FG Group Holdings Inc. - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2017

OR

For the transition period from_____________ to _____________

Commission File Number: 1-13906

BALLANTYNE STRONG, INC.

(Exact Name of Registrant as Specified in Its Charter)

(402) 453-4444

(Registrant’s telephone number, including area code:)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act (check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

TABLE OF CONTENTS

PART I. Financial Information

Item 1. Financial Statements

Ballantyne Strong, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except par values)

See accompanying notes to condensed consolidated financial statements.

Ballantyne Strong, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

Three and Nine Months Ended September 30, 2017 and 2016

(In thousands, except per share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

Ballantyne Strong, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive (Loss) Income

Three and Nine Months Ended September 30, 2017 and 2016

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

Ballantyne Strong, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2017 and 2016

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

Ballantyne Strong, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

1. Nature of Operations

Ballantyne Strong, Inc. (“Ballantyne” or the “Company”), a Delaware corporation, is a holding company with diverse business activities focused on serving the cinema, retail, financial and government markets. The Company, and its wholly owned subsidiaries Strong Technical Services, Inc., Strong/MDI Screen Systems, Inc. (“Strong/MDI”), Convergent Corporation, and Convergent Media Systems Corporation (“Convergent” or “CMS”), design, integrate and install technology solutions for a broad range of applications; develop and deliver out-of-home messaging, advertising and communications; manufacture projection screens; and provide managed services including monitoring of networked equipment to our customers. On November 4, 2016, Strong Westrex (Beijing) Technology Inc. (“SWBTI”), a subsidiary of Strong Westrex, Inc. (“SWI”), was sold, and on May 17, 2017, SWI was sold (see Note 2).

The Company’s products are distributed to the retail, financial, government and cinema markets throughout the world.

2. Discontinued Operations

On June 23, 2016, the Company’s Board of Directors approved a plan to pursue a sale of the operations conducted by its subsidiaries SWBTI and SWI (the “China Operations”) which have historically been included in the Cinema segment. The purpose of the plan was to focus the efforts of the Company on the business units that have opportunities for higher return on invested capital. We reflected the results of the China Operations as discontinued operations for all periods presented. The assets and liabilities of the China Operations have been reclassified as assets and liabilities held for sale in the condensed consolidated balance sheets for all periods presented.

On November 4, 2016, the Company sold SWBTI to GABO Filter, Inc. for total proceeds of $0.4 million. On May 17, 2017, SWI was sold for total proceeds of $0.1 million. The Company recorded an insignificant gain on the sale of SWI.

The summary comparative financial results of discontinued operations were as follows (in thousands):

Depreciation and amortization related to discontinued operations was immaterial for the three and nine month periods ended September 30, 2017 and 2016. There were no capital expenditures related to discontinued operations for the nine months ended September 30, 2017 and 2016.

3. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and all majority owned and controlled domestic and foreign subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The condensed consolidated financial statements included in this report are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America for annual reporting purposes or those made in the Company’s Annual Report on Form 10-K/A. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2016.

The condensed consolidated balance sheet as of December 31, 2016 was derived from the Company’s audited consolidated balance sheet as of that date. All other condensed consolidated financial statements contained herein are unaudited and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary to present a fair statement of the financial position and the results of operations and cash flows for the respective interim periods. The results for interim periods are not necessarily indicative of trends or results expected for a full year.

During the second quarter of 2017, the Company began classifying software in development as an intangible asset rather than property, plant and equipment, to be consistent with its classification of software assets in service. Accordingly, approximately $0.5 million of software in development at December 31, 2016 was reclassified to intangible assets from property, plant and equipment on the condensed consolidated balance sheet to conform to the current period presentation. This reclassification had no effect on the Company’s reported results of operations, comprehensive income, or cash flows.

Use of Management Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results and changes in facts and circumstances may alter such estimates and affect results of operations and financial position in future periods.

Marketable Securities

For the nine months ended September 30, 2016, the Company’s marketable securities were comprised of investments in the common stock of a publicly traded company. Changes in fair value, based on the market price of the investee’s stock, were recognized in other income in the condensed consolidated statement of operations. The Company used the fair value option to account for the investment to more appropriately recognize the value of this investment in our condensed consolidated financial statements since the Company did not exert significant influence over the investment, in which case the equity method of accounting would have been applied. None of the Company’s investments were classified as marketable securities or accounted for using the fair value option during the nine months ended September 30, 2017.

Equity Method Investments

We apply the equity method of accounting to investments when we have significant influence, but not controlling interest in the investee. Judgment regarding the level of influence over each equity method investment includes considering key factors such as ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. The Company’s proportionate share of the net (loss) income resulting from these investments is reported under the line item captioned “equity method investment (loss) income” in our condensed consolidated statements of operations. The carrying value of our equity method investments is reported in equity method investments in the condensed consolidated balance sheets. The Company’s equity method investments are reported initially at cost and adjusted each period for the Company’s share of the investee’s income or loss and dividend paid, if any. The Company’s share of the investee’s income or loss is recorded on a one quarter lag for all equity method investments. The Company classifies distributions received from equity method investments using the cumulative earnings approach on the condensed consolidated statements of cash flows. The Company assesses investments for impairment whenever events or changes in circumstances indicate that the carrying value of an investment may not be recoverable. The Company did not record any impairments related to its investments during the three and nine month periods ended September 30, 2017 or 2016. Note 5 contains additional information on our equity method investments, which are held by the Company’s Cinema segment.

Fair Value of Financial Instruments

Assets and liabilities measured at fair value are categorized into a fair value hierarchy based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. The categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

The following tables present the Company’s financial assets measured at fair value based upon the level within the fair value hierarchy in which the fair value measurements fall, as of September 30, 2017 and December 31, 2016.

Fair values measured on a recurring basis at September 30, 2017 (in thousands):

Fair values measured on a recurring basis at December 31, 2016 (in thousands):

Quantitative information about the Company’s level 3 fair value measurements at September 30, 2017 is set forth below:

The notes receivable are recorded at estimated fair value at September 30, 2017.

The significant unobservable inputs used in the fair value measurement of the Company’s notes receivable are discount rate and probability of default. Significant increases (decreases) in any of these inputs in isolation would result in a significantly lower (higher) fair value measurement. There were no changes in the fair value of the Company’s notes receivable recorded during the three and nine months ended September 30, 2017 or 2016.

