estimated selling price using a cost plus margin approach.
The Company estimates the amount of total contract consideration it expects to receive for variable arrangements by determining the most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide and the contractual pricing based on those quantities. The Company only includes some or a portion of variable consideration in the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. The Company considers the sensitivity of the estimate, its relationship and experience with the client and variable services being performed, the range of possible revenue amounts and the magnitude of the variable consideration to the overall arrangement. The Company receives variable consideration in very few instances.
Revenue is recognized when a customer obtains control of promised goods or services under the terms of a contract and is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing services. The Company does not have any material extended payment terms as payment is due at or shortly after the time of the sale, typically ranging between thirty and ninety days. Observable prices are used to determine the standalone selling price of separate performance obligations or a cost plus margin approach when one is not available. Sales, value-added and other taxes collected concurrently with revenue producing activities are excluded from revenue.
The Company recognizes contract assets or unbilled receivables related to revenue recognized for services completed but not yet invoiced to the clients. A contract liability is recognized as deferred revenue when the Company invoices clients in advance of performing the related services under the terms of a contract. Deferred revenue is recognized as revenue when the Company has satisfied the related performance obligation.
The Company uses the practical expedient for recording an immediate expense for incremental costs of obtaining contracts, including certain design/engineering services, commissions, incentives and payroll taxes, as these incremental and recoverable costs have terms that do not exceed one year.
3. Inventories
Inventories are stated at the lower of cost or net realizable value, determined by the first-in, first-out (FIFO) method, and consist of the following:
| | December 31, | | | December 31, | |
| | 2022 | | | 2021 | |
Raw materials, net of reserve of $1,777 and $502, respectively | | $ | 1,671 | | | $ | 1,583 | |
Work-in-process | | | 596 | | | | 297 | |
Total inventories | | $ | 2,267 | | | $ | 1,880 | |
During the year ended December 31, 2022, the Company increased its reserves for obsolete inventory by $1,275, of which $1,249 related to Safe Space Solutions. The Company is no longer actively promoting the sale of our Safe Space Solutions or purchasing inventory to support such solutions.
4
. Impairment of Long-Lived Assets
We review the carrying value of all long-lived assets, including property and equipment, for impairment annually as of September 30 in accordance with ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets. Under ASC 360, impairment losses are recorded whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable.
If the impairment tests indicate that the carrying value of the asset is greater than the expected undiscounted cash flows to be generated by such asset, an impairment loss would be recognized. The impairment loss is determined as the amount by which the carrying value of such asset exceeds its fair value. We generally measure fair value by considering sale prices for similar assets or by discounting estimated future cash flows from such assets using an appropriate discount rate. Assets to be disposed of are carried at the lower of their carrying value or fair value less costs to sell. Considerable management judgment is necessary to estimate the fair value of assets, and accordingly, actual results could vary significantly from such estimates.
5. Basic and Diluted Income/(Loss) per Common Share
Basic and diluted income/(loss) per common share for all periods presented is computed using the weighted average number of common shares outstanding. Basic weighted average shares outstanding includes only outstanding common shares. Diluted weighted average shares outstanding includes outstanding common shares and potential dilutive common shares outstanding in accordance with the treasury stock method. Shares reserved for outstanding stock options, including stock options with performance restricted vesting, and warrants totaling approximately 7,360,271 and 2,324,007 at December 31, 2022 and 2021, respectively were excluded from the computation of income/(loss) per share as the strike price on the options and warrants were higher than the Company's market price and therefore anti-dilutive.
6. Income Taxes
Deferred income taxes are recognized in the financial statements for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates. Temporary differences arise from net operating losses, differences in basis of intangibles, stock-based compensation, reserves for uncollectible accounts receivable and inventory, differences in depreciation methods, and accrued expenses. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company accounts for uncertain tax positions utilizing an established recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We had no uncertain tax positions as of December 31, 2022 and December 31, 2021.
7. Goodwill and Definite-Lived Intangible Assets
We follow the provisions of ASC 350, Goodwill and Other Intangible Assets. Pursuant to ASC 350, goodwill acquired in a purchase business combination is not amortized, but instead tested for impairment at least annually. The Company uses an annual measurement date of September 30 to assess impairment of goodwill and indefinite-lived intangible assets, or as indicators are identified.
Definite-lived intangible assets are amortized straight-line in accordance with their identified useful lives.
8. Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our significant estimates include: warrant liability valuation, contingent purchase consideration valuation, the allowance for doubtful accounts, valuation allowances related to deferred taxes, the fair value of acquired assets and liabilities, the fair value of liabilities reliant upon the appraised fair value of the Company, valuation of stock-based compensation awards and other assumptions and estimates used to evaluate the recoverability of long-lived assets, goodwill and other intangible assets and the related amortization methods and periods. Actual results could differ from those estimates.
9. 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.
Property and equipment consist of the following at December 31, 2022 and 2021:
| | December 31, | |
| | 2022 | | | 2021 | |
Equipment | | $ | 138 | | | $ | 89 | |
Leasehold improvements | | | 197 | | | | 135 | |
Furniture and fixtures | | | 199 | | | | 121 | |
Other depreciable assets | | | 124 | | | | 56 | |
Total property and equipment | | | 658 | | | | 401 | |
Less: accumulated depreciation and amortization | | | (457 | ) | | | (326 | ) |
Net property and equipment | | $ | 201 | | | $ | 75 | |
The estimated useful lives used to compute depreciation and amortization are as follows:
Asset class | | | Useful life assigned (in years) | |
Equipment | | | 3 – 5 | |
Furniture and fixtures | | | 5 | |
Leasehold improvements | | | Shorter of 5 years or term of lease | |
Depreciation expense was $131 and $109 for the years ended December 31, 2022 and 2021, 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. The Company capitalizes its costs incurred for additional functionality to its internal software. We capitalized approximately $4,444 and $1,140 for the years ended December 31, 2022 and 2021, 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. We are amortizing these costs over 3 years once the new projects are completed and placed in service. These costs are included in intangible assets, net on the Consolidated Balance Sheets.
11. Business Combinations
Accounting for acquisitions requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our Consolidated Statements of Operations.
12. Contingent Consideration
The Company has contingent consideration arrangements related to certain acquisitions to potentially pay additional cash amounts in future periods based on the lack of achievement of certain share price performance goals of our common stock. Such contingent consideration arrangements are recorded at fair value and are classified as liabilities on the acquisition date and are remeasured at each reporting period in accordance with ASC 805-30-35-1 using a Monte Carlo simulation model.
NOTE 3: RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Recently adopted
On January 1, 2022, we early adopted Accounting Standards Update (“ASU”) No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASU 2021-08), which clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606). The adoption of this new standard did not have a material impact on our Consolidated Financial Statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses, which requires entities to estimate expected lifetime credit losses on financial assets and provide expanded disclosures. The main objective is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this update replace the incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. For trade receivables and loans, entities will be required to estimate lifetime expected credit losses. We adopted ASU 2016-13 on January 1, 2023. The adoption of this new standard did not have a material impact on our Consolidated Financial Statements.
Not yet adopted
In August 2020, the FASB issued Accounting Standards Update No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (ASU 2020-06), which simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments. This guidance also eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. This guidance will be effective for us in the first quarter of 2024 on a full or modified retrospective basis, with early adoption permitted. We are currently evaluating the disclosure requirements and potential impact on our Consolidated Financial Statements.
NOTE 4: REVENUE RECOGNITION
The Company applies ASC 606 for revenue recognition. The following table disaggregates the Company’s revenue by major source for the years ended December 31, 2022 and 2021:
| | Year | | | Year | |
| | Ended | | | Ended | |
| | December 31, | | | December 31, | |
(in thousands) | | 2022 | | | 2021 | |
Hardware | | $ | 19,895 | | | $ | 9,450 | |
| | | | | | | | |
Services: | | | | | | | | |
Installation Services | | | 5,693 | | | | 2,600 | |
Software Development Services | | | 556 | | | | 791 | |
Media Sales | | | 1,511 | | | | - | |
License Revenue | | | 1,375 | | | | - | |
Managed Services | | | 14,320 | | | | 5,596 | |
Total Services | | | 23,455 | | | | 8,987 | |
Total Hardware and Services | | $ | 43,350 | | | $ | 18,437 | |
System hardware sales
System hardware revenue is recognized generally upon shipment of the product or customer acceptance depending upon contractual arrangements with the customer in instances in which the sale of hardware is the sole performance obligation. Shipping charges billed to customers are included in hardware sales and the related shipping costs are included in hardware cost of sales. The cost of freight and shipping to the customer is recognized in cost of sales at the time of transfer of control to the customer. System hardware revenues are classified as “Hardware” within our disaggregated revenue.
Installation services
The Company performs outsourced installation services for customers and recognizes revenue upon completion of the installations. Installation services also includes engineering services performed as part of an installation project.
When system hardware sales include installation services to be performed by the Company, the goods and services in the contract are not distinct, so the arrangement is accounted for as a single performance obligation. Our customers control the work-in-process and can make changes to the design specifications over the contract term. Revenues are recognized over time as the installation services are completed based on the relative portion of labor hours completed as a percentage of the budgeted hours for the installation. Installation services revenues are classified as “Installation Services” within our disaggregated revenue.
