CREATIVE REALITIES, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion contains various forward-looking statements within the meaning of Section 21E of the Exchange Act. Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. When used in the following discussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates,” “projects,” should,” “may,” “propose,” and similar expressions (or the negative versions of such words or expressions), as they relate to us or our management, are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those anticipated, and many of which are beyond our control. Factors that could cause actual results to differ materially from those anticipated are set forth under the caption “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2021 as filed with the Securities and Exchange Commission on March 22, 2022. Our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking statements. Accordingly, we cannot be certain that any of the events anticipated by forward-looking statements will occur or, if any of them do occur, what impact they will have on us. We caution you to keep in mind the cautions and risks described in this document and to refrain from attributing undue certainty to any forward-looking statements, which speak only as of the date of the document in which they appear. We do not undertake to update any forward-looking statement. Overview Creative Realities, Inc. (“Creative Realities,” “we,” “us,” or the “Company”) transforms environments through digital solutions by providing innovative digital signage solutions for key market segments and use cases, including: ● Retail ● Entertainment and Sports Venues ● Restaurants, including quick-serve restaurants (“QSR”) ● Convenience Stores ● Financial Services ● Automotive ● Medical and Healthcare Facilities ● Mixed Use Developments ● Corporate Communications, Employee Experience ● Digital out of Home (DOOH) Advertising Networks We serve market-leading companies, so there is a good chance that if you leave your home today to shop, work, eat or play, you will encounter one or more of our digital signage experiences. Our solutions are increasingly visible because we help our enterprise customers achieve a range of business objectives including: ● Increased brand awareness ● Improved customer support 29 ● Enhanced employee productivity and satisfaction ● Increased revenue and profitability ● Improved guest experience ● Increased customer/guest engagement ● Improved patient outcomes Through a combination of organically grown platforms and a series of strategic acquisitions, including our recent acquisition of Reflect Systems, Inc. in February 2022, the Company assist clients to design, deploy, manage, and monetize their digital signage networks. The Company sources leads and opportunities for its solutions through its digital and content marketing initiatives, close relationships with key industry partners, specifically equipment manufacturers, and the direct efforts of its in-house industry sales experts. Client engagements focus on consultative conversations that ensure the Company’s solutions are positioned to help clients achieve their business objectives in the most cost-effective manner possible. When comparing Creative Realities to other digital signage providers, our customers value the following competitive advantages: ● Breadth of solutions – Creative Realities is one of only a few companies in the industry capable of providing the full portfolio of products and services required to implement and run an effective digital signage network. We leverage a ‘single vendor’ approach, providing clients with a one-stop-shop for sourcing digital signage solutions from design through day two services. ● Managed labor pool – Unlike most companies in our industry, we have a curated labor pool including thousands of qualified and vetted field technicians available to service clients quickly nationwide. We can meet tight schedules even in exceptionally large deployments and still ensure quality and consistency. ● In-house creative resources – We assist clients in repurposing existing content for digital signage experiences or creating new content, an activity for which the Company has won several design awards in recent years. In each instance, our services can be essential in helping clients develop an effective content program. ● Network scalability and reliability – Our software as a service (“SaaS”) content management platforms power some of the largest and most complex digital signage networks in North America evidencing our ability to manage enterprise scale projects. This also provides us purchasing power to source products and services for our customers, enabling us to deliver cost effective, reliable and powerful solutions to small and medium size business clients. ● Ad management platform – Our customers are increasingly interested in monetizing their digital signage networks through advertising content. However, efficiently scheduling advertising content into digital signage playlists to meet campaign objectives can be a challenging and labor-intensive process. AdLogic, our home-grown, content