Creative Realities, Inc.: Form 10-Q for the period ended Sep 30, 2024

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,” “proposes,” 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 this Report on Form 10-Q, the Company’s Form 10-K for the year ended December 31, 2023 as filed with the Securities and Exchange Commission on March 21, 2024, as amended on April 26, 2024, and in the Company's Quarterly Report on Form 10-Q filed with the SEC on May 10, 2024.

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

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;
• Enhanced employee productivity and satisfaction;
• Increased revenue and profitability;
• Improved guest experience; and
• Increased customer/guest engagement.

Through a combination of organically grown platforms and a series of strategic acquisitions, the Company assists customers 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. Customer engagements focus on consultative conversations that ensure the Company’s solutions are positioned to help customers achieve their business objectives in the most cost-effective manner possible.

When comparing us to other digital signage providers, our customers value the following competitive advantages:

• Breadth of solutions – Creative Realities offers a wide breadth of solutions to our customers. 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 customers 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 of qualified and vetted field technicians available to service customers quickly nationwide. We can meet tight schedules even in exceptionally large deployments and still ensure quality and consistency.
• In-house creative resources – We assist customers in creating new content or repurposing existing content for digital signage experiences, an activity for which the Company has won several design awards in recent years. In each instance, our services can be essential in helping customers develop an effective content program.
• Network scalability and reliability – Our 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 customers.
• 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 for our customers. AdLogic, our home-grown, content management-agnostic platform, automates this process, allowing network owners to capture more revenue with less expense.
• Media sales – Few digital signage solution providers offer their customers media sales as a service. We have in-house media sales expertise to elevate conversations with our customers interested in better understanding network monetization. We believe this meaningful differentiation in the sales process provides us an additional revenue stream compared to our competitors.
• Market sector expertise – Creative Realities has in-house experts in key market segments such as automotive, retail, QSRs, convenience stores, and DOOH advertising. Our expertise in these business segments enable our teams to provide meaningful business conversations and offer tailored solutions with prospects and customers to their unique business objectives. These experts build industry relationship and create thought leadership that drives lead flow and new opportunities for our business.
• Logistics – Implementing a large digital signage project can be a logistical 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. We simplify and improve end user support by leveraging our own NOC in Louisville, Kentucky. The NOC resolves many issues remotely and when field support is required, it can be dispatched quickly 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. We believe that interactive applications and integrations with other data sources will dominate the future. From social media feeds, mobile integrations, corporate data stores, or point of sale systems, our proven ability to build scalable applications and integrations is a key advantage that customers 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 customers flexibility 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 our customers.

Our Sources of Revenue

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
• Recurring subscription licensing and support revenue from our digital signage software platforms, which are generally sold via a SaaS model. Our platforms 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;
• Clarity, the Company’s menu board solution, which has become a market leader for a range of restaurant and convenience store applications;
• 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; and
• 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.

Our Operating Expenses

Our operating expenses are comprised of sales and marketing, and general and administrative expenses. 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 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.

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 GAAP. 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 September 30, 2024 Compared to Three Months Ended September 30, 2023

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.

Sales

Sales increased $2,874, or 25%, for the three months ending September 30, 2024 as compared to the same period in 2023. Hardware revenues were $5,241, an increase of $394, or 8%, for the three months ending September 30, 2024 as compared to the same period in 2023. Services and other revenues were $9,201, an increase of $2,480 or 37%, driven by increases in both installation and managed services revenues. Installation services revenue tripled from $967 for the three months ending September 30, 2023 to $2,911 for the three months ending September 30, 2024, as a result of significant installation deployment activity during the period. Managed services revenue, which includes the Company’s SaaS subscription services, were $4,885, an increase of $565, or 13%, as compared to the same period in 2023. An increase in the quantity of licenses subject to software subscriptions on our platforms and an expansion in the average price per subscription license per month in part as a result of price increases during contract renewals drove the increase.

Gross Profit

Gross profit margin remained consistent at 46% for the three months ending September 30, 2024 and 2023.

Sales and Marketing Expenses

Sales and marketing expenses generally include the salaries, taxes, and benefits of our sales and marketing personnel, as well as trade show activities, travel, and other related sales and marketing costs. Sales and marketing expenses increased by $224, or 17%, for the three-month period ended September 30, 2024 as compared to the same period in 2023, driven primarily by the Company’s enhanced investments into sales and marketing activities, including increases of (1) $137 in fixed and variable sales costs as the Company continues to invest in new business development to strengthen its pipeline, and (2) $92 in variable third party media-related commissions.