Software design and development services
Software and software license sales are revenue when a fixed fee order has been received and delivery has occurred to the customer. Revenue is recognized generally upon customer acceptance (point-in-time) of the software product and verification that it meets the required specifications. Software is delivered to customers electronically. Software design and development revenues are classified as “Software Development Services” within our disaggregated revenue.
Software as a service license sales
Software as a service includes revenue from software licensing and delivery in which software is licensed on a subscription basis and is centrally hosted by the Company. These services often include software updates which provide customers with rights to unspecified software product upgrades and maintenance releases and patches released during the term of the support period. Contracts for these services are generally 12-36 months in length. We account for revenue from these services in accordance with ASC 985-20-15-5 and recognize revenue ratably over the performance period. Software as a service revenue are classified as “Managed Services” within our disaggregated revenue.
Software as a service perpetual license sales
Perpetual license sales includes revenue from the sale of a perpetual license to customers that host their own instances of our software. These services traditionally are accompanied by the sale of maintenance and support services contracts. Perpetual license revenue is classified as "License Revenue" within our disaggregated revenue.
Maintenance and support services
The Company sells support services which include access to technical support personnel for software and hardware troubleshooting. The Company offers a hosting service through our network operations center, or NOC, allowing the ability to monitor and support its customers’ networks 7 days a week, 24 hours a day. These contracts are generally 12-36 months in length. Revenue is recognized over the term of the agreement in proportion to the costs incurred in fulfilling performance obligations under the contract. Maintenance and Support revenues are classified as “Managed Services” within our disaggregated revenue.
Maintenance and support fees are based on the level of service provided to end customers, which can range from monitoring the health of a customer’s network to supporting a sophisticated web-portal to managing the end-to-end hardware and software of a digital marketing system. These agreements are renewable by the customer. Rates for maintenance and support, including subsequent renewal rates, are typically established based upon a fee per location, per device, or a specified percentage of net software license fees as set forth in the arrangement. These contracts are generally 12-36 months in length. Revenue is recognized ratably and evenly over the service period.
The Company also performs time and materials-based maintenance and repair work for customers. Revenue is recognized at a point in time when the performance obligation has been fully satisfied.
Media sales
Media revenues are derived from selling (i) sponsorship packages, including mobile takeover or physical presence, or (ii) advertising space to customers on digital displays or other outdoor structures, each within physical venues. We generally do not own the physical structures on which we display advertising for our customers but instead sell advertising or sponsorship opportunities on behalf of our media network owners to our brand customers. Media revenue services are recognized either on a straight-line basis over the available hours of advertising during the contracted period, or at the time of an event in the case of sponsorships.
Our media revenue contracts with customers range from four weeks to three years and billing commences at the beginning of the contract term, with payment generally due within ninety (90) days of billing. For the majority of our contracts, transaction prices are explicitly stated. Any contracts with transaction prices that contain multiple performance obligations are allocated primarily based on a relative standalone selling price basis. Any deferred revenues primarily consist of revenues paid in advance of being earned.
On a contract-by-contract basis, we evaluate whether we should be considered the principal (i.e., report revenues on a gross basis) or an agent (i.e., report revenues on a net basis). We are considered the principal in our arrangements and report revenues on a gross basis, wherein the amounts billed to customers are recorded as revenues and amounts paid to network owners are recorded as expenses. We are considered the principal because we control the advertising space before and after the contract term, are primarily responsible to our customers, and have discretion in pricing. For revenues generated through the use of a subcontracted advertising agency, commissions are calculated based on a stated percentage of gross advertising revenue and reported in the Consolidated Statement of Operations within Sales and Marketing expenses.
NOTE 5: FAIR VALUE MEASUREMENT
We measure certain financial assets, including cash equivalents, at fair value on a recurring basis. In accordance with ASC 820-10-30, fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820-10-35 establishes a three-level hierarchy that prioritizes the inputs used in measuring fair value. The three hierarchy levels are defined as follows:
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets.
Level 2 — Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.
Level 3 — Valuations based on inputs that are unobservable and involve management judgment and the reporting entity’s own assumptions about market participants and pricing.
The Company previously recorded warrant liabilities that were measured at fair value on a recurring basis using a binomial option pricing model.
The calculation of the fair value of the contingent consideration contains inputs which are unobservable and involve management judgment and are considered Level 3 estimates. Additionally, the separately identifiable intangible assets rely on a discounted cash flow model which utilizes inputs including the calculation of the weighted average cost of capital and management’s forecast of future financial performance which are unobservable and involve management judgment and are considered Level 3 estimates.
The calculation of the weighted average cost of capital and management’s forecast of future financial performance utilized within our discounted cash flow model for the impairment of goodwill contains inputs which are unobservable and involve management judgment and are considered Level 3 estimates.
The Convertible Loan is deemed to be a Level 3 valuation. Certain unobservable inputs into the calculation of the fair value of this liability include an estimate of the fair value of the Company at a future date using a discounted cash flow model, discount rate assumptions, and an estimation of the likelihood of conversion of the Convertible Loan. The Convertible Loan was refinanced into the Consolidation Term Loan in February 2022.
The calculation of the fair value of the warrant liability contains valuation inputs which are based on observable inputs (other than Level 1 prices) and are considered Level 2 estimates. The liability warrants were converted to equity warrants effective June 30, 2022.
NOTE 6: SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION
| | Year Ended | |
| | December 31, | |
| | 2022 | | | 2021 | |
Supplemental non-cash Investing and Financing activities | | | | | | | | |
Capitalized software in accounts payable | | $ | 556 | | | $ | - | |
Property and equipment in accounts payable | | $ | 11 | | | $ | - | |
Conversion of disbursed escrow loan into common stock | | $ | - | | | $ | 264 | |
Increase in debt related to financing fees | | $ | - | | | $ | 200 | |
Decrease in debt discount via amended Credit Agreement | | $ | - | | | $ | 133 | |
| | | | | | | | |
Supplemental disclosure information for cash flow | | | | | | | | |
Cash paid during the period for: | | | | | | | | |
Interest | | $ | 1,350 | | | $ | 106 | |
Income taxes, net | | $ | 43 | | | $ | 32 | |
NOTE 7: INTANGIBLE ASSETS AND GOODWILL
Intangible Assets
Intangible assets consisted of the following at December 31, 2022 and December 31, 2021:
| | December 31, | | | December 31, | |
| | 2022 | | | 2021 | |
| | Gross | | | | | | | Gross | | | | | |
| | Carrying | | | Accumulated | | | Carrying | | | Accumulated | |
| | Amount | | | Amortization | | | Amount | | | Amortization | |
Technology platform | | $ | 9,765 | | | | 4,354 | | | $ | 4,635 | | | | 3,652 | |
Purchased and developed software | | | 4,682 | | | | 3,375 | | | | 3,488 | | | | 2,713 | |
In-Process internally developed software platform | | | 4,074 | | | | - | | | | 824 | | | | - | |
Customer relationships | | | 15,000 | | | | 2,849 | | | | 3,960 | | | | 1,692 | |
Trademarks and trade names | | | 1,600 | | | | 808 | | | | 640 | | | | 640 | |
Noncompete | | | 30 | | | | 13 | | | | - | | | | - | |
Total amortizable intangible assets | | | 35,151 | | | | 11,399 | | | | 13,547 | | | | 8,697 | |
Accumulated amortization | | | 11,399 | | | | | | | | 8,697 | | | | | |
Net book value of amortizable intangible assets | | $ | 23,752 | | | | | | | $ | 4,850 | | | | | |
For the years ended December 31, 2022 and 2021, amortization of intangible assets charged to operations was $2,702 and $1,251, respectively. For the year ended December 31, 2021, the Company wrote-off a $380 fully amortized trade name asset and a $1,370 fully amortized customer list asset and the related accumulated amortization for each related to a former wholly owned subsidiary of the Company, ConeXus World Global, LLC, an entity dissolved by the Company during 2021. There was no impact on the Company’s Consolidated Balance Sheet or Consolidated Statement of Operations during the period. On February 17, 2022, the Company acquired intangible assets as a result of the Merger in accordance with ASC 805 Business Combinations.
Estimated amortization is as follows:
| | Estimated Future | |
Year ending December 31, | | Amortization | |
2023 | | $ | 3,272 | |
2024 | | | 3,109 | |
2025 | | | 2,875 | |
2026 | | | 2,408 | |
Thereafter | | | 12,088 | |
Intangible assets include the following and are being amortized over their estimated useful lives as follows:
| | Amortization | |
| | Period: | |
Acquired Intangible Asset: | | (years) | |
Technology platform and patents | | 7 - 10 | |
Purchased and developed software | | 3 - 5 | |
Trade names | | 3 - 5 | |
Customer relationships | | 3 - 15 | |
Noncompete | | 2 | |
Goodwill
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 assessed the carrying value of goodwill at the reporting unit level based on an estimate of the fair value of the respective reporting unit. Fair value of the reporting unit was estimated using a discounted cash flow analyses consisting of various assumptions, including expectations of future cash flows based on projections or forecasts derived from analysis of business prospects and economic or market trends that may occur, specifically, the Company gave significant consideration to actual historic financial results, including revenue growth rates in the preceding three years. Based on the Company’s assessment, we determined that the fair value of our reporting unit exceeds its carrying value, and accordingly, the goodwill associated with the reporting unit was not considered to be impaired at September 30, 2022.