management-agnostic platform, automates this process, allowing network owners to capture more revenue with less expense. ● Media sales – Few, if any other digital signage solution providers, can offer their clients media sales as a service. We have in-house media sales expertise to elevate conversations with clients interested in better understanding network monetization. We believe this meaningful differentiation in the sales process provides an additional revenue stream to Creative Realities compared to our competitors. ● Market sector expertise – Creative Realities has in-house experts in key market segments such as automotive, retail, quick-serve restaurants (QSR), convenience stores, and Digital Out of Home (DOOH) advertising. Our expertise in these business segments enables our teams to provide meaningful business conversations and offer tailored solutions with prospects and customers to their unique business objectives. These experts build industry relationships and create thought leadership that drives lead flow and new opportunities for our business. 30 ● Logistics – Implementing a large digital signage project can be a logistics nightmare that can stall an initiative even before deployment. Our expertise in logistics improves deployment efficiency, reduces delays and problems, and saves customers time and money. ● Technical support – Digital signage networks present unique challenges for corporate IT departments. Creative Realities helps simplify and improve end user support by leveraging our own Network Operations Center (“NOC”) in Louisville, Kentucky. The NOC resolves many issues remotely and when field support is required, it can be dispatched from the NOC, leveraging our managed labor pool to resolve customer issues quickly and effectively. ● Integrations and Application Development – The future of digital signage is not still images and videos on a screen. Interactive applications and integrations with other data sources will dominate the future. From social media feeds to corporate data stores to Point of Sale (“POS”) systems, our proven ability to build scalable applications and integrations is a key advantage clients can leverage to deliver more compelling and engaging experiences for their customers. ● Hardware support – A number of digital signage providers sell a proprietary media player or align themselves with just one operating system. We utilize a range of media players including Windows, Android and BrightSign to provide clients the flexibility they need to select the appropriate hardware for any application knowing the entire network can still be served by a single digital signage platform, reducing complexity and improving the productivity of their teams. The three primary sources of revenue for the Company are: ● Hardware sales from reselling digital signage hardware from original equipment manufacturers such as Samsung and BrightSign. ● Services revenue from helping customers design, deploy and manage their digital signage network, including: ○ Hardware system design/engineering ○ Hardware installation ○ Content development ○ Content scheduling ○ Post-deployment network and field support ○ Media sales, as a result of our acquisition of Reflect ● Recurring subscription licensing and support revenue from our digital signage software platforms, which are generally sold via a SaaS model. These include: ○ ReflectView , the Company’s core digital signage platform for most applications, scalable and cost effective from 10 to 100,000+ devices ○ Reflect Xperience , a web-based interface that allows customers to give content scheduling access to local users via the web or mobile devices, while still maintaining centralized programming control ○ Reflect AdLogic , the Company’s ad management platform for digital signage networks, which presently delivers approximately 50 million ads daily ○ Reflect Clarity , the Company’s menu board solution, which has become a market leader for a range of restaurant and convenience store applications 31 ○ Reflect Zero Touch , which allows customers to turn any screen into an interactive experience by allowing guests to engage using their mobile device ○ iShowroomProX , an omni-channel digital sales support platform targeted at original equipment manufacturers in the transportation sector, which integrates with dozens of key data services including dealer inventory at the VIN level ○ OSx+ , a digital VIN-level checklist used to assist in the tracking and delivery of new vehicles in the transportation sector, providing measurable lift in customer satisfaction scores and connected vehicle enrollments and subscription activations. While hardware sales and support services revenues can fluctuate more significantly year over year based on new, large-scale network deployments, the Company expects to see continuous growth in recurring SaaS revenue for the foreseeable future as digital signage adoption/utilization continues to expand across the vertical markets we serve. Recent Developments Please see Note 1 Nature of Organization and Operations to the Company’s Condensed Consolidated Financial Statements contained in this report for a description