Notes to Consolidated Financial Statements

December 31, 2017 and 2016

 

1. Organization and Summary of Significant Accounting Policies

 

Description of the Company

 

RMG Networks Holding Corporation (“RMG” or the “Company”) is a holding company which owns 100% of the capital stock of RMG Networks Holding, Inc. f/k/a Reach Media Group Holdings, Inc. (“Reach Media Group”) and its subsidiaries and RMG Enterprise Solutions Holdings Corporation, f/k/a Symon Holdings Corporation (“Symon”) and its subsidiaries.

 

The Company’s common stock currently trades on The Nasdaq Capital Market (“Nasdaq”), under the symbol “RMGN”. Its warrants are quoted on the Over-the-Counter Bulletin Board quotation system under the symbol “RMGNW”.

 

The consolidated financial statements for all prior periods have been retroactively adjusted to reflect the August 14, 2017 1-for-4 reverse stock split of the Company’s common stock.

 

Description of the Business

 

The Company is one of the largest integrated digital signage solution providers, offering enterprise-class digital signage solutions that are relied upon by a majority of Fortune 100 companies and thousands of overall customers in locations worldwide. Through an extensive suite of products that include proprietary software, software-embedded hardware, maintenance and creative content service, installation services, and third-party displays, the Company delivers complete end-to-end intelligent visual communication solutions to its clients for critical contact center, supply chain, internal communications, hospitality, retail and other applications with a large concentration of customers in the financial services, telecommunications, manufacturing, healthcare, pharmaceutical, utility and transportation industries, and in federal, state and local governments. The Company’s installations deliver real-time intelligent visual content that enhance the ways in which organizations communicate with employees and customers to drive productivity and engagement. The solutions are designed to integrate seamlessly with a customer’s IT infrastructure, data and security environments. The Company conducts operations through its RMG Enterprise Solutions business unit.

 

On July 1, 2015, the Company divested its RMG Media Networks business unit which was focused on selling advertising across airline digital media assets. Therefore, the financial information discussed below and in the consolidated financial statements and accompanying footnotes are exclusive of our Media business, classified as discontinued operations, unless specifically identified otherwise.

 

At December 31, 2017, the Company had $1.3 million in borrowings and $2.5 million in unused availability under the Revolving Facility. At December 31, 2017, the Company’s cash and cash equivalents balance was $1.5 million. This includes cash and cash equivalents of $1.2 million held in bank accounts of its subsidiaries located outside the United States. Through the combination of the Company’s cash and availability under the Revolving Facility, the ability to seek new capital through additional financing and equity capital markets via its effective “shelf” registration statement, and its current forecasts, the Company believes it should have adequate cash to operate the Company through at least the next twelve months. However, if the Company is unable to achieve its forecasts, fails to meet the financial covenants in the Revolving Facility and is unable to obtain a waiver or an amendment from the Bank to allow it to continue to borrow, or raise additional capital, the Company may need to pursue one or more alternatives, such as to reduce or delay investments in its business.

 

Basis of Presentation for Financial Statements

 

The audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for financial information and pursuant to the accounting and disclosure rules and regulations of the Securities and Exchange Commission. In the opinion of management, the audited consolidated financial statements reflect all adjustments and disclosures necessary for a fair presentation of the results of the reported years.

 

Principles of Consolidation

 

The consolidated financial statements of RMG Networks Holding Corporation include the accounts of Reach Media Group and its wholly-owned subsidiaries and the accounts of Symon and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Cash and Cash Equivalents

 

For purposes of the statements of cash flows, cash and cash equivalents include demand deposits in financial institutions and investments with an original maturity of three months or less from the date of purchase.