At December 31, 2022, we concluded the decline in our market value represented an interim indicator of potential impairment. Based on a quantitative assessment of our fair value performed at December 31, 2022, using the same approach as our annual impairment performed at September 30, described above, we concluded that the carrying value of our goodwill did not exceed the reporting unit fair value.
While our overall business performance has been consistent with our expectations, both before and after the acquisition of Reflect, we believe a significant portion of the decline in our market price relates primarily to several macroeconomic factors including: (1) market wide recessionary fears, (2) rapid inflation fears, which often have an outsized, direct negative impact on the share price of high-growth companies with limited or negative cash flow from operations, (3) a lack of comprehension by the markets of the recent Merger with Reflect and related financing transaction, and (4) the sale of over 2,333,334 shares of our common stock into the market by a new investor, resulting in significant negative volume and price pressure on the stock unrelated to the Company fundamentals. We do not believe these factors are consistent with or reflective of the underlying value of the business, and there were no other indicators of potential impairment as of December 31, 2022. Should our market price remain at this level for an extended period of time; however, there could be potential future impairment.
The Company recognizes that any changes in our projected 2023 and future results could potentially have a material impact on our assessment of goodwill impairment. The Company will continue to monitor the actual performance of its operations against expectations and assess further indicators of possible impairment. The valuation of goodwill and intangible assets is subject to a high degree of judgment, uncertainty and complexity. Should any indicators of impairment occur in subsequent periods, the Company will be required to perform an analysis in order to determine whether goodwill is impaired.
NOTE 8: LOANS PAYABLE
The outstanding debt with detachable warrants, as applicable, are shown in the table below. Further discussion of the notes follows.
As of December 31, 2022 |
| Issuance | | | | | Maturity | | | | | Interest Rate |
Debt Type | Date | | Principal | | Date | | Warrants | | Information |
A | 2/17/2022 | | $ | 10,000 | | 2/15/2025 | | | 833,334 | | 8.0% interest(1) |
B | 2/17/2022 | | | 1,456 | | 2/17/2024 | | | - | | 0.59% interest(2) |
C | 2/17/2022 | | | 7,185 | | 2/15/2025 | | | 898,165 | | 10.0% interest(3) |
D | 10/31/2022 | | | 2,000 | | 9/1/2023 | | | - | | 12.5% interest(4) |
| Total debt, gross | | | 20,641 | | | | | 1,731,499 | | |
| Debt discount | | | (3,069 | ) | | | | | | |
| Total debt, net | | $ | 17,572 | | | | | | | |
| Less current maturities | | | (4,499 | ) | | | | | | |
| Long term debt | | $ | 13,073 | | | | | | | |
As of December 31, 2021 |
| Issuance | | | | | Maturity | | | | | Interest Rate |
Debt Type | Date | | Principal | | Date | | Warrants | | Information |
E | 8/17/2016 | | $ | 4,767 | | 2/17/2025 | | | 196,079 | | 8.0% interest(5) |
F | 12/30/2019 | | | 2,418 | | 2/17/2025 | | | - | | 10.0% interest(5) |
| Total debt, gross | | | 7,185 | | | | | 196,079 | | |
| Fair value | | | (166 | ) | | | | | |
| Total debt, gross | | | 7,019 | | | | | | | |
| Debt discount | | | (144 | ) | | | | | |
| Total debt, net | | $ | 6,875 | | | | | | | |
| Less current maturities | | | - | | | | | | | |
| Long term debt | | $ | 6,875 | | | | | | | |
A – Acquisition Term Loan with related party
B – Secured Promissory Note
C – Consolidation Term Loan with related party
D – Term Loan (2022) with related party
E – Senior Secured Term Loan with related party
F – Secured Convertible Special Loan Promissory Note, at fair value, with related party
(1) | 8.0% cash interest per annum through maturity at February 15, 2025 |
(2) | 0.59% cash interest per annum (the applicable federal rate) through February 17, 2023. Annual interest rate on the outstanding principal increased from 0.59% to 4.60% per annum through maturity at February 17, 2024. |
(3) | 10.0% cash interest per annum through maturity date at February 15, 2025. |
(4) | 12.5% cash interest per annum through maturity at September 1, 2023. |
(5) | Interest was paid-in-kind ("PIK") through October 2021, at which point interest became payable in cash at the stated interest rates through maturity. |
Secured Promissory Note
On February 17, 2022, in connection with the closing of the Merger, the Company issued to RSI Exit Corporation (“Stockholders’ Representative”), the representative of Reflect stockholders, a $2,500 Note and Security Agreement (the “Secured Promissory Note”).
The Secured Promissory Note accrues interest at 0.59% per annum (the applicable federal rate on the date of issuance of the Secured Promissory Note) and requires the Company and Reflect to collectively pay equal monthly principal installments of $104 on the fifteenth (15th) day of each month, commencing on March 15, 2022. Any remaining or unpaid principal shall be due and payable on February 17, 2023. All payments under the Secured Promissory Note will be paid to the escrow agent in the Merger Agreement to be placed into the escrow account to secure the Reflect stockholders’ indemnification obligations until released on February 17, 2023 (the one-year anniversary of the closing of the Merger), at which time any remaining proceeds not subject to a pending indemnification claim will be paid to the exchange agent for payment to the Reflect Stockholders. The Secured Promissory Note is secured by a first-lien security interest in certain contracts of Reflect, including obligations arising out of those certain contracts. The Company has the right to offset amounts payable under the Secured Promissory Note upon a final, non-appealable decision of a court that entitles the Company or its affiliates to any damages for indemnification under the Merger Agreement, or the Stockholders’ Representative’s agreement in writing to such damages.
On February 11, 2023, the Company and the Stockholders’ Representative executed an amendment (the “Note Amendment”) to the Secured Promissory Note. The Note Amendment eliminates the balloon payment, extending the maturity date for a one-year period, to February 17, 2024. During the extended period, the Company will continue to make monthly principal payments of $104, and the annual interest rate on the outstanding principal increased from 0.59% to 4.60%, which will accrue and is payable in full on the new maturity date.
Second Amended and Restated Loan and Security Agreement
On February 17, 2022, the Company and its subsidiaries (collectively, the “Borrowers”) refinanced their debt facilities with Slipstream Communications, LLC (“Slipstream”), pursuant to a Second Amended and Restated Credit and Security Agreement (the “Credit Agreement”). The Borrowers include Reflect Systems, Inc. (“Reflect”), which became a wholly owned subsidiary of the Company as a result of the closing of the Merger on February 17, 2022. The debt facilities continue to be fully secured by all assets of the Borrowers.
The Credit Agreement also provides that the Company’s outstanding loans from Slipstream at December 31, 2021, consisting of its pre-existing $4,767 senior secured term loan and $2,418 secured convertible loan, with an aggregate of $7,185 in outstanding principal and accrued and unpaid interest under such loans, were consolidated into a term loan (the “Consolidation Term Loan”). The Consolidation Term Loan has an interest rate of 10.0%, with 75.0% warrant coverage (or 898,165 warrants). On the first day of each month, commencing March 1, 2022 through February 1, 2025, the Borrowers will make interest-only payments on the Consolidation Term Loan. Commencing on September 1, 2023, and on the first day of each month thereafter until the Maturity Date, the Borrowers will make a payment on the Consolidation Term Loan, in an equal monthly installment of principal sufficient to fully amortize the Consolidation Term Loan in eighteen equal installments. The Company assessed the combination of the pre-existing senior secured term loan and secured convertible loan in accordance with ASC 470 Debt and determined the transaction should be accounted for as an extinguishment, in part as the Consolidation Term Loan eliminated a substantive conversion feature. In aggregate the Company recorded a loss on extinguishment of $295, primarily associated with the write-off of pre-existing debt discounts.
In addition to refinancing the existing debt with Slipstream, the Company issued to Slipstream a $10,000, 36-month senior secured term loan (the “Acquisition Term Loan”) resulting in $10,000 in gross proceeds, or $9,950 in net proceeds. The Acquisition Term Loan matures on February 17, 2025 (the “Maturity Date”) and has an interest rate of 8.0%, with 50.0% warrant coverage (or 833,334 warrants). On the first day of each month, commencing March 1, 2022 through February 1, 2025, the Borrowers will make interest-only payments on the Acquisition Term Loan. No principal payments on the Acquisition Term Loan are payable until the Maturity Date.
