WESTERN CAPITAL RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Unaudited)

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared according to the instructions to Form 10-Q and Section 210.8-03(b) of Regulation S-X of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnotenote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been omitted.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periodsperiod ended September 30, 2018March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.2019.

For further information, refer to the Condensed Consolidated Financial Statements and footnotesnotes thereto included in our Form 10-K for the year ended December 31, 2017.2018. The condensed consolidated balance sheet at December 31, 2017,2018, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotesnotes required by GAAP.

Nature of Business

Western Capital Resources, Inc. (WCR) is a parent company owning operating subsidiaries, with percentage owned shown parenthetically, as summarized below.

References in these financial statement notes to “Company” or “we” refer to Western Capital Resources, Inc. and its subsidiaries. References to specific companies within our enterprise, such as” “PQH,” “JPPA,” “JPRE,” “WFL,”“WFL” or “EPI” or “AGI” are references only to those companies.

Basis of Consolidation

The consolidated financial statements include the accounts of the WCR, its wholly owned subsidiaries and other entities in which the Company owns a controlling financial interest. For financial interests in which the Company owns a controlling financial interest, the Company applies the provisions of Financial Accounting Standards Board Accounting Standards Codification (ASC)(“ASC”) 810, “Consolidation” applicable to reporting the equity and net income or loss attributable to noncontrolling interests. All significant intercompany balances and transactions of the Company have been eliminated in consolidation, with the exception of the presentation of dividends received from discontinued subsidiary operations in the Condensed Consolidated Statement of Cash Flows.consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect certain reported amounts and disclosures in the consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates. Significant management estimates relate to the loansnotes and accountsloans receivable allowance, carrying value and impairment of long-lived goodwill and intangible assets, inventory valuation and obsolescence, estimated useful lives of property and equipment, gift certificate and merchandise credits liability and deferred taxes and tax uncertainties.

Reclassifications

Certain Statements of Operations and Statements of Cash Flows reclassifications have been made in the presentation of our prior financial statements and accompanying notes to conform to the presentation as of and for the three and nine months ended September 30, 2018.

In accordance with ASC 205-20-45-6, interest on debt required to be paid as a result of our Franchise segment disposal transaction has been allocated to discontinued operations and, in accordance with ASC 205-20-45-9, general corporate overhead has not been allocated to discontinued operations. These re-allocations and related income tax have been made in the presentation of our prior financial statements and accompanying notes.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued a comprehensive new revenue recognition standard that supersedes nearly all existing revenue recognition guidance under US GAAP. This standard is effective for annual and interim periods beginning after December 15, 2017. The Company has adopted this standard as of January 1, 2018 applying it on a retrospective basis as of the date adopted and determined it had no impact on our financial condition, results of operations and consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), related to recognition of lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees will be required to recognize the following for all leases: (1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Company adopted ASU 2016-02 and ASC 842 using the modified retrospective method on January 1, 2019. See Note 8 for further disclosures.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), related to the measurement of credit losses on financial instruments. The standard requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The ASU is effective for annual reporting periods beginning after December 15, 2018, including2019 and interim periods within that annual period, with early adoption permitted and the standard to be applied using a modified retrospective approach. The Company is currently evaluating the impact thedoes not believe adoption of ASU 2016-13 will have a material impact on our financial condition, results of operations and consolidated financial statementsstatements.

In July 2018, the FASB issued ASU 2018-11, Leases - Targeted Improvements (Topic 842) to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU 2016-02. Specifically, under the amendments in ASU 2018-11: (1) entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and expects its adoption(2) lessors may elect to not separate non-lease components from leases when certain conditions are met. The amendments have a material impact on our financial condition due to a material addition of operating lease assets and liabilities in accordance with the ASU.same effective date as ASU 2016-02 (January 1, 2019 for the Company). The Company adopted certain options available under ASU 2018-11on January 1, 2019. See Note 8 for further disclosures.

No other new accounting pronouncements issued or effective during the fiscal year have had or are expected to have a material impact on the consolidated financial statements.

2.     Risks Inherent in the Operating Environment –

Regulatory

The Company’s Consumer Finance segment activities are highly regulated under numerous federal, state, and local laws, regulations and rules, which are subject to change. New laws, regulations or rules could be enacted or issued, interpretations of existing laws, regulations or rules may change and enforcement action by regulatory agencies may intensify. Over the past several years, consumer advocacy groups and certain media reports have advocated governmental and regulatory action to prohibit or severely restrict sub-prime lending activities of the kind conducted by the Company. After several years of research, debate, and public hearings, in October 2017 the U.S. Consumer Financial Protection Bureau (CFPB) issuedadopted a new rulesrule for payday lending. The proposed rules,rule, originally scheduled to go into effect in August 2019, would impose significant restrictions on the industry, and it is expected that a large number of lenders would be forced to close their stores. The CFPB’s studies projected a reduction in the number of lenders by 50%, while industry studies forecast a much higher attrition rate.rate if the rule is implemented as originally adopted.

