NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES; PRIOR PERIOD RECLASSIFICATION

The Consolidated Financial Statements include the accounts of Cool Holdings and our wholly owned subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these financial statements, we have made our best estimates and judgments of certain amounts included in the financial statements. Changes in the estimates and assumptions used by us could have a significant impact on our financial results. Actual results could differ from those estimates.

We adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (ASC Topic 606) on January 1, 2018 using the modified retrospective method to all noncompleted contracts as of the date of adoption. No adjustment of opening retained earnings for the cumulative effect of initially applying the new revenue standard was required.

Under ASU 2014-09, we apply a five-step approach in determining the amount and timing of revenue to be recognized which includes the following: (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations in the contract and (5) recognizing revenue when the performance obligation is satisfied.

In our retail stores, revenue is recognized at a point in time, which typically is at the time of sale, net of discounts and estimated returns, when collection is reasonably assured and the customer takes possession of the merchandise. Revenues do not include sales taxes or other taxes collected from customers. Products sold in our stores typically come with a manufacturer’s warranty, which is an obligation of the manufacturer. However, our stores also sell AppleCare+ and other third-party plans to customers that provide extended warranty coverage on their device purchases. Because the service to be provided to the consumer under these plans comes directly from third parties, we do not “obtain substantive control” of the service. Consequently, we act as the “agent” in the sales transaction rather than the “principal,” and record the transaction on a “net” basis with the cost being netted against the sale and only the margin being recorded as revenue. For our repair business, revenue is recognized at a point in time, typically upon completion of the repair, and any customer deposits are recorded as liabilities until the service is completed.

For sales by our Cooltech Distribution unit, revenue is recognized when control passes, which generally occurs upon delivery of the product to the customer. Revenue is recorded net of discounts and estimated returns.

Our now discontinued foreign subsidiaries in Argentina and the Dominican Republic have functional currencies that are not the U.S. Dollar. Assets and liabilities of such subsidiaries are translated to U.S. Dollars using exchange rates in effect at the balance sheet dates. Revenues and expenses are translated at average exchange rates in effect during the period. Translation adjustments are included in stockholders’ deficit in the accompanying consolidated balance sheets as a component of accumulated other comprehensive loss.

The International Practices Task Force (“IPTF”) of the Center for Audit Quality discussed the inflationary status of Argentina at its meeting on May 16, 2018 and categorized Argentina as a country with a projected three-year cumulative inflation rate greater than 100%. Therefore, the Company has transitioned its Argentine operations to highly inflationary status as of July 1, 2018.

For operations such as Argentina in highly inflationary economies, we use the U.S. dollar as the functional currency. Accordingly, monetary assets and liabilities are remeasured at exchange rates in effect at the balance sheet date, and non-monetary assets and liabilities are remeasured at historical exchange rates. Nonmonetary assets and liabilities existing on July 1, 2018 (the date that the Company adopted highly inflation accounting) were translated using the Argentine Peso to United States Dollar exchange rate in effect on June 30, 2018, which was 28.880. Foreign currency transaction adjustments are reflected in loss on foreign currency translation included in discontinued operations on the accompanying statement of operations. During the years ended December 31, 2019 and 2018, the Company recorded losses on foreign currency translations and transactions of $384,000 and $470,000, respectively.

Comprehensive income (loss) as defined by U.S. generally accepted accounting principles (GAAP) includes all changes in equity (net assets) during a period from non-owner sources. The Company’s comprehensive loss includes foreign currency translation adjustments, which are excluded from net loss and are reported as a separate component of stockholders’ deficit as accumulated other comprehensive loss.

For consolidated financial statement purposes, cash equivalents are defined as investments which have an original maturity of ninety days or less from the original date of purchase. Cash and cash equivalents consist of cash on hand and in banks. The Company maintains its cash, cash equivalents and restricted cash balances in banks that from time to time exceed amounts insured by the Federal Deposit Insurance Corporation. As of December 31, 2019 and 2018, the Company maintained deposits totaling $2,289,000 and $2,241,000, respectively, with certain financial institutions in excess of federally insured amounts. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash.