 

Accounts Receivable

 

Accounts receivable are comprised of sales made primarily to entities located in the United States of America, Europe, Middle East, and Asia. Accounts receivable are recorded at the invoiced amounts and do not bear interest. Payment is generally due ninety days or less from the invoice date and accounts more than ninety days are analyzed for collectability.  The allowance for doubtful accounts is reviewed monthly and the Company establishes reserves for doubtful accounts on a case-by-case basis based on a current review of the collectability of accounts and historical collection experience. Once all collection efforts have been exhausted, the account is written-off against the allowance.  The allowance for doubtful accounts was $374 thousand and $364 thousand at December 31, 2017 and 2016, respectively. As of and for the years presented, no single customer accounted for more than 10% of accounts receivable or revenues.

 

Inventory

 

Inventory consists primarily of software-embedded smart products, electronic components, computers and computer accessories. Inventories are stated at the lower of average cost or market. Write-offs of slow moving and obsolete inventories are provided based on historical experience and estimated future usage.

 

 

Property and Equipment

 

The Company records purchases of property and equipment at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset.

 

Intangible Assets

 

Intangible assets include software and technology and customer relationships associated with the acquisition of Symon. The intangible assets are being amortized over their estimated useful lives. The definite lived intangible assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment evaluation involves testing the recoverability of the asset on an undiscounted cash-flow basis, and, if the asset is not recoverable, recognizing an impairment charge, if necessary, to reduce the asset’s carrying amount to its fair value. Intangible assets are evaluated for impairment annually and on an interim basis as events and circumstances warrant by comparing the fair value of the intangible asset with its carrying amount.

 

There were no impairments of definite lived intangible assets during the years 2017 and 2016.  

 

The Company’s remaining intangible assets in 2017 are being amortized as follows:

 

 

Deferred Revenue

 

Deferred revenue consists of billings or payments received in advance of revenue recognition from maintenance and content services contracts, software subscriptions and some professional service agreements. Deferred revenue is recognized as the revenue recognition criteria are met. The Company generally invoices the customer in advance for maintenance and content agreements and software subscriptions.

 

Impairment of Long-lived Assets

 

In accordance with ASC 360, Property, Plant, and Equipment, long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted net cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying value of the asset exceeds the fair value of the asset.

 

There was no impairment of long-lived assets during 2017 and 2016.

 

Income Taxes

 

The Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  The Company measures deferred tax assets and liabilities using enacted tax rates expected to be applied to taxable income in the years in which those differences are expected to be recovered or settled.  The Company recognizes in income the effect of a change in tax rates on deferred tax assets and liabilities in the period that includes the enactment date.

 

Under ASC 740, Income Taxes (“ASC 740”), the Company recognizes the effect of uncertain tax positions, if any, only if those positions are more likely than not of being realized.  It also requires the Company to accrue interest and penalties where there is an underpayment of taxes, based on management’s best estimate of the amount ultimately to be paid, in the same period that the interest would begin accruing or the penalties would first be assessed.  The Company maintains accruals for uncertain tax positions until examination of the tax year is completed by the applicable taxing authority, available review periods expire, or additional facts and circumstances cause it to change its assessment of the appropriate accrual amounts (see Note 5).  As of December 31, 2017 and 2016, the Company had no accrual recorded for uncertain tax positions.  In December 2017, the U.S. Congress passed the Tax Cut and Jobs Act of 2017 (“TCAJA”) which reduced the federal income tax rate applicable to corporations to 21% from a maximum rate of 35%. The new rate is applicable for the 2018 tax year, but the Company applied the new rate to temporary differences that will reverse after 2017 in accordance with ASC 740, resulting in a decreased value to deferred tax assets of $9.5 million, which is fully offset against the change in the valuation allowance attributable to such assets (see Note 5). In addition to the reduced tax rate, the TCAJA includes a deemed repatriation provision which requires companies to pay tax on their foreign accumulated earnings and profits measured at either November 2, 2017 or December 31, 2017, whichever produces the greater amount, at a reduced rate with an election to pay the tax over an 8-year period. As of December 31, 2017, the Company has $5.2 million of accumulated earnings in controlled foreign subsidiaries of which $2.3 million is includible as taxable income in 2017 subject to this tax provision. Due to the Company’s current tax loss and federal net operating loss carryforwards of approximately $68.7 million, the Company will apply the deemed repatriation to 2017 taxes and not opt to defer the tax over 8 years. The Company reinvests earnings of foreign subsidiaries in foreign operations and expects that future earnings will also be reinvested in foreign operations indefinitely. The Company has elected to recognize accrued interest and penalties related to income tax matters as a component of income tax expense if incurred.