The Company’s short-term and long-term debt is recorded at historical cost. As of September 30, 2017, the Company’s long-term debt, including current maturities, had a carrying value of $1.95 million. Based on discounted cash flows using current quoted interest rates (Level 2 of the fair value hierarchy), the estimated fair value at September 30, 2017 was $1.96 million.

The carrying values of other financial assets and liabilities, including accounts receivable, accounts payable, accrued expenses and short-term debt, reported in the condensed consolidated balance sheets equal or approximate their fair values due to the short-term nature of these instruments. Note 5 includes fair value information related to our equity method investments. All non-financial assets that are not recognized or disclosed at fair value in the financial statements on a recurring basis, which includes non-financial long-lived assets, are measured at fair value in certain circumstances (for example, when there is evidence of impairment). During the nine months ended September 30, 2017, the Company did not have any significant non-recurring measurements of non-financial assets or liabilities.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The guidance is effective for the Company beginning January 1, 2018. An entity may adopt this ASU either retrospectively or through a cumulative effect adjustment (modified retrospective method) as of the start of the first period for which it applies the ASU. The Company has obtained an understanding of ASU 2014-09 and has been analyzing the impact of the new standard on its financial results. The Company has completed a high-level assessment of the performance obligations within its contracts for its major products and services and is assessing potential impacts to its internal processes, control environment and disclosures. The Company expects to adopt this ASU using the modified retrospective method as of January 1, 2018. While the Company has not yet quantified the impact that the adoption of ASU 2014-09 will have on the consolidated financial statements, the Company is continuing to evaluate the impact of the new standard on our financial results and other possible impacts. The Company will continue to provide enhanced disclosures as we complete our assessment.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”. ASU 2015-11 requires an entity utilizing the first in-first out inventory method to change their measurement principle for inventory changes from the lower of cost or market to lower of cost or net realizable value. The Company prospectively adopted the guidance effective January 1, 2017. The adoption of ASU 2015-11 did not have a material effect on the Company’s consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity investments that do not result in consolidation and are not accounted under the equity method to be measured at fair value with changes in fair value recognized in net income; simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements; clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets; and modifies certain fair value disclosure requirements. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is not permitted. The adoption of ASU 2016-01 is not expected to have a material effect on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. ASU 2016-02 requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases with a term greater than twelve months, on its balance sheet. This ASU is effective in fiscal years beginning after December 15, 2018, with early adoption permitted, and requires a modified retrospective transition method. The Company is evaluating the requirements of ASU 2016-02 and its potential impact on the Company’s financial statements. The Company has leases primarily for property and equipment and is in the process of identifying and evaluating these leases for purposes of ASU 2016-02. For each of these leases, the term will be evaluated, including extension and renewal options as well as the lease payments. While the Company has not yet quantified the impact that the adoption of ASU 2016-02 will have on its consolidated financial statements, the Company expects to record assets and liabilities on its balance sheet upon adoption of this standard, which may be material. The Company will continue to provide enhanced disclosures as it continues its assessment.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”. ASU 2016-09 simplifies accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, and certain classifications on the statement of cash flows. The Company adopted the guidance effective January 1, 2017 on a prospective basis. Additionally, as required by ASU 2016-09, when calculating diluted earnings per share, excess tax benefits were excluded from the calculation of assumed proceeds since such amounts are recognized in the income statement. The Company applied the cash flow presentation requirements prospectively, and the 2016 statement of cash flows was not adjusted. ASU 2016-09 also allows an entity to elect as an accounting policy either to estimate the total number of awards for which the requisite service period will not be rendered or to account for forfeitures for service-based awards as they occur. The Company has elected to account for forfeitures as they occur.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. This ASU will require the measurement of all expected credit losses for financial assets, including trade receivables, held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. The Company believes its adoption will not significantly impact the Company’s results of operations and financial position.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which eliminates the diversity in practice related to eight cash flow classification issues. The Company adopted this ASU in the first quarter of 2017 on a prospective basis. Adoption affected the classification of dividends received from equity method investees on the statement of cash flows, but did not have any other impact.

In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. The new guidance eliminates Step 2 of the goodwill impairment testing which requires the fair value of individual assets and liabilities of a reporting unit to be determined when measuring goodwill impairment. The new guidance may result in different amounts of impairment that could be recognized compared to existing guidance. In addition, failing step 1 of the impairment test, where the carrying value of a reporting unit is compared to its fair value, may not result in impairment under existing guidance. However, under the revised guidance, failing step 1 will always result in a goodwill impairment. ASU 2017-04 is to be applied prospectively for goodwill impairment testing performed in years beginning after December 15, 2019. The Company does not believe the adoption will significantly impact the Company’s results of operations or financial position.

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” The new guidance describes the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. The guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years. The Company believes its adoption will not significantly impact the Company’s results of operations and financial position.

4. (Loss) Earnings Per Common Share

Basic (loss) earnings per share has been computed on the basis of the weighted average number of shares of common stock outstanding. Diluted (loss) earnings per share has been computed on the basis of the weighted average number of shares of common stock outstanding after giving effect to potential common shares from dilutive stock options and certain non-vested shares of restricted stock. The following table provides the reconciliation between average shares used to compute basic and diluted (loss) earnings per share:

For each of the three and nine month periods ended September 30, 2017, options to purchase 470,000 shares of common stock were outstanding but were not included in the computation of diluted loss per share as the option’s exercise price was greater than the average market price of the common shares for each period. An additional 115,754 and 154,161 common stock equivalents related to options and restricted stock awards were excluded for the three and nine months ended September 30, 2017, respectively, as their inclusion would be anti-dilutive, thereby decreasing the net losses per share. For the three and nine month periods ended September 30, 2016, options to purchase 350,000 and 363,700 shares of common stock, respectively, were outstanding but were not included in the computation of diluted earnings per share as the option’s exercise price was greater than the average market price of the common shares for the respective periods. An additional 65,937 and 85,618 common stock equivalents related to options and restricted stock awards were excluded from the calculation of diluted net loss per share for the three and nine months ended September 30, 2016, respectively, as their inclusion would be anti-dilutive, thereby decreasing the net losses per share.