In connection with the Acquisition Term Loan and Consolidation Term Loan warrant coverage, the Company issued to Slipstream a warrant to purchase an aggregate of 1,731,499 shares of Company common stock (the “Lender Warrant”). The Lender Warrant has a five-year term, an initial exercise price of $6.00 per share, subject to adjustments in the Lender Warrant, and is not exercisable until August 17, 2022. The warrants were assessed in accordance with ASC 470 and ASC 815 Derivatives and were deemed to represent bifurcated derivative instruments that should be recorded as liabilities in the Condensed Consolidated Balance Sheets. The Company performed a Black-Scholes valuation of the warrants as of the issuance date, resulting in a fair value of $2.4387 per warrant. In recording the warrant liability, the Company recorded a debt discount associated with each of the Acquisition and Consolidation Term Loans in an amount of $2,032 and $2,190, respectively. These amounts are being amortized straight-line through interest expense over the life of the loans, resulting in incremental interest expense of $1,267 during the year ended December 31, 2022. The Company has deemed straight-line amortization to be materially consistent with the effective interest method.
In certain circumstances, upon a fundamental transaction of the Company (e.g., a disposal or sale of all or the greater part of the assets or undertaking of the Company, an amalgamation or merger with another company, or implementation of a scheme of arrangement), the holder of the Lender Warrant will have the right to require the Company to repurchase the Lender Warrant at its fair value using a Black Scholes option pricing formula; provided that such holder may not require the Company or its successor entity to repurchase the Lender Warrant for the Black Scholes value in connection with a fundamental transaction that is not approved by the Company’s Board of Directors, and therefore not within the Company’s control.
Effective June 30, 2022, the Company amended the terms of the Lender Warrant to remove the holder’s option to exercise such warrant on a cashless basis utilizing the volume weighted average price (“VWAP”) of the Company’s common stock on the trading day immediately preceding the date of a notice of cashless exercise in certain circumstances, and remove the condition to exercising such warrant that the Company’s shareholders approve the exercise thereof (which has already been obtained). The amendments to the Lender Warrant also extend the term of such warrants for an additional one year, such that the Lender Warrant will expire on February 17, 2028. The foregoing amendments to the Lender Warrant caused such warrants to be accounted for as equity instruments in the Company’s Consolidated Financial Statements.
On October 31, 2022, the Borrowers and Slipstream amended the Credit Agreement to provide the Borrowers with a $2,000 term loan ("Term Loan (2022)"), the net proceeds of which are being used by the Company to accelerate an active software development project with potential to expand SaaS revenues associated with an existing customer. The term loan has an annual interest rate of 12.5% and matures on September 1, 2023. Commencing on February 1, 2023, the Borrowers will make monthly installment payments of approximately $270 until the maturity date, consisting of principal and interest sufficient to fully amortize the term loan through the maturity date.
Loan and Security Agreement History
Prior to the execution of the Credit Agreement, Borrower and Slipstream were parties to a Loan and Security Agreement. On March 7, 2021, On February 28, 2021, January 31, 2021, December 31, 2020, November 30, 2020, and September 29, 2020, the parties entered into several amendments to the Loan and Security Agreement to amend the automatic conversion date of the Special Loan and, later, to eliminate the conversion feature. Each amendment extended the automatic conversion date of the Special Loan. The Company paid no fees in exchange for these extensions, with the exception of the March 7, 2021 extension which resulted in the Company recording of $133 of incremental debt discount, a net gain of $26 via the extinguishment of the Special Loan, and expense of $69 of costs incurred with third parties as a result of extinguishment of the Special Loan, modification of the New Term Loan, and extinguishment of the Disbursed Escrow Loan.
Secured Disbursed Escrow Promissory Note
The Fourth Amendment to the Loan and Security Agreement included entry into a Secured Disbursed Escrow Promissory Note between the Company and Slipstream, and, effective June 30, 2018, we drew $264 in conjunction with our exit from a previously leased operating facility. The principal amount of the Secured Disbursed Escrow Promissory Note bears no interest. Upon entry into the Prior Credit Agreement on March 7, 2021, this note was converted into Disbursed Escrow Conversion Shares, with elimination of the debt recorded as an equity issuance within the Statements of Shareholders' Equity.
SBA Paycheck Protection Program Loan
On April 27, 2020, the Company entered into a Promissory Note with Old National Bank (the “Promissory Note”), which provided for an unsecured loan of $1,552 (the “PPP Loan”) pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act and applicable regulations (the “CARES Act”). The Promissory Note had a term of two years with a 1% per annum interest rate.
On January 11, 2021, the Company received a notice from Old National Bank that the full principal amount of the PPP Loan and the accrued interest have been forgiven, resulting in a gain of $1,552 during the year-ended December 31, 2021.
Amended and Restated Seller Note from acquisition of Allure
The Amended and Restated Seller Note represented a note payable due from Allure to Seller, under a pre-existing Seller Note which was amended and restated to a reduced amount of $1,637 through the Stock Purchase Agreement and a subsequent net working capital adjustment. That debt accrued interest at 3.5% per annum, and required us to make quarterly payments of interest only through February 19, 2020, on which date the promissory note matured and all remaining amounts owing thereunder became due.
On February 20, 2020, Creative Realities, Inc. and Allure made a demand for arbitration against Seller for (1) breach of contract, (2) indemnification, and (3) fraudulent misrepresentation under the Allure Purchase Agreement.
On May 13, 2021, the Company and Seller entered into a settlement agreement wherein neither party admitted liability, and the Company agreed to pay, and Seller agreed to accept, $100 as settlement in full for the outstanding balance of principal and accrued interest under the Amended and Restated Seller Note and a mutual release of all claims related to the Amended and Restated Seller Note and sale transaction under the Allure Purchase Agreement and all related agreements.
As a result of this settlement, the full principal amount of the Seller Note and the accrued interest were eliminated, resulting in a gain in the Consolidated Financial Statements of $1,624, representing $1,538 related to the Seller Note and $86 of related interest thereon, during 2021.
NOTE 9: COMMITMENTS AND CONTINGENCIES
Litigation
On August 2, 2019, the Company filed suit in Jefferson Circuit Court, Kentucky, against a supplier of the Company’s wholly owned subsidiary, Allure Global Solutions, Inc. (“Allure”) for breach of contract, breach of warranty, and negligence with respect to equipment installations performed by such supplier for an Allure customer. On October 10, 2019, the Allure customer that is the basis of our claim above sent a demand to the Company for payment of $3,200 as settlement for an alleged breach of contract related to hardware failures of equipment installations performed by Allure between November 2017 and August 2018. On March 10, 2023, the Company, the supplier and the Allure customer reached a Settlement Agreement and Release of Claims ("Settlement Agreement"). Pursuant to the Settlement Agreement, the Company is obligated to pay $733; however, its insurer has agreed to pay $700 of that amount. Thus, the Company is obligated to pay $33 of the settlement amount.
On February 20, 2020, Creative Realities, Inc. and Allure made a demand for arbitration against Seller for (1) breach of contract, (2) indemnification, and (3) fraudulent misrepresentation under the Allure Purchase Agreement. This demand included a claim for the right to offset the amounts owing under the Amended and Restated Seller Note due February 20, 2020. The Company did not pay the Amended and Restated Seller Note on its maturity date. On February 27, 2020, Seller sent the Company a notice of breach for failure to pay the Amended and Restated Seller Note on the maturity date of February 20, 2020 and demanding immediate payment. On September 11, 2020, the Company served a First Amended Demand in the arbitration with Seller, and on November 5, 2020, Seller pre-served a Motion for Summary Disposition in the arbitration demanding payment of the Amended and Restated Seller Note and accrued interest.
On May 13, 2021, the Company and Seller entered into a settlement agreement wherein neither party admitted liability, and the Company agreed to pay, and Seller agreed to accept, $100 as settlement in full for the outstanding balance of principal and accrued interest under the Amended and Restated Seller Note and a mutual release of all claims related to the Amended and Restated Seller Note and sale transaction under the Allure Purchase Agreement and all related agreements. The Company recorded a gain on settlement of obligations of $1,624 during 2021 upon settlement.
Except as noted above, the Company is not party to any other material legal proceedings, other than ordinary routine litigation incidental to the business, and there were no other such proceedings pending during the period covered by this Annual Report.
Settlement of obligations
There were no individually material settlements during the year-ended December 31, 2022.
During 2021, (i) the full principal amount of the PPP Loan and the accrued interest of $1,552 were forgiven and recorded as a gain on settlement, (ii) the Company settled the Amended and Restated Seller Note and related accrued interest for $100, recording a gain on settlement of $1,624, representing $1,538 related to the Amended and Restated Seller Note and $86 of related interest thereon, and (iii) the statute of limitations passed related to the remaining liability on a lease abandoned by the Company in 2015, resulting in a gain of $256. During the year ended December 31, 2021, the Company settled and/or wrote off obligations of $348 for aggregate cash payments of $139 and recognized a gain of $209 related to legacy accounts payable deemed to no longer be legal obligations to vendors.
NOTE 10: BUSINESS COMBINATION
On November 12, 2021, the Company and Reflect Systems, Inc., or “Reflect,” entered into an Agreement and Plan of Merger (as amended on February 8, 2022 and February 11, 2023, the “Merger Agreement") pursuant to which a direct, wholly owned subsidiary of Creative Realities, CRI Acquisition Corporation, or “Merger Sub,” would merge with and into Reflect, with Reflect surviving the merger and becoming our wholly owned subsidiary, which transaction is referred to herein as the “Merger.” On February 17, 2022, the parties consummated the Merger.