 

Revenue Recognition

 

The following revenue recognition accounting policy is based on the accounting principles that were used to prepare these 2017 consolidated financial statements. On January 1, 2018, the Company adopted Accounting Standard Update 2014-09, Revenue from Contracts with Customers, as amended (“ASC 606”). ASC 606 replaces existing revenue recognition rules with a comprehensive revenue measurement and recognition standard and expanded disclosure requirements. See Recently Issued Accounting Pronouncements below for additional information.

 

The Company recognizes revenue primarily from these sources:

 

 

 

 

The Company recognizes revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred, which is when product title transfers to the customer, or services have been rendered; (iii) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (iv) collection is reasonably assured. The Company assesses collectability based on a number of factors, including the customer’s past payment history and its current creditworthiness. If it is determined that collection of a fee is not reasonably assured, the Company defers the revenue and recognizes it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period. Sales and use taxes are reported on a net basis, excluding them from revenue and cost of revenue.

 

Multiple-Element Arrangements

 

Products consist of proprietary software and hardware equipment. The Company considers the sale of software more than incidental to the hardware as it is essential to the functionality of the hardware products. The Company enters into multiple-product and services contracts, which may include any combination of equipment and software products, professional services, maintenance and content services.

 

Multiple Element Arrangements (“MEAs”) are arrangements with customers which include multiple deliverables, including a combination of equipment and services. The deliverables included in the MEAs are separated into more than one unit of accounting when (i) the delivered equipment has value to the customer on a stand-alone basis, and (ii) delivery of the undelivered service element(s) is probable and substantially in the Company’s control. Revenue from arrangements for the sale of tangible products containing both software and non-software components that function together to deliver the product’s essential functionality requires allocation of the arrangement consideration to the separate deliverables using the relative selling price (“RSP”) method for each unit of accounting based first on Vendor Specific Objective Evidence (“VSOE”) if it exists, second on third-party evidence (“TPE”) if it exists, and on estimated selling price (“ESP”) if neither VSOE or TPE of selling price of the Company’s various applicable tangible products containing essential software products and services. The Company establishes the pricing for its units of accounting as follows:

 

 

 

 

The Company has also established VSOE for its professional services, software subscriptions, and maintenance and content services based on the same criteria as previously discussed under the software revenue recognition rules.

 

The Company uses the estimated selling price to determine the relative sales price of its products. Revenue for elements that cannot be separated is recognized once the revenue recognition criteria for the entire arrangement has been met or over the period that our last remaining obligation to perform is fulfilled. Consideration for elements that are deemed separable is allocated to the separate elements at the inception of the arrangement on the basis of their relative selling price and recognized based on meeting authoritative criteria.

 

The Company sells its products and services through its multinational sales force and through a select group of resellers and business partners. In North America, in 2017 approximately 91% of sales were generated solely by the Company’s sales team, with approximately 9% through resellers. Internationally, the situation is reversed, with around 70% of sales coming from the reseller channel in 2017. Overall, approximately 70% of the Company’s multinational sales were derived from direct sales, with the remaining 30% generated through indirect partner channels. The Company has formal contracts with its resellers that set the terms and conditions under which the parties conduct business. The resellers purchase products and services from the Company, generally with agreed-upon discounts, and resell the products and services to their customers, who are the end-users of the products and services. The Company does not normally offer contractual rights of return other than under standard product warranties and product returns from resellers have been insignificant to date. The Company therefore sells directly to its resellers and recognizes revenue on sales to resellers upon delivery, consistent with its recognition policies as discussed above. The Company bills the resellers directly for the products and services they purchase. Software licenses and product warranties pass directly from the Company to the end-users as well as applying to the resellers.