5. Equity Method Investments

The following summarizes our equity method investments:

The following summarizes the (loss) income of equity method investees reflected in the Statement of Operations (in thousands):

RELM Wireless Corporation (“RELM”) is a publicly traded company that designs, manufactures and markets two-way land mobile radios, repeaters, base stations and related components and subsystems. The Company’s Chief Executive Officer is chairman of the board of directors of RELM, and controls entities that, when combined with the Company’s ownership in RELM, own greater than 20% of RELM, providing the Company with significant influence over RELM, but not controlling interest. The Company received dividends of $0.2 million and $0 for the nine month periods ended September 30, 2017 and 2016, respectively. Based on quoted market prices, the market value of the Company’s ownership in RELM was $4.1 million at September 30, 2017.

Itasca Capital, Ltd. (“Itasca”) is a publicly traded Canadian company that is an investment vehicle seeking transformative strategic investments. The Company’s Chief Executive Officer is a member of the board of directors of Itasca. This board seat, combined with the Company’s 32.3% ownership of Itasca, provide the Company with significant influence over Itasca, but not controlling interest. The Company did not receive dividends from Itasca during the nine month periods ended September 30, 2017 or 2016. Based on quoted market prices, the market value of the Company’s ownership in Itasca was $3.9 million at September 30, 2017.

As of December 31, 2016, the Company owned 12.1% of 1347 Property Insurance Holdings, Inc. (“PIH”) and purchased shares increasing its ownership to 17.4% during the nine months ended September 30, 2017 for an additional $2.5 million. PIH is a publicly traded company that provides property and casualty insurance in the States of Louisiana, Texas and Florida. The Company’s Chief Executive Officer was named to the board of directors of PIH in December 2016. This board seat and the Chief Executive Officer’s control of other entities that own shares of PIH, combined with the Company’s 17.4% ownership of PIH, provide the Company with significant influence over PIH, but not controlling interest. The Company did not receive dividends from PIH during the nine month periods ended September 30, 2017 or 2016. Based on quoted market prices, the market value of the Company’s ownership in PIH was $8.0 million at September 30, 2017.

As of September 30, 2017, our retained earnings included undistributed earnings from our equity method investees of $1.2 million.

The summarized financial information presented below reflects the financial information of the Company’s significant equity method investee, Itasca, for the nine months ended June 30, 2017, consistent with the Company’s recognition of the results of its equity method investments on a one-quarter lag. The summarized financial information is presented only for the periods when the Company owned its investment.

(1) Net income primarily related to unrealized gains on investments.

6. Intangible Assets

Intangible assets consisted of the following at September 30, 2017:

Intangible assets consisted of the following at December 31, 2016:

Amortization expense relating to intangible assets was $0.4 million and insignificant, respectively, for the nine months ended September 30, 2017 and 2016.

The following table shows the Company’s estimated future amortization expense related to intangible assets currently subject to amortization for the next five years.

7. Goodwill

The following represents a summary of changes in the Company’s carrying amount of goodwill for the nine months ended September 30, 2017 (in thousands):

8. Warranty Reserves

In most instances, the Company’s digital projection products are covered by the manufacturing firm’s original warranty; however, for certain customers the Company may grant warranties in excess of the manufacturer’s warranty for digital products. In addition, the Company provides warranty coverage on screens it manufactures. The Company accrues for these costs at the time of sale. The following table summarizes warranty activity for the three and nine months ended September 30, 2017 and 2016:

9. Debt

The Company’s long-term debt consists of the following (in thousands):

On April 27, 2017, the Company entered into a debt agreement with a bank consisting of 1) a $2 million five-year term loan secured by a first lien deed of trust on the Company’s Alpharetta, GA facility, bearing interest at a fixed rate of 4.5% and payable in equal monthly installments of principal and interest calculated based on a 20-year amortization schedule with a final balloon payment of approximately $1.7 million due on May 10, 2022 and 2) a line of credit of up to $1 million secured by a second lien deed of trust on the Company’s Alpharetta, GA facility, bearing interest at the Prime Rate published in the Wall Street Journal plus 0.25% and with a term ending May 10, 2018. The debt agreement requires the Company to maintain a ratio of total liabilities to tangible net worth not in excess of 3:1 and maintain minimum liquidity of $2 million. The Company was in compliance with its debt covenants as of September 30, 2017. The Company had outstanding borrowings on the line of credit as of September 30, 2017 of $0.5 million, which is classified as short-term debt on the condensed consolidated balance sheet. The Company’s Chairman and Chief Executive Officer is also a member of the bank’s board of directors.

On September 5, 2017, the Company’s Canadian subsidiary, Strong/MDI, entered into a demand credit agreement with a bank consisting of a revolving line of credit for up to CDN$3.5 million (approximately USD$2.8 million) subject to a borrowing base requirement, a 20-year installment loan for up to CDN$6.0 million (approximately USD$4.8 million) and a 5-year installment loan for up to CDN$500,000 (approximately USD$400,000). Amounts outstanding under the line of credit are payable on demand and will bear interest at the prime rate established by the lender. Amounts outstanding under the installment loans will bear interest at the prime rate plus 0.5% and are payable in monthly installments, including interest, over their respective borrowing periods. The lender may also demand repayment of the installment loans at any time. The Strong/MDI credit facilities are secured by a lien on Strong/MDI’s Quebec, Canada facility and substantially all of Strong/MDI’s assets. The credit agreement requires Strong/MDI to maintain a ratio of liabilities to “effective equity” (tangible stockholders’ equity, less amounts receivable from affiliates and equity method investments) not exceeding 2 to 1, a current ratio (excluding amounts due from related parties) of at least 1.5 to 1 and minimum “effective equity” of CDN$8.0 million (approximately USD$6.4 million). There were no borrowings outstanding at September 30, 2017 on any of the Strong/MDI credit facilities, as Strong/MDI had not yet drawn on the facilities. Strong/MDI was in compliance with its debt covenants as of September 30, 2017.

Scheduled repayments are as follows for the Company’s long-term debt outstanding as of September 30, 2017 (in thousands):

10. Income Taxes

In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. The Company considers the scheduled reversal of taxable temporary differences, projected future taxable income and tax planning strategies in making this assessment. A cumulative loss in a particular tax jurisdiction in recent years is a significant piece of evidence with respect to the realizability that is difficult to overcome. Based on the available objective evidence, including recent updates to the taxing jurisdictions generating income, the Company concluded that a valuation allowance should be recorded against all of the Company’s U.S. tax jurisdiction deferred tax assets as of September 30, 2017 and December 31, 2016.