Reflect provides digital signage solutions, including software, strategic and media services to a wide range of companies across the retail, financial, hospitality and entertainment, healthcare, and employee communications industries in North America. Reflect offers digital signage platforms, including ReflectView, a platform used by companies to power hundreds of thousands of active digital displays. Through its strategic services, Reflect assists its customers with designing, deploying and optimizing their digital signage networks, and through its media services, Reflect assists customers with monetizing their digital advertising networks.
Subject to the terms and conditions of the Merger Agreement, upon the closing of the Merger, Reflect stockholders as of the effective time of the Merger collectively received from the Company, in the aggregate, the following Merger consideration: (i) $16,166 in cash, (ii) 777,778 shares of common stock of Creative Realities (valued based on an issuance price of $6 per share) (the “CREX Shares”), (iii) the Secured Promissory Note (as described below), and (iv) supplemental cash payments (the “Guaranteed Consideration”), if any, payable on or after February 17, 2025 (subject to the Extension Option described below, the “Guarantee Date”), in an amount by which the value of the CREX Shares on such anniversary is less than $19.20 per share, or if certain customers of Reflect collectively achieve over 85,000 billable devices online at any time on or before December 31, 2022, is less than $21.60 per share (such applicable amount, the “Guaranteed Price”), multiplied by the amount of CREX Shares held by the Reflect stockholders on the Guarantee Date (subject to the Extension Option described below). At or before December 31, 2022, the condition of certain customers of Reflect collectively to achieve over 85,000 billable devices online was not met. Accordingly, the contingent cash payment amount was reduced at December 31, 2022 from $21.60 per share to $19.20 per share, a reduction of $2.40 per share.
The Company may exercise an extension option (the “Extension Option”) to extend the Guarantee Date by six (6) months, from February 17, 2025 to August 17, 2025, if (i) the Extension Threshold Price is greater than or equal to 70% of the Guaranteed Price described above, and (ii) the Company provides written notice of its election to exercise the Extension Option no later than February 7, 2025. The “Extension Threshold Price” means the average closing price per share of Creative Realities common stock as reported on the Nasdaq Capital Market (or NYSE) in the fifteen (15) consecutive trading day period ending February 2, 2025. If the Extension Threshold Price is less than 80% of the Guaranteed Price, then the Guaranteed Price will be increased by $3.00 per share.
In connection with the Merger, the Company adopted a Retention Bonus Plan and raised capital to, among other things, pay the cash portion of the Merger consideration. The Retention Bonus Plan is described below.
Retention Bonus Plan
On February 17, 2022, in connection with the closing of the Merger (the “Closing”), the Company adopted a Retention Bonus Plan, pursuant to which the Company is required to pay to key members of Reflect’s management team an aggregate of $1,334 in cash, which was paid 50% at the Closing, and subject to continuous employment with Reflect or Creative Realities, 25% will be paid on February 17, 2023 (the one-year anniversary of Closing) and 25% will be paid on February 17, 2024 (the two-year anniversary of the Closing). The future cash payments due on the one-year and two-year anniversaries of the Closing have been deposited into an escrow agreement. The Retention Bonus Plan also requires the Company to issue Common Stock having an aggregate value of $667 to the plan participants as follows: 50% of the value of such shares were issued at the Closing, and subject to continuous employment with Reflect or Creative Realities, 25% of the value of such shares will be issued on February 17, 2023 (the one-year anniversary of Closing) and the remaining 25% of the value of such shares will be issued on February 17, 2024 (the two-year anniversary of the Closing). The shares issued on the Closing were valued at $6.00 per share, and the shares to be issued after the Closing will be determined based on dividing the value of shares issuable on such date divided by the trailing 10-day volume weighted average price (VWAP) of the shares as of such date as reported on the Nasdaq Capital Market.
Upon the resignation of a participant’s employment for “good reason,” or termination of the employment of a participant without “cause,” each as defined in the Retention Bonus Plan, the participant will be fully vested and will receive all cash and shares allocated to such participant under the Retention Bonus Plan. Any amounts unpaid by reason of a lapse in continuous employment or otherwise will be reallocated among the remaining Retention Bonus Plan participants.
Purchase price
The preliminary purchase price of Reflect consisted of the following items:
(in thousands) | | Consideration | |
Cash consideration for Reflect stock (1) | | $ | 16,664 | |
Cash consideration for Retention Bonus Plan (2) | | | 1,334 | |
Common stock issued to Reflect shareholders (3) | | | 4,667 | |
Common stock issued to Retention Bonus Plan (4) | | | 333 | |
Secured Promissory Note (5) | | | 2,500 | |
Earnout liability (6) | | | 10,862 | |
Total consideration | | | 36,360 | |
Vendor deposit with the Company (7) | | | (818 | ) |
Cash acquired (8) | | | (812 | ) |
Net consideration transferred | | $ | 34,730 | |
(1) Cash consideration for outstanding shares of Reflect capital stock per Merger Agreement.
(2) Cash consideration utilized to fund the Retention Bonus Plan per Merger Agreement.
(3) Company common stock issued in exchange for outstanding shares of Reflect capital stock per Merger Agreement.
(4) Company common stock issued to fund the Retention Bonus Plan per Merger Agreement
(5) The Secured Promissory Note accrues interest at 0.59% (the applicable federal rate at the time of issuance of the Secured Promissory Note) and requires the Company and Reflect to collectively pay equal monthly principal installments of $104 on the fifteenth (15th) day of each month, commencing on March 15, 2022. Any remaining or unpaid principal shall be due and payable on February 17, 2023.
(6) Represents an estimate of the fair value of the Guaranteed Consideration as of the Merger, which, if any, is payable on or after February 17, 2025 (subject to the Extension Option), in an amount by which the value of the CREX Shares on such anniversary is less than $19.20 per share, or if certain customers of Reflect collectively achieve over 85,000 billable devices online at any time on or before December 31, 2022, is less than $21.60 per share (such applicable amount, the “Guaranteed Price”), multiplied by the amount of CREX Shares held by the Reflect stockholders on the Guarantee Date (subject to the Extension Option), subject to the terms of the Merger Agreement. At September 30, 2022, the Company’s third party specialist completed valuation of this contingent liability as of the opening balance sheet date, resulting in a measurement period adjustment recorded to increase goodwill and the contingent liability as of February 17, 2022 by $5,262.
(7) Prior to the Merger, Reflect had engaged the Company on a project and paid the Company a deposit of $818. These amounts reduced consideration paid by the Company in accordance with ASC 805.
(8) Represents the Reflect cash balance acquired at Closing.
The Company incurred $444 of direct transaction costs related to the Reflect Merger for the year ended December 31, 2022. These costs are included in deal and transaction expense in the accompanying Consolidated Statements of Operations.
The Company accounted for the Merger using the acquisition method of accounting. The preliminary allocation of the purchase price is based on estimates of the fair value of assets acquired and liabilities assumed as of February 17, 2022. The Company is continuing to obtain information to determine the acquired assets and liabilities, including tax assets, liabilities and other attributes. The components of the preliminary purchase price allocation, inclusive of measurement period adjustments recorded by the Company during the year ended December 31, 2022, are as follows:
(in thousands) | | Total | |
Accounts receivable | | $ | 1,359 | |
Inventory | | | 190 | |
Prepaid expenses & other current assets | | | 666 | |
Property and equipment | | | 96 | |
Operating right of use assets | | | 493 | |
Other assets | | | 36 | |
Identified intangible assets: | | | | |
Definite-lived trade names | | | 960 | |
Definite-lived developed technology | | | 5,130 | |
Definite-lived customer relationships | | | 11,040 | |
Definite-lived noncompete agreements | | | 30 | |
Goodwill | | | 18,935 | |
Accounts payable | | | (104 | ) |
Accrued expenses | | | (483 | ) |
Customer deposits | | | (1,661 | ) |
Deferred revenues | | | (1,259 | ) |
Current maturities of operating leases | | | (277 | ) |
Long-term obligations under operating leases | | | (216 | ) |
Other liabilities | | | (205 | ) |
Net consideration transferred | | $ | 34,730 | |
The Company engaged a third-party valuation specialist to assist in the identification and calculation of the fair value of those separately identifiable intangible assets.
The Company completed its valuation procedures by asset utilizing the following approaches:
(1) Customer relationship asset was estimated using the income approach through a discounted cash flow analysis wherein the cash flows will be based on estimates used to price the Merger. Discount rates were benchmarked with reference to the implied rate of return from the Company’s pricing model and the weighted average cost of capital.
(2) Trade name asset represents the “Reflect” brand name as marketed primarily as a full services digital software solution, marketed in numerous verticals with the exception of food service. The Company applied the income approach through an excess earnings analysis to determine the fair value of the trade name asset. The Company applied the income approach through a relief-from-royalty analysis to determine the fair value of this asset.
(3) The developed technology assets are primarily comprised of know-how and functionality embedded in Reflect’s proprietary content management applications, which drive currently marketed products and services. The Company applied the income approach through a relief-from-royalty analysis to determine the preliminary fair value of this asset.