 

The Company recognizes revenue on sales to resellers consistent with its recognition policies as discussed below.

 

Product revenue

 

The Company recognizes revenue on product sales generally upon delivery of the product or customer acceptance depending upon contractual arrangements with the customer. Shipping charges billed to customers are included in revenue and the related shipping costs are included in cost of revenue.

 

Maintenance and content services revenue

 

Maintenance support revenue consists of support and updates for perpetual use software licenses, hardware maintenance and repair. Software subscription revenue consists of the right to access and use software, support and software updates. Software updates provide customers with rights to unspecified software product upgrades and maintenance releases and patches released during the term of the support period. Support includes access to technical support personnel for software and hardware issues. Content subscription services consist of providing customers live and customized news feeds.

 

Maintenance and content services revenue is recognized ratably over the term of the contracts, which is typically one to five years. Perpetual use software license maintenance, content services and software subscriptions are renewable by the customer at the end of each contract term. Rates, including subsequent renewal rates, are typically established based upon specified rates as set forth in the arrangement. The Company’s hosting support agreement fees are based on the level of service provided to its customers, which can range from monitoring the health of a customer’s network to supporting a sophisticated web-portal.

 

Professional services revenue

 

Professional services consist primarily of project management, installation, training and custom creative services. Installation fees are contracted either on a fixed-fee basis or on a time-and-materials basis. For fixed-fee and time-and materials contracts, the Company recognizes revenue as services are performed. Such services are readily available from other vendors and are not considered essential to the functionality of the product. Training services are also not considered essential to the functionality of the product and have historically been insignificant; the fee allocable to training is recognized as revenue as the Company performs the services.

 

Research and Development Costs

 

Research and development costs incurred prior to the establishment of technological feasibility of the related software product are expensed as incurred. After technological feasibility is established, any additional software development costs are capitalized in accordance with ASC 985-20, Costs of Software to be Sold, Leased, or Marketed. The Company believes its process for developing software is essentially completed concurrent with the establishment of technological feasibility and, accordingly, no software development costs have been capitalized to date.

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Concentration of Credit Risk and Fair Value of Financial Instruments

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable and accounts payable. The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities reflected in the financial statements approximates fair value due to the short-term maturity of these instruments; the secured line of credit’s carrying value approximates its fair value due to the variable market interest rate of the debt.

 

The Company does not generally require collateral or other security for accounts receivable. However, credit risk is mitigated by the Company’s ongoing evaluations of customer creditworthiness. The Company maintains an allowance for doubtful accounts receivable balances.

 

The Company maintains its cash and cash equivalents in the United States with one financial institution. These balances routinely exceed the Federal Deposit Insurance Corporation insurable limit. Cash and cash equivalents of $1.2 million held in foreign countries as of December 31, 2017 were not insured.

 

Fair Value Measurements

 

The Company follows the authoritative guidance on fair value measurements and disclosures with respect to assets and liabilities that are measured at fair value on both a recurring and non-recurring basis. Under this guidance, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels defined as follows:

 

 

 

 

As part of its testing of intangible assets for impairment, the Company fair values all of its assets and liabilities, many of which were based on discounted cash flows analysis and forecasted future operating results which represent Level 3 inputs. In addition, the Company values its warrant liability at the end of each period based on Level 2 inputs.

 

Net Income (Loss) per Common Share

 

Basic net income (loss) per share of common stock, excluding any dilutive effects of stock options, warrants and unvested restricted stock, is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted income (loss) per share is computed similar to basic; however diluted income (loss) per share reflects the assumed conversion of all potentially dilutive securities. Due to the reported net loss for all periods presented, all stock options, warrants, or other equity instruments outstanding at December 31, 2017 and 2016 are anti-dilutive.