of recent developments of the Company that occurred during the three months ended March 31, 2022. Our Sources of Revenue We generate revenue through digital signage solution sales, which include system hardware, professional and implementation services, software design and development, software licensing, deployment, and maintenance and support services. We currently market and sell our technology and solutions primarily through our sales and business development personnel, but we also utilize agents, strategic partners, and lead generators who provide us with access to additional sales, business development and licensing opportunities. Our Expenses Our expenses are primarily comprised of three categories: sales and marketing, research and development, and general and administrative. Sales and marketing expenses include salaries and benefits for our sales, business development solution management and marketing personnel, and commissions paid on sales. This category also includes amounts spent on marketing networking events, promotional materials, hardware and software to prospective new customers, including those expenses incurred in trade shows and product demonstrations, and other related expenses. Our research and development expenses represent the salaries and benefits of those individuals who develop and maintain our proprietary software platforms and other software applications we design and sell to our customers. Our general and administrative expenses consist of corporate overhead, including administrative salaries, real property lease payments, salaries and benefits for our corporate officers and other expenses such as legal and accounting fees. 32 Critical Accounting Policies and Estimates The Company’s significant accounting policies are described in Note 2 Summary of Significant Accounting Policies of the Company’s Condensed Consolidated Financial Statements included elsewhere in this report. The Company’s Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States. Certain accounting policies involve significant judgments, assumptions, and estimates by management that could have a material impact on the carrying value of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Our actual results could differ from those estimates. Results of Operations Note: All dollar amounts reported in Results of Operations are in thousands, except share and per-share information. Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021 The tables presented below compare our results of operations and present the results for each period and the change in those results from one period to another in both dollars and percentage change. We acquired Reflect via the Merger during the three months ended March 31, 2022, on February 17, 2022. As a result, our consolidated financial results for such period include the operations of Reflect for 44 days, between February 17, 2022 and March 31, 2022. Three months ended March 31, Change 2022 2021 $ % Sales $ 10,757 $ 5,004 $ 5,753 115 % Cost of sales 6,865 2,770 4,095 148 % Gross profit 3,892 2,234 1,658 74 % Sales and marketing expenses 707 335 372 111 % Research and development expenses 241 171 70 41 % General and administrative expenses 2,754 2,109 645 31 % Bad debt expense/(recovery) 106 (512 ) 618 -121 % Depreciation and amortization expense 707 344 363 106 % Deal and Transaction expenses 391 0 391 100 % Total operating expenses 4,906 2,447 2,459 100 % Operating income/(loss) (1,014 ) (213 ) (801 ) 376 % Other income/(expenses): Interest expense (449 ) (249 ) (200 ) 80 % Change in fair value of Special Loan - 166 (166 ) -100 % Gain on settlement of debt (295 ) 1,565 (1,860 ) -119 % Change in Fair Value of Warrant Liability 5,469 - 5,469 100 % Other income/(expense) (1,206 ) 4 (1,210 ) -30,250 % Total other income/(expense) 3,519 1,486 2,033 137 % Net income/(loss) before income taxes 2,505 1,273 1,232 97 % Provision from income taxes (3 ) (1 ) (2 ) -200 % Net income/(loss) $ 2,502 $ 1,272 1,230 97 % Sales Revenues were $10,757, representing an increase of $5,753, or 115%, as compared to the same period in 2021 despite a reduction in revenues generated from the sale of our Safe Space Solutions products and services of $894. Revenues generated from our core digital signage products and services increased $6,647, or 133% in 2022 as compared to 2021, despite continued supply chain disruptions related to semiconductor chips delaying the delivery of digital displays and media players to the Company. 