The Company is amortizing the identifiable intangible assets on a straight-line basis over the weighted average lives ranging from 2 to 10 years as outlined in the table below. The table below sets forth the valuation and amortization period of identifiable intangible assets:
| | | | | Amortization |
(in thousands) | | Valuation | | Period |
Identifiable definite-lived intangible assets: | | | | | |
Trade names | | $ | 960 | | 5 years |
Developed technology | | | 5,130 | | 10 years |
Noncompete | | | 30 | | 2 years |
Customer relationships | | | 11,040 | | 10 years |
Total | | $ | 17,160 | | |
The Company estimated the preliminary fair value of the acquired property, plant and equipment using a combination of the cost and market approaches, depending on the component. The preliminary fair value of such property, plant and equipment is $96.
The excess of the purchase price over the preliminary estimated fair value of the tangible net assets and identifiable intangible assets acquired was recorded as goodwill and is subject to change upon final valuation. The factors contributing to the recognition of the amount of goodwill are based on several strategic and synergistic benefits that are expected to be realized from the Merger. These benefits include a comprehensive portfolio of iconic customer brands, complementary product offerings, enhanced national footprint, and attractive synergy opportunities and value creation. None of the goodwill is expected to be deductible for income tax purposes.
The following unaudited pro forma information presents the combined financial results for the Company and Reflect as if the Merger had been completed at the beginning of the Company’s prior year, January 1, 2021.
(in thousands, except earnings per common share) | | 2021 | |
Net sales | | $ | 30,680 | |
Net income | | $ | 799 | |
Earnings per common share | | $ | 0.06 | |
The information above does not include the pro forma adjustments that would be required under Regulation S-X for pro forma financial information and does not reflect future events that may occur after December 31, 2021 or any operating efficiencies or inefficiencies that may result from the Merger and related financings. Therefore, the information is not necessarily indicative of results that would have been achieved had the businesses been combined during the periods presented or the results that the Company will experience going forward. We have not included disaggregated information for Reflect on a standalone basis in the current year for either revenue or net income as the integration activities undertaken by the Company have prevented this information from being useful to financial statement readers.
| | Year | |
| | Ended | |
| | December 31, | |
Reflect Systems, Inc. (in thousands) | | 2021 | |
Net sales | | $ | 12,243 | |
Net (loss) income | | $ | 567 | |
NOTE 11: INCOME TAXES
Income tax expense consisted of the following:
| | Year ended December 31, | |
| | 2022 | | | 2021 | |
Tax provision summary: | | | | | | | | |
State income tax | | $ | (51 | ) | | $ | (22 | ) |
Deferred tax expense - federal | | | (30 | ) | | | - | |
Deferred tax benefit – state | | | 2 | | | | - | |
Tax expense | | $ | (79 | ) | | $ | (22 | ) |
The income tax expense includes federal and state income taxes currently payable and those deferred or prepaid because of temporary differences between financial statement and tax bases of assets and liabilities. The Company records income taxes under the liability method. Under this method, deferred income taxes are recognized for the estimated future tax effects of differences between the tax bases of assets and liabilities and their financial reporting amounts based on enacted tax laws.
A reconciliation of the statutory income tax rate to the effective income tax rates as a percentage of income before income taxes is as follows:
| | 2022 | | | 2021 | |
Federal statutory rate | | | 21.00 | % | | | 21.00 | % |
State taxes, net of federal benefit | | | (2.02 | )% | | | 5.21 | % |
Foreign rate differential | | | (2.51 | )% | | | (26.47 | )% |
PPP Loan Forgiveness | | | - | | | | (128.43 | )% |
Fair value of Warrant Liability/Contingent Consideration | | | (79.66 | )% | | | 0.00 | % |
Discrete items, Transaction items, and Other | | | (2.37 | )% | | | 21.92 | % |
Changes in valuation allowance | | | 69.60 | % | | | 115.43 | % |
Effective tax rate | | | 4.04 | % | | | 8.66 | % |
The net deferred tax assets and liabilities recognized in the accompanying Consolidated Balance Sheets, determined using the income tax rate applicable to each period, consist of the following:
| | December 31, | |
| | 2022 | | | 2021 | |
Deferred tax assets (liabilities): | | | | | | | | |
Reserves | | $ | 472 | | | $ | 267 | |
Property and equipment | | | 165 | | | | (2 | ) |
Accrued expenses | | | 593 | | | | 106 | |
Right-of-use Asset | | | (253 | ) | | | (91 | ) |
Right-of-use Liability | | | 253 | | | | 91 | |
IRC 163(j) Interest Deduction | | | 18 | | | | 18 | |
Debt issuance costs | | | 286 | | | | - | |
Non-qualified stock options | | | 1,469 | | | | 1,074 | |
IRC Section 174 | | | 196 | | | | - | |
R&D credits | | | 2,312 | | | | 1,801 | |
Net foreign carryforwards | | | 3,664 | | | | 3,485 | |
US net operating loss and credit carryforwards | | | 37,953 | | | | 35,448 | |
Intangibles | | | (3,737 | ) | | | (11 | ) |
| | | | | | | | |
Total deferred tax liabilities, net | | | 43,391 | | | | 42,186 | |
Valuation allowance | | | (43,419 | ) | | | (42,186 | ) |
Net deferred tax liabilities | | $ | (28 | ) | | $ | - | |
As of December 31, 2022, the Company had no reserves recorded as a liability for unrecognized tax benefits for U.S. federal and state tax jurisdictions. There were no unrecognized tax benefits as of December 31, 2022 that, if recognized, would affect the tax rate. It is the Company’s policy to accrue interest and penalties related to liabilities for income tax contingencies in the provision for income taxes. As of December 31, 2022, the Company had no accrued interest or penalties related to uncertain tax positions.
Our deferred tax assets are primarily related to net federal and state operating loss carryforwards (NOLs). As of December 31, 2022, the Company has federal and state net operating loss carryforwards expiring between 2023 and 2037, $10,651 of which has an indefinite carryforward period. The federal statute of limitations remains open for tax years 2019 through 2021 and state tax jurisdictions generally have statutes of limitations open for tax years 2018 through 2021.
We have substantial NOLs that are limited in usage by IRC Section 382. IRC Section 382 generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership within a statutory testing period.
We have performed a preliminary analysis of the annual NOL carryforwards and limitations that are available to be used against taxable income. Based on the history of losses of the Company, there continues to be a full valuation allowance against the net deferred tax assets of the Company.
NOTE 12: WARRANTS
A summary of outstanding warrants for the years ended December 31, 2022 and 2021 is included below:
Year Ended December 31, 2022 | |
| | Warrants (Equity) | |
| | | | | | | | | | Weighted | |
| | | | | | Weighted | | | Average | |
| | | | | | Average Exercise | | | Remaining | |
| | Amount | | | Price | | | Contractual Life | |
Balance January 1, 2022 | | | 1,367,737 | | | $ | 13.44 | | | | 1.73 | |
Warrants issued | | | 1,950,502 | | | | 4.60 | | | | 5.00 | |
Warrants exercised | | | (1,950,502 | ) | | | 4.60 | | | | 4.86 | |
Warrants expired | | | (130,712 | ) | | | 10.44 | | | | - | |
Warrants reclassified | | | 4,587,002 | | | | 4.90 | | | | 4.73 | |
Balance December 31, 2022 | | | 5,824,027 | | | $ | 6.56 | | | | 3.91 | |
Year Ended December 31, 2022 | |
| | Warrants (Liability) | |
| | | | | | | | | | Weighted | |
| | | | | | Weighted | | | Average | |
| | | | | | Average Exercise | | | Remaining | |
| | Amount | | | Price | | | Contractual Life | |
Balance January 1, 2022 | | | - | | | $ | - | | | | - | |
Warrants issued | | | 4,587,002 | | | | 4.90 | | | | 5.00 | |
Warrants reclassified | | | (4,587,002 | ) | | | (4.90 | ) | | | (5.00 | ) |
Balance December 31, 2022 | | | - | | | $ | - | | | | - | |
Year Ended December 31, 2021 | |
| | Warrants (Equity) | |
| | | | | | | | | | Weighted | |
| | | | | | Weighted | | | Average | |
| | | | | | Average Exercise | | | Remaining | |
| | Amount | | | Price | | | Contractual Life | |
Balance January 1, 2021 | | | 1,475,633 | | | $ | 13.86 | | | | 2.83 | |
Warrants issued | | | - | | | | - | | | | - | |
Warrants expired | | | (107,896 | ) | | | 14.07 | | | | - | |
Balance December 31, 2021 | | | 1,367,737 | | | $ | 13.44 | | | | 1.73 | |
On February 3, 2022, the Company entered into a Securities Purchase Agreement with a purchaser (the “Purchaser”), pursuant to which the Company agreed to issue and sell to the Purchaser, in a private placement priced at-the-market under Nasdaq rules, (i) 438,334 shares (the “Shares”) of the Company’s common stock, par value $0.01 per share (the “Common Stock”) and accompanying warrants to purchase an aggregate of 438,334 shares of Common Stock, and (ii) pre-funded warrants to purchase up to an aggregate of 1,950,502 shares of Common Stock (the “Pre-Funded Warrants”) and accompanying warrants to purchase an aggregate of 1,950,502 shares of Common Stock (collectively, the “Private Placement”). The accompanying warrants to purchase Common Stock are referred to herein collectively as the “Common Stock Warrants.” Under the Securities Purchase Agreement, each Share and accompanying warrants to purchase Common Stock were sold together at a combined price of $4.605, and each Pre-Funded Warrant and accompanying warrants to purchase Common Stock were sold together at a combined price of $4.6047, for gross proceeds of approximately $11,000, before deducting placement agent fees and estimated offering expenses payable by the Company. In the first quarter of 2022, each of the Pre-Funded Warrants were exercised. The Common Stock Warrants expire five years from the date of issuance. The Company evaluated the Pre-Funded Warrants and concluded that they met the criteria to be classified within stockholders’ equity, with proceeds recorded as common stock and additional paid-in-capital. The Company evaluated the Common Stock Warrant and concluded they did not meet the criteria to be classified within stockholders’ equity. The Common Stock Warrant included provisions which could result in a different settlement value for the Common Stock Warrant depending on the registration status of the underlying shares. Because these conditions were not an input into the pricing of a fixed-for-fixed option on the Company’s ordinary shares, the Common Stock Warrant was not considered to be indexed to the Company’s own stock. The Company recorded these warrants as liabilities on the Consolidated Balance Sheets at fair value, with subsequent changes in their respective fair values recognized in the Consolidated Statements of Operations at each reporting date. At the date of issuance, the Company performed a Black-Scholes valuation of the warrants, resulting in a fair value of $3.2781 per warrant. The Company recorded a gain on the fair value of these warrants of $4,951 in the Consolidated Statements of Operations for the year ended December 31, 2022, which reflects the change in fair value from granting of the warrants through June 30, 2022, the effective date of the warrant agreement amendment.