 

Foreign Currency Translation

 

The functional currency of the Company’s United Kingdom subsidiary is the British pound sterling. All assets and all liabilities of the subsidiary are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated to U.S. dollars at the weighted-average rate of exchange prevailing during the year. Resultant translation adjustments are recorded in accumulated other comprehensive loss, a separate component of stockholders’ equity.

 

The Company includes currency gains and losses on temporary intercompany advances in the determination of net loss. Currency gains and losses are included in interest and other expenses in the consolidated statements of comprehensive loss.

 

Business Segments

 

Operating segments are defined as components of an enterprise about which separate financial information is available and evaluated regularly by the Company’s chief operating decision maker (the Company’s Chief Executive Officer (“CEO”)) in assessing performance and deciding how to allocate resources. The Company’s business operates as one business segment, Enterprise Solutions.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation in accordance with FASB ASC No. 718-10 - “Compensation – Stock Compensation”. Stock-based compensation expense recognized during the period is based on the value of the portion of share-based awards that are ultimately expected to vest during the period. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The fair value of restricted stock is determined based on the number of shares granted and the closing price of the Company’s common stock on the date of grant. Compensation expense for all share-based payment awards is recognized using the straight-line amortization method over the vesting period.

 

Recent Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance creating Accounting Standards Codification (“ASC”) Section 606, “Revenue from Contracts with Customers”. The FASB issued subsequent amendments to the initial guidance in August 2015, March 2016, April 2016, May 2016, and December 2016 within ASU 2015-14, ASU 2016-08, ASU 2016-10 ASU 2016-12 and ASU 2016-20, respectively.  The core principle of ASC 606 requires entities to apportion consideration from contracts to performance obligations on a relative standalone selling price basis, based on a five-step model. The new revenue standard is effective for annual and interim periods beginning after December 15, 2017 and early adoption is permitted. The Company adopted the standard on January 1, 2018, using the modified retrospective method. The adoption of this new guidance will require expanded disclosures in the Company’s consolidated financial statements including separate quantitative disclosure of revenues.

 

The Company has assessed the impact of this standard by reviewing representative samples of customer contracts for each revenue stream, analyzing those contracts under the new revenue standard, and comparing the conclusions to the current accounting policies and practices to identify potential changes. As a result of this assessment, the Company expects the revenue recognition of its primary revenue streams to remain substantially unchanged and, therefore, does not expect a material impact on its revenues upon adoption of ASC 606. The adoption of ASC 606 will potentially have an immaterial impact on the Company’s consolidated financial statements with respect to its accounting for sales commissions related to software subscription, and maintenance and content services agreements with terms that exceed one year. In making this determination the Company has also considered the impact of the guidance in ASC 340-40, Other Assets and Deferred Costs; Contracts with Customers, under ASU 2014-09 (“ASC 340-40”). Under the Company’s prior accounting policy, it recognized the expense of incremental costs of obtaining a contract, such as sales commission costs, when they are incurred rather than capitalizing the costs. Under ASC 340-40, the Company is required to capitalize and amortize incremental costs of obtaining a contract and certain sales commissions may require amortization over a period longer than the term of the associated customer contract.

 

In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842)”, which requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company will further study the implications of this statement in order to evaluate the expected impact on its consolidated financial statements.

 

Recent Adopted Accounting Pronouncements

 

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern” (“ASU 2014-15”). The new standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU 2014-15 as of January 1, 2017 and there was no material impact on our consolidated financial statements upon adoption.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 781), Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"), which amends and simplifies the accounting for share-based payment awards in three areas: (1) income tax consequences, (2) classification of awards as either equity or liabilities, and (3) classification on the statement of cash flows. For public companies, ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company has adopted ASU 2016-09 as of January 1, 2017 and there was no significant impact to its consolidated financial statements for its current options.

 

Reclassifications

 

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations. On August 14, 2017, the Company affected a 1-for-4 reverse stock split of the Company’s issued shares of common stock. All share and per share amounts have been presented to give retroactive effect to the 1-for-4 reverse stock split as if it occurred at the date of inception.