However, in January 2018, the CFPB issued a statement that it intends to “reconsider” the regulation. The most current information from the CFPB website states the proposals it is considering includes rescinding the mandatory underwriting provisions contained in the rule and to delay the August 19, 2019 compliance date for the other provisions to November 19, 2020. At this time it is uncertain whether the rule will be implemented as announced, rewritten with more favorable terms for the industry, or thrown out altogether. If the rule is implemented as written, it could have a significant and negative impact on business conducted within our Consumer Finance segment.

The above rule or any other adverse change in present federal, state, or local laws or regulations that govern or otherwise affect lending could result in the Consumer Finance segment’s curtailment or cessation of operations in certain or all jurisdictions or locations. Furthermore, any failure to comply with any applicable federal,local, state or localfederal laws or regulations could result in fines, litigation, closure of one or more store locations or negative publicity. Any such change or failure would have a corresponding impact on the Company’s and segment’s results of operations and financial condition, primarily through a decrease in revenues resulting from the cessation or curtailment of operations, or a decrease in operating income through increased legal expenditures or fines, and could also negatively affect the Company’s general business prospects due to lost or decreased operating income or if negative publicity affectseffects its ability to obtain additional financing as needed.

In addition, the passage of federal, state or local laws and regulations or changes in interpretations of them could, at any point, essentially prohibit the Consumer Finance segment from conducting its lending business in its current form. Any such legal or regulatory change would certainly have a material and adverse effect on the Company, its operating results, financial condition and prospects, and perhaps even the viability of the Consumer Finance segment.

3.     Cash Equivalents and Investments –Concentrations

The Company has demand deposits at financial institutions, often times in excess of the limit for insurance by the Federal Deposit Insurance Corporation. As of March 31, 2019, the Company had demand deposits in excess of insurance amounts of approximately $4.38 million.

The following table shows the Company’s cash equivalents and held-to-maturity investments, by significant investment category, recorded as cash equivalents or short- and long-term investments:

As of September 30,March 31, 2019 and December 31, 2018, held to maturity securitiesinvestments consisted of the following:

Interest income recognized on held-to-maturity investments and other sources was $142,146 and $39,397, respectively, for the three month period ended March 31, 2019 and $133,669 and $33,842, respectively, for the three month period ended March 31, 2018.

4.       Loans Receivable –

The Consumer Finance segment’s outstanding loans receivable aging iswas as follows:

5.       Loans Receivable Allowance –

A rollforward of the Consumer Finance segment’s loans receivable allowance is as follows:

6.       Accounts Receivable –

A breakdown of accounts receivables by segment is as follows:

A portion of accounts receivable are unsettled credit card sales from the prior one to five business days. This makes up 40% and 57% of the net accounts receivable balance at March 31, 2019 and December 31, 2018, respectively.

7.       Inventory –

Finished goods inventory, net of allowance, by segment consists of the following:Inventories consist of:

As a result of changes in the market for certain Company products and the resulting deteriorating value, carrying amounts for those inventories were reduced by approximately $704,000 and $670,000 at March 31, 2019 and December 31, 2018, respectively. These inventory write-downs have been reflected in cost of goods sold in the statement of operations. Management believes that these reductions properly reflect inventory at lower of cost or market, and no additional losses will be incurred upon disposition.

8.       Leases –

The Company adopted ASC 842 - Leases, using the modified retrospective method on January 1, 2019. The Company elected the package of practical expedients relief option offered in ASU 2016-02 and the accounting policy election for lessees not to separate lease and non-lease components (election applies to leased real property asset class).

The most significant impact of the adoption of ASC 842 was the recognition of right-of-use (“ROU”) assets and lease liabilities for operating leases of $11.53 million and $11.76 million, respectively, and a reversal of deferred rent of $0.23 million on January 1, 2019. The Company’s accounting for finance leases, which are insignificant, remained unchanged. The adoption of ASC 842 did not have any impact on the Company’s operating results or cash flows.

The Company has retail and office space lease agreements which are accounted for as operating leases. The Company’s leases typically are for three- to five-year terms with many containing options for similar renewal periods. The Company determines if an arrangement is or contains a lease at inception. Operating leases are included in operating lease right-of-use assets and operating lease liabilities (current and noncurrent) in the condensed consolidated balance sheet. Finance leases are included in property and equipment and finance lease obligations in the condensed consolidated balance sheet.

ROU assets and lease liabilities are recognized based on the present value of future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, Management used the Company’s collateralized incremental borrowing rate based on the information available at commencement date in determining the present value of future payments.