The Company is subject to examination for Federal purposes for fiscal years 2014, 2015 and 2016. In most cases, the Company is subject to examinations by state or local jurisdictions based on the particular jurisdiction’s statute of limitations.

11. Stock Compensation

The Company recognizes compensation expense for all stock-based payment awards made to employees and directors based on their estimated grant date fair values. Stock-based compensation expense included in selling and administrative expenses approximated $0.2 million and $0.1 million for the three months ended September 30, 2017 and 2016, respectively, and $0.5 million and $0.4 million, respectively, for the nine months ended September 30, 2017 and 2016, respectively.

Equity Compensation Plans

The Company’s 2010 Long-Term Incentive Plan (“2010 Plan”) provided the Compensation Committee of the Board of Directors with the discretion to grant stock options, stock appreciation rights, restricted shares, restricted stock units, performance shares and performance units. Vesting terms varied with each grant and could be subject to vesting upon a “change in control” of the Company.

The Ballantyne Strong, Inc. 2014 Non-Employee Directors’ Restricted Stock Plan (the “2014 Non-Employee Plan”) provided for the award of restricted shares to outside directors. Shares issued under the 2014 Non-Employee Plan vested the day preceding the Company’s Annual Meeting of Stockholders in the year following issuance. The 2010 Plan and the 2014 Non-Employee Plan were replaced during the second quarter of 2017 by the 2017 Omnibus Equity Compensation Plan (“2017 Plan”), and therefore, no additional awards will be granted under the 2010 Plan or the 2014 Non-Employee Plan.

The 2017 Plan was approved by the Company’s shareholders at the annual meeting on June 15, 2017, and provides the Compensation Committee of the Board of Directors with the discretion to grant stock options, stock appreciation rights, restricted shares, restricted stock units, performance shares, performance units and other share-based awards and cash-based awards. Vesting terms vary with each grant and may be subject to vesting upon a “change in control” of the Company. The total number of shares reserved for issuance under the 2017 Plan is 1,371,189 shares.

Options

The Company granted a total of 435,000 and 100,000 options during the nine month periods ended September 30, 2017 and 2016, respectively. Options to purchase shares of common stock were granted with exercise prices equal to the fair value of the common stock on the date of grant.

The weighted average grant date fair value of stock options granted during the nine month periods ended September 30, 2017 and 2016 was $2.42 and $1.42, respectively. The fair value of each stock option granted was estimated on the date of grant using a Black-Scholes valuation model with the following weighted average assumptions:

The risk-free interest rate assumptions were based on the U.S. Treasury yield curve in effect at the time of the grant. During 2017, the expected volatility was based on historical daily price changes of the Company’s stock for six years prior to the date of grant. During 2016, the Company used a one year period to calculate volatility, but updated this assumption in the current year to align the expected volatility with the expected life of the options. The expected life of options is the average number of years the Company estimates that options will be outstanding.

The following table summarizes stock option activity for the nine months ended September 30, 2017:

The aggregate intrinsic value in the table above represents the total that would have been received by the option holders if all in-the-money options had been exercised and sold on September 30, 2017.

As of September 30, 2017, 785,000 stock option awards were non-vested. Unrecognized compensation cost related to stock option awards was approximately $1.5 million, which is expected to be recognized over a weighted average period of 4.1 years.

Restricted Stock

The Company estimates the fair value of restricted stock awards based upon the market price of the underlying common stock on the date of grant. As of September 30, 2017, the total unrecognized compensation cost related to non-vested restricted stock awards was approximately $0.6 million, which is expected to be recognized over a weighted average period of 1.9 years.

The following table summarizes restricted share activity for the nine months ended September 30, 2017:

The following table summarizes restricted stock unit activity for the nine months ended September 30, 2017:

12. Commitments, Contingencies and Concentrations

Litigation

In the ordinary course of business operations, we are involved, from time to time, in certain legal disputes. No such disputes, individually or in the aggregate, are expected to have a material effect on our business or financial condition.

Concentrations

The Company’s top ten customers accounted for approximately 53.7% and 50.1% of total consolidated net revenues for the three and nine months ended September 30, 2017, respectively. Trade accounts receivable from these customers represented approximately 41.2% of net consolidated receivables at September 30, 2017. While the Company believes its relationships with such customers are stable, most arrangements are made by purchase order and are terminable at will by either party. A significant decrease or interruption in business from the Company’s significant customers could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company could also be adversely affected by such factors as changes in foreign currency rates and weak economic and political conditions in each of the countries in which the Company sells its products.

Financial instruments that potentially expose the Company to a concentration of credit risk principally consist of accounts receivable. The Company sells product to a large number of customers in many different geographic regions. To minimize credit concentration risk, the Company performs ongoing credit evaluations of its customers’ financial condition.

Leases

The Company and its subsidiaries lease plant and office facilities, furniture, autos and equipment under operating leases expiring through 2022. These leases generally contain renewal options and the Company expects to renew or replace certain of these leases in the ordinary course of business.

The Company’s future minimum lease payments for leases at September 30, 2017 are as follows:

13. Business Segment Information

As of September 30, 2017, the Company’s operations were conducted principally through two business segments: Cinema and Digital Media. Cinema operations include the sale of digital projection equipment, screens and sound systems. Digital Media operations include the delivery of end to end digital signage solutions, video communication solutions, content creation and management and service of digital signage and digital cinema equipment. The Company allocates resources to business segments and evaluates the performance of these segments based upon reported segment operating profit. The Company records intersegment sales at cost and has eliminated all significant intersegment sales in consolidation. The results of discontinued operations are excluded from the Cinema segment information below.