33 The Company acquired Reflect on February 17, 2022, and the Company’s consolidated results for the three months ended March 31, 2022 include 44 days of Reflect’s operations. Hardware revenues were $6,459 in 2022, an increase of $3,643, or 129%, as compared to the prior year, driven primarily delivering Phase I of our previously announced a large customer transaction expected to exceed $10,000 in revenues. The Company began providing services and deliverables on the customer transaction in February 2022 and is anticipated to complete the project by the end of the first quarter of 2023, subject to the customer’s capacity to receive such products and services. Excluding Safe Space Solutions hardware, which reduced $768 year-over-year, core digital signage hardware sales increased $4,411 million, or 158%. Services and other revenues were $4,298 in the three months ended March 31,2022, an increase of $2,110, or 96%, with the inclusion of 44 days of Reflect’s operations in the Company’s consolidated results for such period. Managed services revenue, which includes both software-as-a-service (“SaaS”) and help desk technical subscription services, were $2,703 in the three months ended March 31, 2022 as compared to $1,339 in the same period in 2021, with the inclusion of 44 days of Reflect’s operations in the Company’s consolidated results for such period. Gross Profit Gross profit increased by $1,658, or 74% driven by an increase in revenue but offset by a reduction in gross profit margin. Gross profit margin decreased to 36.2% from 44.6% driven by a shift in revenue mix to 60% hardware in the first quarter of 2022 related to a material customer rollout underway. We expect this contraction in gross profit margin to be less severe as we move into the second quarter of 2022 and beyond, with significant pressure in the current quarter driving by a single, large-scale/hardware-heavy deployment. Sales and Marketing Expenses Sales and marketing expenses increased by $372, or 111%, driven by the acquisition of Reflect during the three months ended March 31, 2022period. Immediately following the acquisition of Reflect, the Company integrated the sales and marketing functions and does not disaggregate these expenses between the two legacy companies. Following the Merger and through integration activities, the Company has adopted certain tools, technology, and processes – particularly with respect to lead generation and brand marketing – that were minimally invested in historically by the Company. Additionally, the Company engaged an Investor Relations firm and has increased investor relations activities, including conferences and presentations. As a result, we expect the sales and marketing expenses of the Company to continue at the current pace for future periods. Research and Development Expenses Research and development expenses increased $70, or 41% in 2022, driven primarily by the acquisition of Reflect. Through the acquisition of Reflect, we acquired a fully staffed, experienced software development team and elected to keep that team in-tact, in full, particularly given employment market conditions with respect to talented software engineers. We have integrated the pre-existing CRI development team with the acquired team and have experienced enhanced speed to market on new feature and functionality development activities from increasing this resource pool. We expect this elevated level of expense to continue into the future as we continue to develop our current and future product set. General and Administrative Expenses General and administrative expenses – excluding bad debt expense – increased $645, or 31%, driven by the acquisition of Reflect. While the Company anticipates carrying higher G&A expenses moving forward as a result of the acquisition, the integration activities include several projects (including but not limited to consolidation of CMS tools, cloud hosting environments, IT tools, and rightsizing leases for office space) that we expect will be realized by the end of 2022. Bad debt expense returned to a more normalized rate of $106 during the first quarter of 2022, representing an increase of $618 as compared to the comparable period in 2021 as the result of a bankruptcy recovery in 2021. 34 Bad Debt Expenses related to the Company’s allowance for bad debts increased by $618, or 121%, in 2022 compared to 2021. This return to expense is the result of standard operations. The prior year included a cash recovery of $555 related to a customer bankruptcy for which the Company previously recorded a reserve. Depreciation and Amortization Expenses Depreciation and amortization expenses increased by $363, or 106%, in 2022 compared to 2021. This was driven by the addition of $21,500 in amortizing intangible assets as a result of the Merger. Interest Expense, Change in fair value of warrant liability, Other expense See Note 8 Loans Payable to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt and related interest expense obligations. During the three months ended March 31, 2022, the Company recorded a gain of $5,469 as the result of assessing the fair value of warrant liabilities associated with the Company’s issuance of warrants in its debt and equity offerings completed in February 2022 to finance the Merger. These warrants were initially assessed at fair value through Black Scholes calculation and were subsequently re-assessed at March 31, 2022, resulting in the gain. Supplemental Operating Results on a Non-GAAP Basis The following non-GAAP data, which adjusts for the categories of expenses described below, is a non-GAAP financial measure. Our management believes that this non-GAAP financial measure is useful information for investors, shareholders and other stakeholders of our company in gauging our results of operations on an