General and Administrative Expenses

General and administrative expenses remained relatively flat, increasing $86, or 2%, during the three months ending September 30, 2024 as compared to the same period in 2023.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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.

Sales

Sales increased $9,134, or 30%, for the nine months ending September 30, 2024 as compared to the same period in 2023. Hardware revenues were $14,409, an increase of $1,803, or 14%, for the nine months ending September 30, 2024 as compared to the same period in 2023. Services and other revenues were $25,433, an increase of $7,331 or 40%, as compared to the same period in 2023, driven by increases in both installation and managed services revenues. Installation services revenue were $7,109, an increase of $4,027, or 131%, as compared to the same period in 2023, as a result of significant installation deployment activity during the period. Managed services revenue, which includes the Company’s SaaS subscription services were $14,506, an increase of $2,279, or 19%, as compared to the same period in 2023. An increase in the quantity of licenses subject to software subscriptions on our platforms and an expansion in the average price per subscription license per month in part as a result of price increases during contract renewals drove the increase.

Gross Profit

Gross profit margin remained consistent at 48% for the nine months ending September 30, 2024 and 2023.

Sales and Marketing Expenses

Sales and marketing expenses generally include the salaries, taxes, and benefits of our sales and marketing personnel, as well as trade show activities, travel, and other related sales and marketing costs. Sales and marketing expenses increased by $989, or 27%, for the nine months ending September 30, 2024 as compared to the same period in 2023, driven primarily by the Company’s enhanced investments into sales and marketing activities, including increases of (1) $714 in fixed and variable sales costs as the Company continues to invest in new business development to strengthen its pipeline, and (2) $285 in variable third party media-related commissions.

General and Administrative Expenses

General and administrative expenses increased $1,180, or 10%, during the nine months ending September 30, 2024 as compared to the same period in 2023. The change is driven by an increase of $1,395 in personnel costs, including both the Company’s portion of employee benefits and other administrative and processing costs associated with employment, in the current year driven by increased headcount in development and administrative functions to support active and anticipated deployments for a growing number of customers. Increases in general and administrative expenses were offset by a $528 decrease in stock compensation expense in the current period as all outstanding time vested and performance awards for employees and directors were fully expensed as of December 31, 2023.

Interest Expense

See Note 7 Debt to the Condensed Consolidated Financial Statements for a discussion of the Company’s debt and related interest expense obligations.

Changes in fair value of contingent consideration

The Company has a contingent consideration arrangement related to the Merger to potentially pay additional cash amounts in future periods based on the lack of achievement of certain share price performance goals of our common stock. See Note 2 Section 11 Summary of Significant Accounting Policies - Contingent Consideration to the Condensed Consolidated Financial Statements for a discussion of the Company's obligations related to the contingent consideration arrangement. The contingent consideration arrangement is recorded at fair value and is classified as a liability on the acquisition date and is remeasured at each reporting period in accordance with ASC 805-30-35-1 using a Monte Carlo simulation model. The change in the period represents the mark-to-market adjustment as of the balance sheet date.

Loss on extinguishment of debt

The Company recognized a $1,059 loss on extinguishment of debt equal to the remaining unamortized portion of debt discount associated with the Acquisition Term Loan and Consolidation Term Loan as of May 23, 2024, the date the Company entered into the Credit Agreement.

Summary Unaudited Quarterly Financial Information

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 earnings before interest, depreciation, and amortization (“EBITDA”) is a performance measure and not a liquidity measure, and therefore a reconciliation between net (loss) income, a GAAP financial measure, 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 Condensed Consolidated Financial Statements prepared in accordance with GAAP that are included elsewhere in this Report.

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Liquidity and Capital Resources

See Note 1 Nature of Organization and Operations to the accompanying Condensed Consolidated Financial Statements for a discussion of liquidity and financial resources.

Operating Activities

The net cash provided by operating activities during the nine months ended September 30, 2024 was $4,750, compared to $8,306 for the same period in 2023. During the nine month period ending September 30, 2024, the Company generated net loss of $478, which included depreciation and amortization expense (inclusive of amortization of debt discount) of $2,901, a loss on the extinguishment of debt of $1,059, and a gain on the change in fair value of contingent consideration of $414. The Company generated a $905 increase in cash as of September 30, 2024, provided by changes in operating assets and liabilities.

Investing Activities

Net cash used in investing activities during the nine months ended September 30, 2024 was $2,302, compared to $3,138 during the same period in 2023. We currently do not have any material commitments for capital expenditures as of September 30, 2024. The reduction in capital expenditures in 2024 compared to the prior period was anticipated as the Company has been reducing third-party development resources utilized for the previously disclosed modernization and internationalization of our automotive platform, which launched to user acceptance testing during the second quarter of 2024.