Summary by Business Segments

Summary by Geographical Area

Net revenues by business segment are to unaffiliated customers. Identifiable assets by geographical area are based on location of facilities. Net sales by geographical area are based on destination of sales.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this report. Management’s discussion and analysis contains not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements that are not historical are forward-looking and reflect expectations for future Company performance. For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve a number of risks and uncertainties, including but not limited to those discussed in the “Risk Factors” section contained in Item 1A in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2016 and the following risks and uncertainties: the Company’s ability to expand its revenue streams, potential interruptions of supplier relationships or higher prices charged by suppliers, the Company’s ability to successfully compete and introduce enhancements and new features that achieve market acceptance and that keep pace with technological developments, the Company’s ability to successfully execute its capital allocation strategy, the Company’s ability to retain or replace its significant customers, the impact of a challenging global economic environment or a downturn in the markets, economic and political risks of selling products in foreign countries, risks of non-compliance with U.S. and foreign laws and regulations, cybersecurity risks and risks of damage and interruptions of information technology systems, the Company’s ability to retain key members of management and successfully integrate new executives, the Company’s ability to assert its intellectual property rights, the impact of natural disasters and other catastrophic events, the adequacy of insurance and the impact of having a controlling stockholder. Given the risks and uncertainties, readers should not place undue reliance on any forward-looking statement and should recognize that the statements are predictions of future results which may not occur as anticipated. Actual results could differ materially from those anticipated in the forward-looking statements and from historical results, due to the risks and uncertainties described herein, as well as others not now anticipated. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Except where required by law, the Company assumes no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements.

Overview

Ballantyne Strong, Inc. (“BTN”, “Ballantyne”, “the Company”, “we”, “our” and “us”) is a holding company with diverse business activities focused on serving the cinema, retail, financial and government markets. The Company and its subsidiaries design, integrate and install technology solutions for a broad range of applications; develop and deliver out-of-home messaging, advertising and communications; manufacture projection screens; and provide managed services including monitoring of networked equipment to our customers. We add value through our design, engineering, manufacturing excellence and customer service.

We conduct our operations through two primary business segments: Cinema and Digital Media. The Cinema segment provides a full range of product solutions primarily for the theater exhibition industry, including a wide spectrum of premier audio-visual products and accessories such as digital projectors, state of the art projection screens, servers, library management systems, menu boards, flat panel displays and sound systems. The Digital Media segment delivers solutions and services across two primary markets: digital out-of-home and cinema. While there is digital signage and cinema equipment sold within this segment, the primary focus of this segment is providing solutions and services to our customers.

Our segments were determined based on the manner in which management organizes segments for making operating decisions and assessing performance. Approximately 48% of our revenues for the nine months ended September 30, 2017 were from Cinema and approximately 52% were from Digital Media. Additional information related to our reporting segments can be found in the notes to the condensed consolidated financial statements.

On June 23, 2016, the Company’s Board of Directors approved a plan to pursue a sale of the operations conducted by its subsidiaries SWBTI and SWI (the “China Operations”) which have historically been included in the Cinema segment. The purpose of the plan was to focus the efforts of the Company on the business units that have opportunities for higher return on invested capital. We reflected the results of the China Operations as discontinued operations for all periods presented. The assets and liabilities of the China Operations have been reclassified as assets and liabilities held for sale in the condensed consolidated balance sheets for all periods presented.

On November 4, 2016, the Company sold SWBTI to GABO Filter, Inc. for total proceeds of $0.4 million. As a result of this sale the Company recorded a loss on disposal of discontinued operations of approximately $0.6 million in the fourth quarter of 2016, which was included in net income from discontinued operations. The sale of SWI was completed on May 17, 2017 for total proceeds of $0.1 million. We recorded an insignificant gain on the sale of the business.

Results of Operations:

Three Months Ended September 30, 2017 Compared to the Three Months Ended September 30, 2016

Revenues

Net revenues during the three months ended September 30, 2017 increased 4.8% to $19.6 million from $18.7 million during the three months ended September 30, 2016.

Cinema

Sales of cinema products and services decreased 21.6% to $8.7 million in the third quarter of 2017 from $11.1 million in the third quarter of 2016. This decrease was driven by decreased sales of projectors, lamp products and screen support systems, partially offset by slight increases in sales of screens and digital parts. In July 2017, we terminated our distributorship for certain cinema lamp products due to the very low margins earned on these products, and we expect this to result in a further decrease in revenues. The lamp products were expected to generate approximately $1.5 million in revenues during the fourth quarter of 2017.

Digital Media

Sales of digital media products and services increased 40.1% to $11.1 million in the third quarter of 2017 from $7.9 million in the third quarter of 2016. This increase was driven by increased sales of digital signage equipment and installation services.

Export Revenues

Sales outside the United States (primarily from the cinema segment) increased to $4.2 million in the third quarter of 2017 from $4.0 million a year ago resulting primarily from increased sales in China and Latin America. Export sales are sensitive to worldwide economic and political conditions that lead to volatility. Certain areas of the world are more cost conscious than the U.S. market and there are instances where our products are priced higher than local manufacturers, making it more difficult to generate sufficient profit to justify selling into these regions. Additionally, foreign exchange rates and excise taxes sometimes make it difficult to market our products overseas at reasonable selling prices.

Gross Profit

Consolidated gross profit increased to $5.3 million, or 27.2% as a percentage of revenues, in the third quarter of 2017 compared to $4.4 million, or 23.4% as a percentage of revenues, in the third quarter of 2016. Gross profit in the cinema segment increased to $3.1 million, or 35.2% as a percentage of revenues, in the third quarter of 2017 from $2.7 million, or 24.8% as a percentage of revenues, in the third quarter of 2016. This increase in gross margin as a percentage of revenue was driven by product mix, as screen sales, which carry a higher margin, comprised a greater percentage of total revenue. Gross margin percentage was also impacted by higher screen warranty expense in the third quarter of the prior year. Gross profit dollars in the cinema segment are not expected to be significantly impacted by our termination of our cinema lamp product distributorship discussed above, due to the very low margins that we earned on the lamps.

The gross profit in the digital media segment increased to $2.2 million, or 20.3% as a percentage of revenues, in the third quarter of 2017 from $1.6 million or 20.6% as a percentage of revenues in the third quarter of 2016. The increase in gross profit dollars was driven by the increases in revenue described above.

Selling Expenses

Selling expenses increased 15.1% to $1.3 million in the third quarter of 2017 compared to $1.1 million a year-ago and as a percentage of revenues increased to 6.6% from 6.0% a year-ago. The increase in selling expenses was primarily due to a $0.1 million increase in employee-related costs, along with higher external commission and tradeshow expenses.

Administrative Expenses

Administrative expenses increased 16.1% to $3.5 million in the third quarter of 2017 from $3.0 million in the third quarter of 2016 and as a percent of total revenue increased to 17.8% in the third quarter of 2017 from 16.0% in the third quarter of 2016. This increase was primarily driven by a $0.3 million increase in consulting and software licensing costs associated with our CRM and ERP systems implementation and $0.2 million in bad debt expense, partially offset by a decrease of $0.2 million in employee-related costs primarily due to lower bonus expense.