ongoing basis. We believe that EBITDA is a performance measure and not a liquidity measure, and therefore a reconciliation between net loss/income and EBITDA and Adjusted EBITDA has been provided. EBITDA should not be considered as an alternative to net loss/income as an indicator of performance or as an alternative to cash flows from operating activities as an indicator of cash flows, in each case as determined in accordance with GAAP, or as a measure of liquidity. In addition, EBITDA does not take into account changes in certain assets and liabilities as well as interest and income taxes that can affect cash flows. We do not intend the presentation of these non-GAAP measures to be considered in isolation or as a substitute for results prepared in accordance with GAAP. These non-GAAP measures should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Quarters Ended March 31 December 31, September 30, June 30 March 31, Quarters ended 2022 2021 2021 2021 2021 GAAP net income (loss) $ 2,502 $ (1,722 ) $ (343 ) $ 1,025 $ 1,272 Interest expense: Amortization of debt discount 181 29 29 29 72 Other interest, net 268 160 158 153 177 Depreciation/amortization: Amortization of intangible assets 680 302 320 317 312 Amortization of finance lease assets - - - - 4 Amortization of employee share-based awards 469 324 329 329 512 Depreciation of property, equipment 27 27 27 27 28 Income tax expense/(benefit) 3 13 1 7 1 EBITDA $ 4,130 (867 ) $ 521 1,887 2,378 Adjustments (Gain)/loss on fair value of debt - - - - (166 ) (Gain)/loss on fair value of warrant liability (5,469 ) - - - - (Gain)/loss on settlement of obligations 295 - (256 ) (1,628 ) (1,565 ) (Gain)/loss on debt waiver consent 1,212 - - - - Deal and transaction expenses 391 518 - - - Other income (6 ) - - - - Stock-based compensation – Director grants 82 318 27 27 27 Adjusted EBITDA $ 635 (31 ) $ 292 286 674 35 Liquidity and Capital Resources The accompanying Condensed Consolidated Financial Statements have been prepared on the basis of the realization of assets and the satisfaction of liabilities and commitments in the normal course of business and do not include any adjustments to the recoverability and classifications of recorded assets and liabilities as a result of uncertainties. We produced net income for the three months ended March 31, 2022 and for the year ended December 31, 2021 and had positive cash flows from operating activities for both periods. As of March 31, 2022, we had cash and cash equivalents of $5,988 and a working capital surplus of $2,288. Management believes that, based on (i) the execution of the Equity Financing, (ii) the refinancing of our debt as part of the Debt Financing, including extension of the maturity date on our term loans, and (iii) our operational forecast through 2022 following completion of the Merger, that we can continue as a going concern through at least June 30, 2023. However, given our historical net losses and cash used in operating activities, we obtained a continued support letter from Slipstream through May 16, 2023. We can provide no assurance that our ongoing operational efforts will be successful which could have a material adverse effect on our results of operations and cash flows. Operating Activities The cash flows provided by operating activities were $1,201 for the period ended March 31, 2022 as compared to cash flows used in operating activities of $21 for the period ended March 31, 2021. We produced net income of $2,502. Following the Merger, our business has significantly expanded, particularly with respect to managed services revenue. Other than net income, cash provided by operating activities was driven by growth of $1,901 of deferred revenue and $2,292 of accounts payable, partially offset by an expansion of accounts receivable of $3,724. Investing Activities Net cash used in investing activities during the three months ended March 31, 2022 was $17,969 compared to $115 during the same period in 2021. The use of cash in the current year was driven by (1) completion of the Merger and (2) continued investments in our software platforms. We currently do not have any material commitments for capital expenditures as of March 31, 2022; however, we anticipate continued elevated capital expenditures in excess of historical trends through as a result of the Merger, which included acquisition of a software development team. Financing Activities Net cash provided by financing activities during the three months ended March 31, 2022 was $19,873 compared to $1,845 for the same period in 2021. The increase is the result of the Company’s completion of the Equity Financing and the Debt Financing (each as described in “Recent Developments” above) in the period to facilitate the Merger, which provided net cash of $10,109 and $9,868, respectively. Contractual Obligations We have no material commitments for capital expenditures, and we do not anticipate any significant capital expenditures for the remainder of 2022. Off-Balance Sheet Arrangements During the three months ended March 31, 2022, we did not engage in any off-balance sheet arrangements set forth in Item 303(a) (4) of Regulation S-K. 36