The lease payment terms may include fixed payment terms and variable payments. Fixed payment terms and variable payments that depend on an index (i.e., Consumer Price Index or “CPI”) or rate are considered in the determination of the operating lease liabilities. While lease liabilities are not remeasured because of changes to the CPI, changes are treated as variable lease payments and recognized in the period in which the obligation for those payments was incurred. Variable payments that do not depend on an index or rate are not included in the lease liabilities determination. Rather, these payments are recognized as variable lease expense when incurred. Expenses related to leases with a lease term of one month or less are recognized as variable lease expense when incurred. Variable lease payments are included within operating costs and expenses in the condensed consolidated statement of operations.

Due to the significant assumptions and judgements required in accounting for leases (to include whether a contract contains a lease, the allocation of the consideration, and the determination of the discount rate), the judgements and estimates made could have a significant effect on the amount of assets and liabilities recognized.

Total components of lease expense for the three months ended March 31, 2019 (in thousands) were as follows:

Other information related to leases was as follows:

Future minimum lease payments under leases as of March 31, 2019 (in thousands) were as follows:

As previously disclosed in our 2018 Form 10-K under the prior guidance of ASC 840, future minimum payments under operating lease agreements as of December 31, 2018 (in thousands) were as follows:

9.       Notes Payable ���– Long Term –

The Company is party to a Credit Agreement with a financial institution entered into on April 22, 2016 and last amended on April 26, 2018.subject to subsequent amendments. The Credit Agreement provides the Company with a revolving line of credit facility in an aggregate amount up to $3,000,000, havingwith a maturity date of April 21, 2020 and an acquisition loan facility in an aggregate amount of up to $9,000,000, havingwith a maturity date of April 21, 2020. The revolver and the acquisition loan facility bear interest at a floating per annum rate equal to one-month LIBOR plus 3.50%, adjusted on a monthly basis. Funds advanced under the acquisition loan facility mature five years from the date of advance. At September 30, 2018,March 31, 2019, the entire $12,000,000 of credit was available under the credit facilities. See Note 1416 for additional terms conditions and amendmentsconditions related to the Credit Agreement.

9.10.       Income Taxes –

The provision for income taxes for continuing operations is 30.8%20.9% and 34.3%121.3% of income (loss) before the provision for income taxes for the ninethree month period ended September 30,March 31, 2019 and 2018, and 2017, respectively. The significant difference in rate is the result of the 2018impact of net income attributable to noncontrolling interests not being subjected to income tax at the corporate level. Rather the “passthrough” taxable income is taxed to the noncontrolling interests at an individual level.

10.11.       Cash Dividends –

Our Board of Directors declared the following dividends payable in 2018:

12.       Revenue –

Our contracts with customers primarily consist of sales of merchandise and services at the point of sale (“POS”) and short-term lending agreements. Revenue within the Cellular Retail segment also includes ancillary back-end compensation from Cricket Wireless.

Total net sales of merchandise, which exclude sales taxes, are generally recorded as follows: 

11.Services revenue is generally recorded at point of sale when payment is received and the customer receives the benefit of the service. Other compensation from Cricket Wireless is recorded at the time certain Cricket Wireless Customers make a service payment, as reported to us by Cricket Wireless.

Consumer Finance loan fees and interest on cash advance loans are recognized on a constant-yield basis ratably over a loan’s term. Installment loan fees and interest are recognized using the interest method, except that installment loan origination fees are recognized as they become non-refundable and installment loan maintenance fees are recognized when earned. The Company recognizes fees on pawn loans on a constant-yield basis ratably over the loans’ terms, less an estimated amount for expected forfeited pawn loans which is based primarily on historical forfeiture rates. See Note 15, “Segment Information,” for disaggregation of revenue by segment.

13.       Acquisitions –

On February 21, 2019, PQH entered into a joint venture agreement with another Cricket Wireless dealer (“dealer”). Pursuant to the agreement, PQH contributed a note payable in exchange for a 51% ownership interest in a newly formed subsidiary and dealer contributed substantially all its assets, including 28 Cricket Wireless retail locations, and specified liabilities in exchange for a 49% ownership interest in the newly formed subsidiary and receipt of the note payable contributed by PQH. Effective March 1, 2019, we consummated the transaction. Under the purchase method of accounting, the assets acquired and liabilities assumed were recorded at their estimated fair values as of the purchase date as follows:

14.       Other Operating Expense –

A breakout of other expense is as follows:

12.   Discontinued Operations –

As more fully disclosed in Note 19 of the Notes to Consolidated Financial Statements for the year ended December 31, 2017, on October 3, 2017 the Company closed on the sale of its franchise segment.

In accordance with the provisions of ASC 205-20, the Company has not included the results of operations of the Franchise segment in the results from continuing operations. The results of operations for this business have been reflected as discontinued operations in the unaudited Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2017, and consist of the following: