RMG Networks Holding Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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, which expired on April 8, 2018, were 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.

 

As more fully described below, on April 2, 2018, the Company entered into a Merger Agreement (defined below) and Subordinated Loan Agreement (defined below).

 

On July 16, 2018, the Company paid interest owed to SCG Digital Finance, LLC under the Subordinated Loan Agreement pursuant to which the Bridge Loan (as defined below) was made for interest due June 30, 2018. The Company inadvertently failed to pay the interest payment when it came due on June 30, 2018 and it paid the default interest premium on July 17, 2018. On July 23, 2018, the Company received a letter from SCG Digital Finance, LLC (“Subordinated Lender”), notifying the Company that it is in default under the Subordinated Loan Agreement due to the Company’s failure to timely pay cash interest pursuant to the terms of the Subordinated Loan Agreement. In the letter, the Subordinated Lender also states that the breaches of the Merger Agreement alleged by Parent in its letters dated June 21, 2018, July 10, 2018 and July 20, 2018 constitute breaches of the Subordinated Loan Agreement. In addition, the Subordinated Lender states that it is not exercising any remedies at this time but reserves its rights and remedies. 

 

Additionally, the default under the Subordinated Loan Agreement caused a cross default under the Loan Agreement (defined below) as a result of the Company’s failure to timely pay cash interest on the Subordinated Loan Agreement due on June 30, 2018.

At June 30, 2018, the Company had $1.1 million in borrowings and $2.4 million in unused availability under the Revolving Facility (defined below) and $2.0 million in borrowings under the Bridge Loan. At June 30, 2018, the Company’s cash and cash equivalents balance was $1.7 million. This includes cash and cash equivalents of $1.1 million held in bank accounts of its subsidiaries located outside the United States. Year-to-date through June 30, 2018, the Company has incurred $1.3 million in transaction related expenses.

 

The Company projects the transaction related expenses to continue until the effective date of the merger which is expected to occur by the end of the third quarter of 2018. Assuming a merger transaction occurs, the Company believes it should have adequate cash to operate the Company through at least the next twelve months. However, if a merger transaction does not occur or 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 (defined below) to allow it to continue to borrow, the Company would need to aggressively pursue one or more alternatives, including immediately restructuring and significantly reducing its operating expense structure, seeking an alternative transaction, seeking new capital through additional financings and the equity capital markets or seeking protection under bankruptcy laws.

 

 

Merger Agreement

 

On April 2, 2018 (the “Execution Date”), the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with SCG Digital, LLC, a Delaware limited liability company (“Parent”), SCG Digital Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”) and SCG Digital Financing, LLC, a Delaware limited liability company and an affiliate of Parent, solely for the purposes of Sections 6.19, 8.03 and 8.04 of the Merger Agreement. Under the terms, and subject to the conditions, of the Merger Agreement, Merger Sub will be merged with and into the Company, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”). Shareholders of the Company’s common stock (other than Parent and its affiliates and rollover shareholders that enter into agreements with Parent to contribute shares of Company common stock to an affiliate of Parent prior to the closing of the Merger) will receive $1.27 in cash per share in the Merger. Parent is owned by SCG Digital Holdings, LLC, a Delaware limited liability company and an affiliate of Gregory H. Sachs, the Company’s Executive Chairman (collectively, the “Sponsor”).

Mr. Sachs and certain of his affiliates have entered into a voting agreement (the “Voting Agreement”) with the Company and agreed, among other things, to vote their shares of the Company’s common stock in favor of adoption and approval of the Merger Agreement and to take certain other actions in furtherance of the transactions contemplated by the Merger Agreement.  All members of the Board of Directors of the Company in attendance at the meeting approved the Merger Agreement on the unanimous recommendation (with Mr. Sachs recusing himself and one member unable to attend the final meeting due to a personal matter) of a Special Committee comprised entirely of independent directors of the Company (the “Special Committee”).

The Merger Agreement contains a “go shop” provision pursuant to which the Company has the right to solicit and engage in discussions and negotiations with respect to competing proposals through May 17, 2018 (the “Initial Go Shop End Date”); provided that such end date may be extended at the election of the Company (upon written notice to Parent) at any time prior to the Initial Go Shop End Date until June 1, 2018 (such period commencing with the Execution Date, as may be extended, the “Go-Shop Period” and the first calendar day immediately after the Go-Shop Period, the “Non-Solicitation Start Date”). After the conclusion of the Go-Shop Period, the Company may continue discussions with any “Excluded Person”, defined as a party that submits (and has not withdrawn) a written proposal during the Go-Shop Period that the Special Committee determines in good faith, after consultation with its financial advisor and outside legal counsel, is, or would reasonably be expected to lead to, a “Superior Proposal,” as defined in the Merger Agreement and with whom the Company remains in continuous active discussions.

Except with respect to Excluded Persons, after the conclusion of the Go-Shop Period, the Company will be subject to a “no-shop” restriction on its ability to solicit third-party proposals, provide information and engage in discussions with third parties. The no-shop provision is subject to a “fiduciary-out” provision that allows the Company to provide information and participate in discussions with respect to third party proposals submitted after the conclusion of the Go-Shop Period and with respect to which the Special Committee has made the determinations previously described.

The Company may terminate the Merger Agreement under certain circumstances, including if its Board of Directors determines in good faith that it has received a Superior Proposal, and otherwise complies with certain terms of the Merger Agreement. In connection with such termination, a termination fee, as well as reimbursement for certain fees and expenses up to an “Expense Make Whole Threshold” may be payable by the Company to Parent in the following circumstances: (i) if such termination occurs before the Initial Go Shop End Date, the Company will not be required to pay a termination fee, (ii) if the Go Shop Period is extended and the Merger Agreement is terminated by the Company before the Non-Solicitation Start Date so that the Company can enter into an alternative acquisition agreement with an Excluded Person, then the Company will be required to pay a fee of $150,000 and (iii) if the Merger Agreement is terminated by the Company or Parent in certain other circumstances more fully set forth in the Merger Agreement, then the Company will be required to pay a fee of $500,000. In the event that the Merger Agreement is terminated by the Company due to a material breach of the Merger Agreement by Parent or Merger Sub or in the event that Parent or Merger Sub fail to consummate the Merger when otherwise obligated to do so pursuant to the terms and conditions thereof, the Merger Agreement provides for Parent to pay to the Company a penalty loan of $1 million upon termination of the Merger Agreement, as described below.

Consummation of the Merger is subject to various conditions and other customary closing conditions described in the Merger Agreement, including adoption and approval of the Merger Agreement that requires the affirmative vote in person or by proxy of holders of at least both (1) a majority of the outstanding shares of Company common stock entitled to vote at the special meeting anticipated to be held during the third quarter of 2018 and (2) a majority of the outstanding shares of Company common stock, excluding shares held by (i) Parent or Merger Sub or any of their respective affiliates, including Gregory H. Sachs, the Company’s executive chairman, (ii) any rollover investors (defined as stockholders that enter into rollover agreements to contribute shares of the Company’s common stock to SCG Digital Holdings, LLC in return for equity interest in SCG Digital Holdings, LLC) and (iii) any of the Company’s executive officers. Parent and the Company may, if they choose, mutually agree to waive the voting requirement set forth in clause (2) above, but may not waive the requirement set forth in clause (1). The parties expect to close the transaction by the end of the third quarter of 2018. 

 

Basis of Presentation for Interim Financial Statements

 

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the accounting and disclosure rules and regulations of the Securities and Exchange Commission. Accordingly, the unaudited condensed consolidated financial statements do not include all of the information and the notes required by GAAP for complete financial statements. The Balance Sheet as of December 31, 2017 has been derived from the Company’s audited financial statements but does not include all disclosures required by GAAP for complete financial statements. In the opinion of management, the unaudited condensed interim consolidated financial statements reflect all adjustments, consisting of only normal recurring adjustments, and disclosures necessary for a fair presentation of the results of the reported interim periods. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s annual audited consolidated financial statements and notes thereto. The interim results of operations are not necessarily indicative of the results to be expected for the full year. 