Financing Activities

Net cash used in financing activities during the nine months ended September 30, 2024 was $4,490, compared to net cash provided from financing activities of $1,575 for the same period in 2023. Net cash used in financing activities during the nine month period ended September 30, 2024 is primarily the result of the repayment of related party term debt totaling $15,147, partially offset by net proceeds of $10,979 from borrowings and payments under the Company's revolving credit facility.

Off-Balance Sheet Arrangements

During the three and nine months ended September 30, 2024, we did not engage in any off-balance sheet arrangements set forth in Item 303(a)(4) of Regulation S-K.

Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this Report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2024, and were designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As a smaller reporting company, we are not required to provide the information required by this Item; however, the discussion of our business and operations should be read together with the Risk Factors set forth in our Annual Report on Form 10-K filed with the SEC on March 21, 2024, as amended on April 26, 2024, our Quarterly Report on Form 10-Q filed with the SEC on May 10, 2024, and subsequent filings made with the SEC. Such risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flow, strategies or prospects in a material and adverse manner. In addition, below is an updated risk factor for which you should be aware:

The Guaranteed Consideration payable to former Reflect stockholders is an estimate only and is subject to change. Accordingly, the contingent liability that we book for payment of the Guaranteed Consideration is an estimate only, and the actual liability may differ. In addition, disputes over the proper calculation of the Guaranteed Consideration could result in litigation or arbitration.

Pursuant to the Merger Agreement governing the merger in which we acquired Reflect (the “Merger”), shares of Reflect’s capital were converted into the right to receive cash and a total of 2,333,334 shares of our common stock (the “Merger Shares”). The Merger Agreement also requires us to make additional contingent cash payments to the former Reflect stockholders (the “Guaranteed Consideration”) on or after February 17, 2025 (subject to a six-month extension under certain circumstances) (the “Guarantee Date”) in an amount by which the value of our shares on the Guarantee Date is less than $6.40 per share (such applicable amount, the “Guaranteed Price”), multiplied by the number of Merger Shares held by the Reflect stockholders on the Guarantee Date. The actual amount of Guaranteed Consideration cannot be determined until such time.

On March 23, 2023, the Company completed a 1-for-3 reverse stock split (the “Reverse Split”) primarily intended to bring the Company into compliance with the minimum bid price requirement to maintain the listing of its common stock on the Nasdaq Capital Market. As a result of the Reverse Split, the number of Merger Shares decreased from 2,333,334 to 777,778.

Our financial statements have and continue to book a contingent liability for payment of the Guaranteed Consideration conservatively as though the Reverse Split resulted in an upward adjustment of the Guaranteed Price from $6.40 per share to $19.20 per share. Notwithstanding this accounting position, we have engaged in discussions with RSI Exit Corporation, as representative of the former Reflect stockholders (“RSI”), regarding the impact that the Reverse Split properly had on the calculation of the Guaranteed Consideration, given that the Merger Agreement provides for a Guaranteed Price of $6.40 per share and does not provide for any adjustment to the Guaranteed Price as a result of the Reverse Stock Split or other similar transaction with respect to our common stock. To date, the Company and RSI have not reached any agreement regarding the calculation of the Guaranteed Consideration under the plain terms of the Merger Agreement.

Ultimately, the Guaranteed Price may not be adjusted for the Reverse Split based on the terms of the Merger Agreement, and the contingent liability that we book for payment of the Guaranteed Consideration may differ from the amount ultimately paid. See “Note 2 Section 11 Summary of Significant Policies - Contingent Consideration” to the Company’s Consolidated Financial Statements contained in this Report for a description of our obligations to pay the contingent consideration.

If we and RSI are ultimately unable to agree upon the proper calculation of the Guaranteed Consideration, the matter may result in litigation or arbitration. RSI may file claims against us for, among other things, failure to pay the correct amount for the Guaranteed Consideration once the payment due date occurs, which is anticipated to occur in February 2025. We cannot provide any certainty that our interpretation of the Merger Agreement, and position on the amount of the Guaranteed Consideration, will ultimately be accepted by RSI and the former Reflect stockholders, or by any arbitrator or court that ultimately adjudicates the matter. In addition, any claim will require significant time of management, and the Company will likely incur substantial expenses. If our interpretation of the Merger Agreement is not correct, we may be forced to cover the expenses of RSI in bringing such claim.