Amounts included in restricted cash are pledged as collateral to banks and restricted to use in support of letters of credit issued to vendors for inventory purchases. Below is a reconciliation of cash and restricted cash at December 31, 2019 and 2018 (in thousands):

	December 31,
	2019		2018
Cash	$	2,232	$	1,147
Restricted cash (short term)		1,196		2,012
Restricted cash (non-current)		—		—
Total	$	3,428	$	3,159

Trade accounts receivable are comprised primarily of amounts due from the Company’s retail B2B customers, distribution customers, and from financial institutions for the settlement of credit card transactions. The Company provides for the possible inability to collect accounts receivable by recording an allowance for doubtful accounts. The Company writes off an account when it is considered to be uncollectible. The Company evaluates the collectability of its accounts receivable on an ongoing basis. In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations, the Company records a specific allowance against amounts due to reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and the Company’s historical experience. The allowance for doubtful accounts was $39,000 and $55,000 at December 31, 2019 and 2018, respectively.

Inventory is stated at the lower of cost (first-in, first-out) or net realizable value and consists primarily of consumer electronics and accessories. The Company writes down its inventory to net realizable value when it is estimated to be slow-moving or obsolete. For the years ended December 31, 2019 and 2018, inventory write-downs were $540,000 and $76,000, respectively.

Property and equipment are stated at cost less accumulated depreciation. The Company provides for depreciation using the straight-line method over estimated useful lives of three to five years. Expenditures for maintenance and repairs are charged to operations as incurred while renewals and betterments are capitalized. Gains or losses on the sale of property and equipment are reflected in the statements of operations.

The Company measures its financial instruments in its financial statements at fair value or amounts that approximate fair value in accordance with ASC 820, “Fair Value Measurements and Disclosure.” ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. ASC 820 also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are described below:

Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that is accessible by the Company;

Level 2 Inputs – Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly;

Level 3 Inputs – Unobservable inputs for the asset or liability including significant assumptions of the Company and other market participants.

The Company seeks to measure fair value based upon the lowest level of available input in the fair value hierarchy. When available, the Company uses quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters. If market observable inputs for model-based valuation techniques are not available, the Company makes judgments about assumptions market participants would use in estimating the fair value of the financial instrument.

Carrying values of the Company’s cash, cash equivalents, restricted cash, trade and other accounts receivable, prepaid expenses, accounts payable, accrued expenses and short-term notes payable approximate their fair values due to the short-term nature and liquidity of these financial instruments. The Company estimates that the fair value of its notes payable approximates its carrying value based on significant level 2 observable inputs.

As discussed in Note 8, in connection with the issuance by the Company during 2019 of certain convertible notes and warrants, as well as the conversion of certain notes into common stock and warrants, the conversion features and warrants were deemed to qualify as derivatives to be separately accounted for in accordance with ASC 815. The table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2019 (in thousands):

	Derivative Liability
Balance, December 31, 2018	$	—
Initial recognition of conversion features and warrants		7,954
Change in fair value of derivative liability		(6,233	)
Balance, December 31, 2019	$	1,721

We account for business combinations under the acquisition method of accounting. This method requires the recording of acquired assets and assumed liabilities at their acquisition date fair values. The excess of the purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Results of operations related to business combinations are included prospectively beginning with the date of acquisition and transaction costs related to business combinations are recorded within selling, general and administrative ("SG&A") expenses.

Goodwill represents the excess purchase price over tangible net assets and identifiable intangible assets acquired. Intangible assets are recorded apart from goodwill if they arise from a contractual right and are capable of being separated from the entity and sold, transferred, licensed, rented or exchanged individually. We are required to evaluate goodwill and other intangible assets not subject to amortization for impairment at least annually or when circumstances indicate the carrying value of the goodwill or other intangible assets might be impaired. Goodwill has been assigned to reporting units for the purpose of impairment testing. Excluding our verykool unit that was discontinued in the fourth quarter of 2018, we have two operating segments: our retail stores and our Cooltech distribution unit. Within the retail segment, we define our reporting units by their three geographic country locations: Argentina and the Dominican Republic, both of which were classified as discontinued operations at December 31, 2019, and the United States. The 2018 annual impairment tests for Argentina and the United States were performed as of October 1, 2018, while the annual impairment test for the Dominican Republic was performed as of December 31, 2018. As a result of those impairment tests, all of our goodwill and intangible assets were fully impaired as of December 31, 2018. The 2019 annual impairment test was performed on October 6, 2019 and resulted in no impairment recognized.