 

Inventory

 

Inventory consists primarily of software-embedded smart products, electronic components, and hardware 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.

 

The composition of inventory at June 30, 2018 and December 31, 2017 was as follows:

 

 

Revenue Recognition

 

The Company recognizes revenue primarily from these sources:

 

 

Product revenue

 

The Company recognizes revenue when performance obligations from product sales are satisfied, 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 service performance obligations for perpetual software licenses well as hardware maintenance and repair service performance obligations. 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 performance obligations consist of providing customers live and customized news feeds.

 

Maintenance and content services revenue is recognized ratably over the term of the contracts as the performance obligations are satisfied, 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 performance obligations. Installation fees are contracted either on a fixed-fee basis or on a time-and-materials basis. For both fixed-fee and time-and materials contracts, the Company recognizes revenue as the service performance obligations are performed. Such services are readily available from other vendors and are not considered essential to the functionality of the product and thus are considered separate performance obligations. 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 service performance obligation.

 

Arrangements with Multiple Performance Obligations

 

The Company’s contracts with customers may include multiple performance obligations. Revenue relating to agreements that provide more than one performance obligation is recognized based upon the relative fair value to the customer of each performance obligation as each obligation is earned. The fair value of the performance obligations are determined using an analysis that considers cash consideration that would be received for instances when the performance obligations are sold separately. If the fair value to the customer for each performance obligation is not objectively determinable, the Company makes its best estimate of the obligation’s stand-alone selling price and records revenue as it is earned.

 

Costs to Obtain a Contract

 

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The asset will be amortized over a period consistent with the transfer to the customer of the goods or services to which the asset relates, calculated based on the customer term and the average life of the products and services underlying the contracts. The Company has determined that there were no material sales commissions that meet the requirements to be capitalized in the three and six months ended June 30, 2018 and 2017, respectively, therefore no capitalized costs to obtain a contract were included in other current and long-term assets on the Company’s consolidated balance sheets as of June 30, 2018 and December 31, 2017, respectively. The amortization of capitalized sales commissions is recorded within selling and general expenses.

 

The Company expenses sales commissions when incurred if the amortization period would have been one year or less. These costs are recorded within selling and general expenses.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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, accounts payable, accrued liabilities and the Company’s secured line of credit. The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities reflected in the consolidated financial statements approximates fair value due to the short-term maturity of these instruments; the 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 balance.

 

The Company maintains its cash and cash equivalents in the United States with one financial institution as of June 30, 2018. These balances routinely exceed the Federal Deposit Insurance Corporation insurable limit. Cash and cash equivalents of $1.1 million held in foreign countries as of June 30, 2018 were not insured.

 

Net Income (Loss) per Common Share

 

Basic net income (loss) per share of common stock, excluding any dilutive effects of stock options, warrants and other equity instruments, 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, and other equity instruments outstanding at June 30, 2018 and 2017 were 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 quarter-end exchange rates. Income and expense items are translated to U.S. dollars at the weighted-average rate of exchange prevailing during the period. Resultant translation adjustments are recorded in accumulated other comprehensive income (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 (expense) and other income - net 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. 

 

Recent Issued Accounting Pronouncements

 

In February 2016, the FASB (defined below) 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 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.  

 

On January 1, 2018, The Company adopted ASC 606 using the modified retrospective transition method applied to its open revenue contracts with customers as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior year amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 605. We recorded no change to opening retained earnings as of January 1, 2018 since there was no material impact due to the cumulative effect of adopting ASC 606 related to revenue or treatment of costs to obtain a contract.

 

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 effected 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.