Other Financial Items

The third quarter of 2017 includes total other expense of $0.4 million primarily consisting of foreign currency transaction losses. Other expense during the third quarter of 2016 was insignificant.

The effective tax rate differs from the statutory rates primarily as a result of the valuation allowance recorded against the Company’s U.S. tax jurisdiction deferred tax assets and differing foreign and U.S. tax rates applied to respective pre-tax earnings by tax jurisdiction.

The third quarter of 2017 includes equity method investment losses of $0.8 million, consisting of a $1.0 million loss from Itasca, partially offset by income of $0.2 million from PIH and $0.1 million from RELM. Equity method investment income in the third quarter of 2016 was not significant.

As a result of the items outlined above, we generated net losses from continuing operations of approximately $1.0 million and basic and diluted losses per share from continuing operations of $0.07 in the third quarter of 2017, compared to net losses from continuing operations of $0.5 million and basic and diluted losses per share from continuing operations of $0.03 in the third quarter of 2016.

Nine Months Ended September 30, 2017 Compared to the Nine Months Ended September 30, 2016

Revenues

Net revenues during the nine months ended September 30, 2017 increased 1.0% to $56.9 million from $56.3 million during the nine months ended September 30, 2016.

Cinema

Sales of cinema products and services decreased 14.0% to $27.6 million in the first nine months of 2017 from $32.1 million in the first nine months of 2016. This decrease was driven by lower sales of digital projectors, lamps and screens, partially offset by higher sales of digital displays, digital parts and servers.

Digital Media

Sales of digital media products and services increased 16.2% to $29.5 million in the first nine months of 2017 from $25.4 million in the first nine months of 2016. This increase was driven by increased installation, digital signage as a service (“DSaaS”) and nonrecurring maintenance revenues, partially offset by decreased recurring maintenance contract revenue.

Export Revenues

Sales outside the United States (primarily from the cinema segment) increased slightly to $12.2 million for the first nine months of 2017 from $12.1 million in 2016. Increased sales in Canada and Asia were mostly offset by decreased sales in Mexico and Europe. Certain areas of the world are more cost conscious than the U.S. market and there are instances where our products are priced higher than local manufacturers, making it more difficult to generate sufficient profit to justify selling into these regions. Additionally, foreign exchange rates and excise taxes sometimes make it difficult to market our products overseas at reasonable selling prices.

Gross Profit

Consolidated gross profit was $15.0 million, or 26.4% as a percentage of revenues, in the first nine months of 2017 and $15.8 million, or 28.0% as a percentage of revenues, in the first nine months of 2016. Gross profit in the cinema segment decreased to $8.7 million, or 31.4% as a percentage of revenues, in the first nine months of 2017 from $10.0 million, or 31.2% as a percentage of revenues, in the first nine months of 2016. The decrease in gross margin dollars was caused by the lower revenues described above.

The gross profit in the digital media segment increased to $6.3 million, or 21.5% of revenues, in the first nine months of 2017 from $5.8 million, or 22.7% of revenues, in the first nine months of 2016. The increase in gross margin dollars was caused by the higher revenues described above, while the slight decrease in gross margin percentage was caused by lower margins on nonrecurring maintenance revenue.

Selling Expenses

Selling expenses increased 27.4% to $4.2 million in the first nine months of 2017 compared to $3.3 million in the first nine months of 2016 and as a percentage of revenues increased to 7.4% from 5.9% in the same period of the prior year. The increase in selling expenses was primarily due to increased employee-related costs and external commissions.

Administrative Expenses

Administrative expenses increased 28.3% to $11.7 million in the first nine months of 2017 from $9.1 million in the first nine months of 2016, and as a percentage of total revenue increased to 20.6% in the first nine months of 2017 from 16.2% in the first nine months of 2016. This increase was driven by a $0.9 million increase in consulting and software licensing costs associated with our CRM and ERP systems implementation, $0.7 million in bad debt expense, a $0.8 million increase in audit and legal expenses primarily related to the restatement of our 2016 financial statements and our internal control remediation efforts and a $0.2 million increase in employee-related costs.

Other Financial Items

The first nine months of 2017 includes total other expense of $0.5 million, consisting primarily of foreign currency transaction losses and interest expense. The first nine months of 2016 includes total other expense of $0.8 million, primarily consisting of $1.0 million of net losses on foreign currency transactions and $0.4 million of decrease in market value of marketable securities, partially offset by $0.5 million of excess joint venture distributions recognized as income.

The effective tax rate differs from the statutory rates primarily as a result of the valuation allowance recorded against the Company’s U.S. tax jurisdiction deferred tax assets and differing foreign and U.S. tax rates applied to respective pre-tax earnings by tax jurisdiction.

The first nine months of 2017 includes equity method investment income of $1.5 million, consisting of $1.3 million from Itasca and $0.2 million from PIH. The first nine months of 2016 included equity method investment income of $0.1 million, consisting of $0.2 million from RELM, partially offset by losses of $0.1 million on Itasca.

As a result of the items outlined above, we generated net losses from continuing operations of approximately $2.6 million and basic and diluted losses per share from continuing operations of $0.18 in the first nine months of 2017, compared to net income from continuing operations of $0.5 million and basic and diluted earnings per share from continuing operations of $0.03 for the first nine months of 2016.

Results of Discontinued Operations

Our discontinued operations related to our former China Operations generated an after tax loss of $49 thousand and negligible basic and diluted loss per share in the first nine months of 2017, compared to an after tax loss of $0.7 million and basic and diluted loss per share of $0.05 in the first nine months of 2016.