On February 17, 2022, in connection with the Credit Agreement with Slipstream, the Company issued to Slipstream 1,731,499 warrants with an exercise price of $6.00 per share, which expire five years from the date of issuance (the “Lender Warrant”). These warrants are not exercisable until 180 days after the issuance date. The common shares underlying these warrants have not yet been registered for resale under the Securities Act of 1933, which provides Slipstream with an option for cashless exercise once the warrant becomes exercisable until such time as such registration occurs. The Lender Warrant expired five years from the date of issuance. The Company evaluated the Lender Warrant and concluded that it did not meet the criteria to be classified within stockholders’ equity. The Lender Warrant included provisions that could result in a different settlement value for the Lender Warrant depending on the registration status of the underlying shares. Because these conditions were not an input into the pricing of a fixed-for-fixed option on the Company’s ordinary shares, the Lender Warrant was not considered to be indexed to the Company’s own stock. The Company recorded these warrants as liabilities in the Consolidated Balance Sheets at fair value, with subsequent changes in their respective fair values recognized in the Consolidated Statements of Operations at each reporting date. At the date of issuance, the Company performed a Black-Scholes valuation of the warrants, resulting in a fair value of $2.4387 per warrant. In recording the warrant liability, the Company recorded an increase in debt discount in the Consolidated Balance Sheets associated with the issuance of the warrants of $4,223, which is being amortized through interest expense in the Consolidated Statements of Operations over the life of the Acquisition Term Loan and Consolidation Term Loan. The Company recorded a gain on the fair value of these warrants of $2,302 in the Consolidated Statements of Operations for the year ended December 31, 2022, which reflects the change in fair value from granting of the warrants through June 30, 2022, the effective date of the warrant agreement amendment.
On February 17, 2022, in connection with obtaining a waiver of certain restrictions in investment documents between an investor and the Company in order to consummate the financing contemplated by the Credit Agreement, the Company paid consideration to such investor in the form of a warrant (the “Purchaser Warrant”) to purchase 466,667 shares of Company common stock in an at-the-market offering under Nasdaq rules. The number of shares of Company common stock subject to the Purchaser Warrant is equal to the waiver fee ($175) divided by $0.375 per share. The exercise price of the Purchaser Warrant is $4.23 per share, and the Purchaser Warrant is not exercisable until August 17, 2022. The Purchaser Warrant expired five years from the date of issuance. The Company evaluated the Purchaser Warrant and concluded that it did not meet the criteria to be classified within stockholders’ equity. The Purchaser Warrant included provisions which could result in a different settlement value for the Purchaser Warrant depending on the registration status of the underlying shares. Because these conditions were not an input into the pricing of a fixed-for-fixed option on the Company’s ordinary shares, the Purchaser Warrant was not considered to be indexed to the Company’s own stock. The Company recorded these warrants as liabilities on the Consolidated Balance Sheets at fair value, with subsequent changes in their respective fair values recognized in the Consolidated Statements of Operations at each reporting date. At the date of issuance, the Company performed a Black-Scholes valuation of the Purchaser Warrant, resulting in a fair value of $2.5968 per warrant. In recording the warrant liability, the Company recorded an expense in the Consolidated Statements of Operations associated with the issuance of the Purchaser Warrant of $1,212. The Company recorded a gain on the fair value of the Purchaser Warrant of $649 in the Consolidated Statements of Operations for the year ended December 31, 2022, which reflects the change in fair value from granting of the warrants through June 30, 2022, the effective date of the warrant agreement amendment.
Effective June 30, 2022, the Company amended the terms of the Common Stock Warrant (2,388,836 warrants), Lender Warrant (1,731,499 warrants) and Purchaser Warrant (466,667 warrants). The amendments to such warrants removes the holder’s option to determine the value of such warrants utilizing the volume weighted average price (“VWAP”) of the Company’s common stock on the trading day immediately preceding the date of a notice in a cashless exercise, and removes the condition to exercising such warrants that the Company’s shareholders approve the exercise thereof (which has already been obtained). The amendments to the warrants also extend the term of such warrants for an additional one year, such that the Common Stock Warrant will expire on February 3, 2028, and the Lender Warrant and Purchaser Warrant will expire on February 17, 2028.
As a result of the extension in term provided in exchange for the amendment, the Company reassessed the fair value of each of the Common Stock, Lender and Purchaser Warrants, resulting in the Company recording a loss on the fair value of these warrants of $345 in the Consolidated Statements of Operations for the year ended December 31, 2022. The foregoing amendments to the warrants resulted in such warrants to be accounted for as equity instruments in the Company’s Consolidated Financial Statements. As such, following recording the gains and losses with respect to these warrant amendments, the Company reclassified the warrant liability of $5,709 from noncurrent liabilities to additional paid-in-capital. These amounts are reflected as additional paid-in-capital in the Consolidated Balance Sheet as of December 31, 2022.
As of December 31, 2022, there remained outstanding 68,508 warrants which contain weighted average anti-dilution protection. During 2022, those warrants were subject to a downward adjustment in their strike price following completion of the Company’s issuance of common stock or common stock equivalents in (1) the Private Placement, (2) the Credit Agreement, and (3) the Waiver, each in February 2022. The strike prices prior to adjustment ranged from $16.83 to $17.31 and were adjusted to between $10.23 and $10.44, resulting in the Company recording an increase in additional paid-in-capital of $31 in the Consolidated Statements of Shareholders' Equity for the year ended December 31, 2022. The remaining weighted-average exercise price and weighted average contractual life of warrants subject to weighted average anti-dilution protection is $10.41 and 0.24 years, respectively, as of December 31, 2022.
As of December 31, 2021, there remained outstanding 307,123 warrants which contain weighted average anti-dilution protection. During 2020, those warrants were subject to a downward adjustment in their strike price following completion of the Company’s issuance of common stock via at-the-market offering activities. The strike prices prior to adjustment ranged from $18.27 to $18.75 and were adjusted to between $17.40 and $17.88. The remaining weighted-average contractual life of warrants subject to weighted average anti-dilution protection is 1.71 years as of December 31, 2021.