In order to test goodwill for impairment, we compare a reporting unit’s carrying amount to its estimated fair value. If the reporting unit’s carrying value exceeds its estimated fair value, then an impairment charge is recorded in the amount of the excess, limited to the amount of the goodwill in the reporting unit. The estimated fair value of a reporting unit is determined based on a combination of enterprise market valuation methods including (1) income approach using discounted cash flow analysis based on our long-term financial forecasts, (2) market approach using data for comparable market transactions, and (3) asset approach valuing the individual assets of the reporting unit. The discounted cash flows analysis requires significant assumptions including, among others, a discount rate and a terminal value. The Company elected to early adopt ASU 2017-04, Intangibles-Goodwill and Other (ASC Topic 350) on January 1, 2018, which eliminates step 2 from the impairment test. Goodwill impairment charges of $13.7 million were recognized in 2018, including $12.3 million included in discontinued operations. See Note 6, "Goodwill and Intangible Assets" for additional information.

Our definite-lived intangible assets consist primarily of trade names and covenants not to compete recorded as a result of business acquisitions. The estimated useful life and amortization methodology of intangible assets are determined based on the period in which they are expected to contribute directly to cash flows. Intangible assets that are determined to have a definite life are amortized over that period. During 2019, the Company determined that certain intangible assets were impaired and, accordingly, recorded impairment charges of $630,000, which amount is included in loss from discontinued operations.

The Company’s share-based compensation plans are described in Note 11. The Company measures compensation cost for all employee stock-based awards at fair value on the date of grant and recognizes compensation expense, net of estimated forfeitures, over the requisite service period, usually the vesting period. The fair value of stock options is determined using the Black-Scholes valuation model. Effective January 1, 2018, the Company adopted ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 to include share-based payment awards to nonemployees. As a result, stock-based awards granted to consultants and non-employees are accounted for in the same manner as awards granted to employees and directors as described above.

The Company expenses all advertising costs, including direct response advertising, as they are incurred. Advertising expense for the years ended December 31, 2019 and 2018 was $89,000 and $99,000, respectively.

The Company recognizes deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company’s financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of the Company’s assets and liabilities result in a deferred tax asset, the Company performs an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or the entire deferred tax asset will not be realized.

In addition, the Company recognizes the financial statement impact of a tax position when it is more likely than not that the position will be sustained upon examination. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. The Company recognizes interest and penalties related to tax uncertainties as operating expenses.

Based on our evaluation, the Company has concluded that there are no significant uncertain tax positions requiring recognition in its financial statements.

The Company computes basic earnings (loss) per share by dividing income (loss) available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings (loss) per share is computed similarly to basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would be issued as a result of potentially dilutive securities outstanding during the period. Potentially dilutive securities include preferred stock, stock options and warrants. In periods when a net loss is incurred, no additional shares are included in the computation of diluted loss per share because the effect of inclusion would be anti-dilutive.

Common shares from exercise of certain options and warrants are excluded from the computation of diluted earnings (loss) per share when their exercise prices are greater than the Company’s weighted-average stock price for the period. For the years ended December 31, 2019 and 2018, the number of such shares excluded was 4,937,000 and 161,000, respectively. In addition, for the year ended December 31, 2019, because their inclusion would have been anti-dilutive to the loss calculation, common shares from exercise of 26,347,000 in-the-money warrants and 25,000 preferred shares were excluded from the computation of net loss per share. For the year ended December 31, 2018, because their inclusion would have been anti-dilutive to the loss calculation, common shares from exercise of 5,192,000 in-the-money warrants and 322,000 preferred shares were excluded from the computation of net loss per share. Additionally, the Company has warrants outstanding with undetermined exercise prices and an undertermined number of underlying shares, which were issued with debt (see Note 8).

All share and per share numbers in this report have been retroactively restated for the Company’s one-for-five reverse stock split effected in March 2018.

The Company allocates revenues to geographic areas based on the location where our retail stores are located or, in the case of Cooltech Distribution, the countries to which the product is shipped. Currently, all retail stores are located in the United States.

The Company purchases its Apple products either directly from Apple or from major distributors, depending on availability of product and credit lines at the time of purchase. Ultimately, Apple is the sole source of supply of Apple products, and the Company’s business is highly dependent on Apple for its supply of current and future products. Approximately 70% and 48% of the Company’s sales for 2019 and 2018, respectively, are comprised of sales of Apple products. In addition, the growth of our business is highly dependent upon our relationship with Apple in providing us with the licenses and approvals necessary to expand our footprint into various countries and regions around the world. Apple has very strict performance standards and guidelines that we must achieve and adhere to in order to be successful and continue to receive their support. Consequently, our performance deterioration or failure to adhere to their guidelines could jeopardize our strategy and adversely affect our financial performance.