Liquidity and Capital Resources

During the past several years, we have primarily met our working capital and capital resource needs from our operating cash flows. We believe that our existing sources of liquidity, including cash and cash equivalents, credit facilities and operating cash flow, will be sufficient to meet our projected capital needs for the foreseeable future. On April 27, 2017, we entered into a debt agreement with a bank consisting of 1) a $2 million five-year term loan secured by a first lien deed of trust on our Alpharetta, GA facility, bearing interest at a fixed rate of 4.5% and payable in equal monthly installments of principal and interest calculated based on a 20-year amortization schedule with a final balloon payment of approximately $1.7 million due on May 10, 2022 and 2) a line of credit of up to $1 million secured by a second lien deed of trust on our Alpharetta, GA facility, bearing interest at the Prime Rate published in the Wall Street Journal plus 0.25% and with a term ending May 10, 2018. Under the debt agreement, we must maintain a ratio of total liabilities to tangible net worth not in excess of 3 to 1 and maintain minimum liquidity of $2 million. At September 30, 2017, the balance of the term loan including current maturities was $1.98 million. We also had outstanding borrowings on our line of credit of $0.5 million and had the ability to borrow up to an additional $0.5 million. At September 30, 2017, we were in compliance with our debt covenants.

On September 5, 2017, our Canadian subsidiary, Strong/MDI, entered into a demand credit agreement with a bank consisting of a revolving line of credit for up to CDN$3.5 million (approximately USD$2.8 million) subject to a borrowing base requirement, a 20-year installment loan for up to CDN$6.0 million (approximately USD$4.8 million) and a 5-year installment loan for up to CDN$500,000 (approximately USD$400,000). Amounts outstanding under the line of credit are payable on demand and will bear interest at the prime rate established by the lender. Amounts outstanding under the installment loans will bear interest at the prime rate plus 0.5% and are payable in monthly installments, including interest, over their respective borrowing periods. The lender may also demand repayment of the installment loans at any time. The Strong/MDI credit facilities are secured by a lien on Strong/MDI’s Quebec, Canada facility and substantially all of Strong/MDI’s assets. The credit agreement requires Strong/MDI to maintain a ratio of liabilities to “effective equity” (tangible stockholders’ equity, less amounts receivable from affiliates and equity method investments) not exceeding 2 to 1, a current ratio (excluding amounts due from related parties) of at least 1.5 to 1 and minimum “effective equity” of CDN$8.0 million (approximately USD$6.4 million). There were no borrowings outstanding at September 30, 2017 on any of the Strong/MDI credit facilities, as Strong/MDI had not yet drawn on the facilities. Strong/MDI was in compliance with its debt covenants as of September 30, 2017.

We ended the third quarter with total cash and cash equivalents of $4.0 million, compared to $7.6 million at December 31, 2016. As of September 30, 2017, $2.5 million of the $4.0 million in cash and cash equivalents was held by our foreign subsidiary. If these funds are needed for our operations in the U.S., we would be required to pay U.S. income taxes and foreign withholding taxes on a portion of these funds when repatriated back to the U.S.

Cash Flows from Operating Activities

Net cash used in operating activities from continuing operations was $0.9 million in the first nine months of 2017, which included net losses from continuing operations of $2.6 million and $1.5 million of equity method investment earnings, partially offset by $3.7 million of other net non-cash charges. Changes in working capital decreased cash from operating activities of continuing operations by $0.5 million, primarily due to decreases in accrued expenses and customer deposits, partially offset by increases in accounts payable.

Net cash used in operating activities from continuing operations was $0.5 million in the first nine months of 2016, which included net income from continuing operations of $0.5 million and net non-cash charges totaling $1.8 million. Changes in working capital decreased cash from operating activities of continuing operations by $2.8 million, primarily due an increase in inventories and a decrease in current income taxes payable. Inventories increased $0.7 million primarily due to timing of customer orders at the end of the quarter. Current income taxes decreased $1.7 million primarily due to payments for Canadian income taxes.

Net cash used in operating activities of discontinued operations was $0.1 million in the first nine months of 2017 compared to $1.6 million in the first nine months of 2016, as the significant discontinued operations were divested in the fourth quarter of 2016.

Cash Flows from Investing Activities

Net cash used in investing activities was $5.2 million in the first nine months of 2017 primarily due to $2.5 million used in purchases of equity securities and $2.9 million for capital expenditures. Net cash used in investing activities amounted to $5.0 million in the first nine months of 2016 primarily due to $4.1 million used in purchases of equity securities and $1.1 million for capital expenditures.

Cash Flows from Financing Activities

Net cash provided by financing activities was $2.2 million in the first nine months of 2017 due to $2.5 million of proceeds from issuance of debt, offset slightly by $0.1 million of treasury stock purchases and $0.2 million of capital lease payments.

Net cash used in financing activities in the first nine months of 2016 was $0.3 million and primarily for purchase of treasury stock and payments on capital leases.

The effect of changes in foreign exchange rates from continuing operations increased cash and cash equivalents by $0.3 million and $0.8 million in the first nine months of 2017 and 2016, respectively.

Hedging and Trading Activities

Our primary exposure to foreign currency fluctuations pertains to our subsidiary in Canada. In certain instances, we may enter into a foreign exchange contract to manage a portion of this risk. We do not have any trading activities that include non-exchange traded contracts at fair value.

Off Balance Sheet Arrangements and Contractual Obligations

The future estimated payments under these arrangements are summarized below along with our other contractual obligations (in thousands):

There were no other material contractual obligations other than inventory and property, plant and equipment purchases in the ordinary course of business.

Seasonality

Generally, our quarterly revenue and earnings fluctuate moderately from quarter to quarter. As we increase our sales in our current markets, and as we expand into new markets in different geographies, it is possible we may experience different seasonality patterns in our business. As a result, the results of operations for the three months and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for an entire fiscal year.

Recently Issued Accounting Pronouncements

See Note 3, Summary of Significant Accounting Policies to the condensed consolidated financial statements for a description of recently issued accounting pronouncements.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements in conformity with U.S. generally accepted accounting principles, management must make a variety of decisions which impact the reported amounts and the related disclosures. These decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In making these decisions, management applies its judgment based on its understanding and analysis of the relevant circumstances and our historical experience.

Our accounting policies and estimates that are most critical to the presentation of our results of operations and financial condition, and which require the greatest use of judgments and estimates by management, are designated as our critical accounting policies. See further discussion of our critical accounting policies under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K/A for our year ended December 31, 2016. We periodically re-evaluate and adjust our critical accounting policies as circumstances change. There were no significant changes in our critical accounting policies during the nine months ended September 30, 2017.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The principal market risks affecting us are exposure to interest rates and foreign currency exchange rates. We market our products throughout the United States and the world. As a result, we could be adversely affected by such factors as changes in foreign currency rates and weak economic conditions. As a majority of our sales are currently denominated in U.S. dollars, a strengthening of the dollar can and sometimes has made our products less competitive in foreign markets.