NOTE 13: STOCK-BASED COMPENSATION
A summary of outstanding options as of December 31, 2022 is included below:
Time Vesting Options
| | | | | | Weighted | | | | | | | | | | | | | |
| | | | | | Average | | | Weighted | | | | | | | Weighted | |
| | | | | | Remaining | | | Average | | | | | | | Average | |
Range of Exercise | | Number | | | Contractual | | | Exercise | | | Options | | | Exercise | |
Prices between | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
$0.01 - $4.00 | | | - | | | | - | | | $ | - | | | | - | | | $ | - | |
$4.01 - $8.00 | | | 566,673 | | | | 7.63 | | | | 7,42 | | | | 352,227 | | | $ | 7.47 | |
8.01+ | | | 96,237 | | | | 3.02 | | | | 25.37 | | | | 96,237 | | | $ | 25.37 | |
| | | 662,910 | | | | 6.96 | | | $ | 10.02 | | | | 448,464 | | | | | |
Performance Vesting Options
| | | | | | Weighted | | | | | | | | | | | | | |
| | | | | | Average | | | Weighted | | | | | | | Weighted | |
| | | | | | Remaining | | | Average | | | | | | | Average | |
Range of Exercise | | Number | | | Contractual | | | Exercise | | | Options | | | Exercise | |
Prices between | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
$0.01 - $4.00 | | | - | | | | - | | | $ | - | | | | - | | | $ | - | |
$4.01 - $8.00 | | | 240,000 | | | | 7.42 | | | $ | 7.59 | | | | 80,000 | | | $ | 7.59 | |
8.01+ | | | - | | | | - | | | $ | - | | | | - | | | $ | - | |
| | | 240,000 | | | | 7.42 | | | $ | 7.59 | | | | 80,000 | | | | | |
Market Vesting Options
| | | | | | Weighted | | | | | | | | | | | | | |
| | | | | | Average | | | Weighted | | | | | | | Weighted | |
| | | | | | Remaining | | | Average | | | | | | | Average | |
Range of Exercise | | Number | | | Contractual | | | Exercise | | | Options | | | Exercise | |
Prices between | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
$0.01 - $4.00 | | | 633,334 | | | | 2.13 | | | $ | 3.00 | | | | - | | | $ | - | |
$4.01 - $8.00 | | | - | | | | - | | | $ | - | | | | - | | | $ | - | |
8.01+ | | | - | | | | - | | | $ | - | | | | - | | | $ | - | |
| | | 633,334 | | | | 2.13 | | | $ | 3.00 | | | | - | | | | | |
| | Market Vesting Options | | | Time Vesting Options | | | Performance Vesting Options | |
| | | | | | Weighted | | | | | | | Weighted | | | | | | | Weighted | |
| | | | | | Average | | | | | | | Average | | | | | | | Average | |
| | Options | | | Exercise | | | Options | | | Exercise | | | Options | | | Exercise | |
Date/Activity | | Outstanding | | | Price | | | Outstanding | | | Price | | | Outstanding | | | Price | |
Balance, December 31, 2021 | | | - | | | | - | | | | 689,603 | | | | 10.44 | | | | 266,667 | | | $ | 7.59 | |
Granted | | | 633,334 | | | | 3.00 | | | | - | | | | - | | | | - | | | | - | |
Exercised | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Forfeited or expired | | | - | | | | - | | | | (26,712 | ) | | | 8.37 | | | | (26,667 | ) | | | 7.59 | |
Balance, December 31, 2022 | | | 633,334 | | | | 1.00 | | | | 662,891 | | | | 10.02 | | | | 240,000 | | | $ | 7.59 | |
The weighted average remaining contractual life for options exercisable is 6.7 years as of December 31, 2022.
Valuation Information for Stock-Based Compensation
For purposes of determining estimated fair value under FASB ASC 718-10, Stock Compensation, the Company computed the estimated fair values of stock options using the Black-Scholes model.
Amendment to Performance Options
On June 1, 2020, Rick Mills, CEO, and Will Logan, CFO, were issued ten-year options to purchase 160,000 and 80,000 shares of common stock (the “Performance Options”), respectively, which vest in equal installments over a three-year period (2020-2022), subject to satisfying the Company revenue target and EBITDA (earnings before interest, taxes, depreciation and amortization) targets for the applicable year. In each of calendar years 2020, 2021 and 2022, one-third of the total shares may vest (if the revenue and EBITDA targets are met), and the shares that are subject to vesting each year are allocated equally to each of the revenue and EBITDA targets for such year. The Performance Options includes a catch-up provision, where any options that did not vest during a prior year due to the Company’s failure to meet a prior revenue or EBITDA target may vest in a subsequent vesting year if the revenue or EBITDA target, as applicable, is met in the future year.
On June 15, 2022, the Board approved of an amendment to the Performance Options to provide that the revenue target for the calendar year 2022 set forth therein ($38,000) is eliminated, and the remaining shares that are available for vesting under the Performance Options (106,667 unvested shares for Mr. Mills and 53,334 for Mr. Logan) (including the unvested portions of shares based on the satisfaction of the revenue targets for 2020 and 2021 by virtue of the catch-up provisions in the Performance Options) will fully vest upon the achievement of an updated EBITDA target for calendar year 2022 of $3,600.
The Performance Options state that the calculation of EBITDA set forth in the Performance Options shall be calculated in a form consistent with the Company’s 2022 approved budget, which
(i) excludes any impact on EBITDA of:
(a) the accounting treatment (including any "mark-to-market accounting") of the Company's warrants or the "Guaranteed Consideration" (as defined in the Merger Agreement),
(b) non-recurring transaction expenses associated with the Merger and the capital raising financing activities of the Company to effectuate the Merger, and
(c) any write-down or write-off of any Company inventory of Safe Space Solutions products.
(ii) includes deductions related to any cash or stock bonuses paid or payable to any employees of the Company for services provided in calendar year 2022 (even if such bonuses are actually paid after calendar year 2022), including bonuses paid pursuant to the terms of the 2022 Cash Bonus Plan (as described below) (collectively, the “EBITDA Calculations”).
The exercise price of the foregoing options is $7.59 per share, the closing price of the Company’s common stock on the date of issuance. The options were issued from the 2014 Stock Incentive Plan. The fair value of the options on the grant date was $5.61 and was determined using the Black-Scholes model. These values were calculated using the same weighted average assumptions as the time vesting options issued. Performance against the identified EBITDA target is assessed quarterly by the Company in order to determine whether any compensation expense should be recorded.
For the year ended December 31, 2022, the Company recognized $849 in stock-based compensation expense related to the Performance Options, net of a benefit of $50 recorded for forfeiture awards, as the Company achieved the specified performance target for the performance period.
Issuance of New Options
On June 15, 2022, Messrs. Mills and Logan received ten-year options to purchase 333,334 and 200,000 shares of common stock, respectively (the “New Options”). The New Options are eligible to vest at any time on or prior to February 17, 2025 if the trailing 10-trading day volume-weighted average price (“VWAP”) of the Company’s common stock, as reported on the Nasdaq Capital Market, exceeds the share price targets below, subject to such executive serving the Company as a director, officer, employee or consultant at such time:
The “Guaranteed Price” has the meaning ascribed to such term in the Merger Agreement, which means $19.20 per share.
The exercise price of the New Options is $3.00 per share, which exceeds the closing price of the Company’s common stock on the date of issuance. The New Options are issued from the Company’s 2014 Stock Incentive Plan, as amended. An additional 100,000 options with identical market vesting restrictions were issued to non-executives during the year ended December 31, 2022.
The fair value of the options on the grant date varied between $0.63 and $1.11 per award as determined using the Monte Carlo model. These values were calculated using the following weighted average assumptions:
The options awarded vest over 3 years and have an exercise price of $7.59, the market value of the Company’s common stock on the grant date. The fair value of the options on the grant date was $5.61 and was determined using the Black-Scholes model. These values were calculated using the following weighted average assumptions:
Compensation expense recognized for the issuance of stock options to employees for the years ended December 31, 2022 and 2021 of $1,689 and $1,494, respectively, was included in general and administrative expense in the Consolidated Financial Statements.
Compensation expense recognized for the issuance of stock options, including those options awarded to our Board of Directors, for the years ended December 31, 2022 and 2021 of $198 and $398, respectively, was included in general and administrative expense in the Consolidated Financial Statements. At December 31, 2022, there was approximately $62 of total unrecognized compensation expense related to unvested share-based awards with time vesting criteria for non-employee directors. Generally, expense related to the time vesting options will be recognized over the next two- years and will be adjusted for any future forfeitures as they occur.
The Company engages certain consultants to perform services in exchange for Company common stock. Shares issued for services were calculated based on the ten (10) day volume weighted average price (“VWAP”) for the last ten (10) days during the month of service provided.
The Company's lease portfolio is primarily comprised of operating leases for offices. At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on whether the contract conveys the right to control the use of identified property or equipment for a period of time in exchange for consideration. Leases are classified as operating or finance leases at the commencement date of the lease.
Operating lease right of use assets and obligations are recognized within the Consolidated Balance Sheets based on the present value of lease payments over the lease term. As the implicit rate is generally not readily determinable for most leases, the Company uses an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate reflects the estimated rate of interest that the Company would pay to borrow on a collateralized basis over a similar term in a similar economic environment. Lease expense for operating leases is recognized on a straight-line basis over the lease term.
The following table provides lease term and discount rate information related to operating leases as of December 31, 2022:
The following table sets forth the scheduled maturities of lease obligations as of December 31, 2022:
The following table provides supplemental information related to the Company's Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021:
We have a Registered Retirement Savings Plan for eligible associates in Canada. Associates may contribute up to 18% of earned income reported on their tax return in the previous year, subject to legal contribution limits. Beginning on April 1, 2018, the Company began contributing an employer contribution match of 50% of employee wages up to 6%, for an effective match of 3%. The Company indefinitely suspended the employer match at the end of March 2020 in response to the uncertainty of the COVID-19 pandemic and reinstated the employer match in October 2021.
The Company contributed $142 and $19 to employee retirement plans for the year-ended December 31, 2022 and 2021, respectively.
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 material sales for the years ended December 31, 2022 and 2021 were in the United States and Canada.