During the year ended December 31, 2019, the Company’s three largest suppliers accounted for 52%, 19% and 14%, respectively, of total cost of sales. During the year ended December 31, 2018, the Company’s three largest suppliers accounted for 47%, 18% and 9%, respectively, of total cost of sales.

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. We maintain our cash and cash equivalents with various high-credit-quality financial institutions located primarily in the United States. Currently, the Company’s cash balances are kept primarily in demand accounts at these banks, but the Company may periodically invest excess cash in certificates of deposit or money market accounts in order to maintain safety and liquidity. The Company’s investment strategy generally results in lower yields on investments but reduces the risk to principal in the short term prior to these funds being used in its business. The Company has not experienced any material losses on financial instruments held at financial institutions.

The Company’s retail stores sell primarily to end consumers, with periodic sales to corporate customers. The Company’s Cooltech Distribution segment sells primarily to resellers. The Company selectively provides credit to corporate and reseller customers in the normal course of business and generally requires no collateral. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses based upon the Company’s historical experience related to credit losses and any unusual circumstances that may affect the ability of its customers to meet their obligations. The Company’s bad debt expenses have not been significant relative to its total revenues.

In both 2019 and 2018, no customer represented 10% or more of the Company’s total net sales. Three customers represented 10% or more of accounts receivable at December 31, 2019, individually representing 23%, 21% and 17% of receivables. Three customers represented 10% or more of accounts receivable at December 31, 2018, individually representing 19%, 17% and 17% of receivables.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The guidance in ASU 2016-02 and subsequently issued amendments required lessees to capitalize virtually all leases with terms of more than twelve months on the balance sheet as a right-of-use asset and recognize an associated lease liability. Entities were allowed to apply the modified retrospective approach (1) retrospectively to each comparative period presented (comparative method) or (2) retrospectively at the beginning of the period of adoption through a cumulative-effect adjustment (effective date method). ASU 2016‑02 was effective for public companies for interim and annual reporting periods beginning after December 15, 2018. The Company adopted the new standard on January 1, 2019 using the effective date method. Therefore, upon adoption, the Company recognized and measured leases without revising comparative period information or disclosures. The Company implemented the transition package of three practical expedients permitted within the standard, which among other things, allows for the carryforward of historical lease classifications. As a result of adopting the new standard on January 1, 2019, the Company recorded initial right-of-use assets of $4,642,000, which includes $304,000 related to discontinued operations, with a corresponding initial lease liability, which was also adjusted by reclassifications of existing assets and liabilities primarily related to deferred rent. The adoption of this new standard did not have a material impact on the Company’s consolidated results of operations or cash flows.

The Company enters into leases primarily for its retail stores, distribution center and corporate offices. Leases with an initial term of 12 months or less are not recorded on the balance sheet, and lease expense for such leases are recognized on a straight-line basis over the lease term.

The Company determines if an arrangement is a lease at inception and whether the lease meets the classification criteria of a finance or operating lease. The Company currently has no financing leases. Lease-related assets, or right-of-use assets, are recognized at the lease commencement date at amounts equal to the respective lease liabilities. Lease-related liabilities are recognized at the present value of the remaining contractual fixed lease payments, discounted using the Company’s incremental borrowing rates. Operating lease expense is recognized on a straight-line basis over the lease term, while variable lease payments are expensed as incurred.

Where lease agreements contain renewal options, the Company does not recognize right-of-use assets or lease liabilities for renewal periods unless it is determined that the Company is reasonably certain of renewing the lease at inception or when a triggering event occurs. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain to be exercised. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which removes, adds and modifies certain disclosure requirements for fair value measurements in Topic 820. ASU 2018-13 removes the following disclosure requirements: (i) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and (ii) the entity’s valuation processes for Level 3 fair value measurements. ASU 2018-13 adds the following disclosure requirements: (i) provide information about the measurement uncertainty of Level 3 fair value measurements as of the reporting date rather than a point in the future, (ii) disclose changes in unrealized gains and losses related to Level 3 measurements for the period included in other comprehensive income, and (iii) disclose for Level 3 measurements the range and weighted average of the significant unobservable inputs and the way it is calculated. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. We do not expect the adoption of this pronouncement to have a material impact on our consolidated financial statements other than additional disclosure requirements.

Other Accounting Standards Updates not effective until after December 31, 2019 are not expected to have a material effect on the Company’s financial position or results of operations.

Certain operating expenses in the Company’s consolidated statement of operations for the year ended December 31, 2018 were reclassified to conform to their presentation for the year ended December 31, 2019.