Interest Rates—Interest rate risks from our interest related accounts such as our postretirement obligations are not deemed significant. We currently have long-term notes receivables, recorded at fair value, bearing interest rates of 15% and long-term debt with an interest rate of 4.5%. A change in long-term interest rates for comparable types of instruments would have the effect of us recording changes in fair value of the notes receivable through our statement of operations.

Foreign Exchange—Exposures to transactions denominated in currencies other than the entity’s functional currency are primarily related to our Canadian subsidiary. Fluctuations in the value of foreign currencies create exposures, which can adversely affect our results of operations. From time to time, as market conditions indicate, we will enter into foreign currency contracts to manage the risks associated with forecasted transactions. A portion of our cash in our Canadian subsidiary is denominated in foreign currencies, where fluctuations in exchange rates will impact our cash balances in U.S. dollar terms. A hypothetical 10% change in the value of the U.S. dollar would impact our reported cash balance by approximately $0.2 million.

Equity Price Risk—We are exposed to price risk related to our investments in equity securities. At September 30, 2017, our carrying value of investments in equity securities aggregated $17.6 million, all of which were accounted for using the equity method. The fair value of these investments was $16.0 million at September 30, 2017. A change in the equity price of the equity method investments would result in a change in the fair value or economic value of such securities.

Item 4. Controls and Procedures

The Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report, the Company’s disclosure controls and procedures were ineffective, due to the material weaknesses described below.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

During the fourth quarter of fiscal 2016, we implemented a new integrated Customer Relationship Management (CRM) system and a new enterprise resource planning (ERP) system including inventory management and financial reporting modules that will upgrade and standardize our information systems. We have completed the implementation with respect to some of our subsidiaries and plan to continue to roll out the CRM and ERP system modules over the next year for certain of our other subsidiaries. Therefore, as appropriate, we modified the design and are still in the process of updating certain documentation of internal control processes and procedures to supplement and complement existing internal controls over financial reporting to accommodate the system changes. The CRM and ERP resulted in changes that materially affected our system of internal control over financial reporting during the three months ended December 31, 2016. As a result, our controls over system access were not fully aligned with our functional segregation of duties. During the nine months ended September 30, 2017, we made progress in aligning our system access with our functional segregation of duties for certain of our subsidiaries. However, our system access was not yet fully aligned with our functional segregation of duties as of September 30, 2017.

In the course of our preparations for making management’s report on internal control over financial reporting in our most recent Form 10-K as required by Section 404 of the Sarbanes-Oxley Act of 2002, we identified areas in need of improvement and have taken remedial actions to strengthen the affected controls as appropriate. One such area was our documentation of business processes, procedures and internal controls for one of our subsidiaries that enters into arrangements with its customers involving multiple deliverables which affects revenue recognition. As of December 31, 2016, we were still in the process of updating our documentation as resource constraints stemming from the aforementioned CRM and ERP implementation have delayed our efforts in making these updates. We evaluated our current documentation over revenue recognition for arrangements with multiple deliverables and concluded it was not sufficient to ensure internal controls over this accounting were effective. We believe this deficiency in aggregate with the aforementioned deficiency stemming from our CRM and ERP system segregation of duties result in a material weakness which may have a material effect on our internal control over financial reporting impacting controls over revenue recognition.

We plan to continue to implement the CRM and other significant modules of the ERP in these and other subsidiaries in the coming years, as we believe these changes will simplify our business processes and system of internal control over financial reporting. In connection with these and future enhancements, the Company will update its internal controls over financial reporting, as necessary, to accommodate any modification to its business processes and procedures.

In addition, during the preparation of its Form 10-Q for the quarter ended March 31, 2017, management of the Company identified two misstatements in the Company’s previously issued consolidated financial statements for the year ended December 31, 2016. The first misstatement related to approximately $477,000 of maintenance service revenue that was pre-billed at a customer’s request, but related to services not completed by December 31, 2016. This revenue was improperly recognized during the year ended December 31, 2016. The second misstatement related to earnings at one of the Company’s Canadian subsidiaries that would be subject to a withholding tax if repatriated to the U.S. The Company improperly excluded earnings to the extent of certain intercompany loans between its Canada and U.S. entities from its provision for deferred income taxes, resulting in an understatement of deferred income tax expense of approximately $238,000.

The Company has restated its Consolidated Balance Sheet as of December 31, 2016, and the related Consolidated Statement of Operations, Consolidated Statement of Comprehensive (Loss) Income, Consolidated Statement of Stockholders’ Equity and Consolidated Statement of Cash Flows for the year then ended to correct the misstatements described above. We determined our controls over cutoff for maintenance service revenues were insufficient, resulting in a material weakness that had a material effect on our internal control over financial reporting impacting revenue recognition.

During the nine months ended September 30, 2017, we engaged a consulting firm to assist us in evaluating our internal controls, including controls over cutoff for maintenance service revenues and updating our documentation, including documentation related to arrangements with customers involving multiple deliverables. This engagement is expected to continue into late 2017. During the nine months ended September 30, 2017, we implemented additional controls to address deficiencies regarding revenue recognition. We expect to fully remediate the above-mentioned material weaknesses before the end of the fiscal year ending December 31, 2017.

The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated any change during the fiscal quarter for the period covered by this report and have concluded that, except for controls implemented to address the deficiencies as described above, there has been no other change that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. Other Information

Item 1. Legal Proceedings

In the ordinary course of business operations, we are involved, from time to time, in certain legal disputes. No such disputes, individually or in the aggregate, are expected to have a material effect on our business or financial condition.

Item 1A. Risk Factors

Item 1A “Risk Factors” in our Annual Report on Form 10-K/A for the year ended December 31, 2016 includes a detailed discussion of the Company’s risk factors. There have been no material changes to the risk factors as previously disclosed.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On August 20, 2015, we announced that our Board of Directors adopted a stock repurchase program authorizing the repurchase of up to 700,000 shares of our outstanding Common Stock pursuant to a plan adopted under Rule 10b5-1 of the Securities Exchange Act of 1934 (as amended). The repurchase program has no expiration date. There were no repurchases during the three months ended September 30, 2017. As of September 30, 2017, there were 637,006 shares that may yet be purchased under the stock repurchase program.

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.