LENDWAY, INC. - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

_______________________________

FORM 10-Q

☒     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the quarterly period ended September 30, 2022

or

☐     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the transition period from ___________ to ____________

Commission File Number:  1-13471

Securities registered to Section 12(b) of the Act:

        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 12 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 ☒     No ☐ 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒     No ☐

 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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:

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 ☒ 

Number of shares outstanding of Common Stock, $.01 par value, as of November 7, 2022 was 1,796,506.

Insignia Systems, Inc.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Insignia Systems, Inc.

Notes To Financial Statements

(Unaudited)

1. Summary of Significant Accounting Policies.

Description of Business. Insignia Systems, Inc. (the “Company”) is a leading provider of in-store solutions to consumer-packaged goods (“CPG”) manufacturers, retailers, shopper marketing agencies and brokerages. The Company operates in a single reportable segment. The Company’s leadership and employees have extensive industry knowledge with direct experience in both CPG manufacturers and retailers. The Company provides marketing solutions to CPG manufacturers spanning from some of the largest multinationals to new and emerging brands.  The Company’s primary solutions are merchandising solutions, on-pack solutions and signage.

Basis of Presentation. The accompanying unaudited condensed financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Securities and Exchange Commission (“SEC”) Regulation S-X. They do not include all information and footnotes required by U.S. GAAP for complete financial statements. However, except as described herein, there has been no material change in the information disclosed in the notes to financial statements included in the Company’s financial statements as of and for the year ended December 31, 2021 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 9, 2022 (the Form 10-K). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year.  The accompanying condensed balance sheet as of December 31, 2021 has been derived from the audited balance sheet as of December 31, 2021 contained in the Form 10-K. 

As discussed in Note 6, the Company settled a lawsuit and recorded a net pre-tax gain from litigation settlement of $12,000,000 in operations in the three months ended September 30, 2022.

Cash and Cash Equivalents and Restricted Cash.  The following table provides a reconciliation of cash, cash equivalents and restricted cash to amounts shown in the statement of cash flows:

Included in cash and cash equivalents is a U.S. Treasury Bill with a carrying value of $11,100,000.

Inventories. Inventories are primarily comprised of sign cards and hardware. Inventory is valued at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method.

Property and Equipment. Property and equipment consisted of the following:

Depreciation expense was approximately $15,000 and $46,000 in the three and nine months ended September 30, 2022, respectively, and was $14,000 and $46,000 in the three and nine months ended September 30, 2021, respectively.

Stock-Based Compensation. The Company measures and recognizes compensation expense for all stock-based payments at fair value. Restricted stock units and awards are valued at the closing market price of the Company’s stock as of the date of the grant. The Company uses the Black-Scholes option pricing model to determine the weighted average fair value of options and employee stock purchase plan rights. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as by assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

During the nine months ended September 30, 2022 and 2021, no equity awards were issued by the Company, except those awarded to non-employee members of the Board of Directors in August 2022 and in June 2021.

In August 2022, non-employee members of the Board of Directors received restricted stock grants totaling 6,248 shares pursuant to the 2018 Equity Incentive Plan (the “2018 Plan”). The shares underlying the awards were assigned a value of $9.60 per share, which was the closing price of the Company’s common stock on the date of grant, for a total grant date value of $60,000. The shares are scheduled to vest the day immediately preceding the date of the next annual shareholder meeting.

In June 2021, non-employee members of the Board of Directors received restricted stock grants totaling 5,514 shares pursuant to the 2018 Plan. The shares underlying the awards were assigned a value of $8.16 per share, which was the closing price of the Company’s common stock on the date of grant, for a total grant date value of $45,000. The shares vested on June 1, 2022.

Total stock-based compensation expense recorded for the three and nine months ended September 30, 2022 was $32,000 and $91,000, respectively, and for the three and nine months ended September 30, 2021 was $56,000 and $198,000, respectively.

Net Income (Loss) per Share. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average shares outstanding and excludes any potential dilutive effects of stock options and restricted stock units and awards. Diluted net income (loss) per share gives effect to all dilutive potential common shares outstanding during the period.

Options to purchase approximately 14,086 shares of common stock with a weighted average exercise price of $11.91 and $11.98, respectively, were outstanding at September 30, 2022 and were not included in the computation of common stock equivalents for the three and nine months ended September 30, 2022 because their exercise prices were higher than the average fair market value of the common stock during the reporting period.

Due to the net loss incurred during the three and nine months ended September 31, 2021 all outstanding stock options were anti-dilutive for those periods.  As of September 30, 2021 the Company had options to purchase 21,741 shares of common stock and 32,410 restricted stock units, each representing the contingent right to receive one share of common stock, outstanding.

Weighted average common shares outstanding:

2. Revenue Recognition. Under Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (“Topic 606”), revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to a customer and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer, as further described below under “Performance Obligations.”

Taxes collected from customers and remitted to governmental authorities are excluded from revenue on the net basis of accounting.

The Company includes shipping and handling fees in revenues. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of services.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The following is a description of the Company’s performance obligations included in its primary revenue streams and the timing or method of revenue recognition for each:

Merchandising, On-Pack, and Non-POPS Signage Solutions. The Company supplies CPG manufacturers with retailer approved promotional services, such as merchandising, on-pack, and signage solutions. These services are more customized than POPS, consisting of variable durations and variable specifications. Due to the variable nature of these services, revenue recognition is a mix of over-time and point-in-time recognition.

POPS Signage Solution Services. The Company provides a service of displaying promotional signs in close proximity to the CPG manufacturer’s product in participating stores, which the Company maintains in two-to-four-week cycle increments.

Each of the individual activities under the Company’s services, including production activities, are inputs to an integrated sign display service. Customers receive and consume the benefits from the promotional displays over the duration of the contracted display cycle. Additionally, the display of the signs does not have an alternative use to the Company and the Company has an enforceable right to payment for services performed to date. As a result, the Company recognizes the transaction price for service performance obligations as revenue over time. Given the nature of the Company’s performance obligations is to provide a display service over the duration of a specified period or periods, the Company recognizes revenue on a straight-line basis over the display service period as it best reflects the timing of transfer of its sign solutions.

Disaggregation of Revenue

In the following table, revenue is disaggregated by major revenue stream and timing of revenue recognition.

Contract Costs

Sales commissions that are paid to internal or external sales representatives are eligible for capitalization as they are incremental costs that would not have been incurred without entering into a specific sales arrangement and are recoverable through the expected margin on the transaction. The Company is applying the practical expedient in Accounting Standards Codification 340-40-25-4 that allows the incremental costs of obtaining a contract to be recorded as an expense when incurred when the amortization period of the asset that would have otherwise been recognized is one year or less. These costs are included in selling expenses.

Deferred Revenue

Deferred revenues represent amounts collected from customers in advance of the satisfaction of performance obligations.  Significant changes in deferred revenue during the period are as follows:

Transaction Price Allocated to Remaining Performance Obligations

The Company applies the practical expedient in paragraph 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less, which reflect the majority of its performance obligations. This practical expedient is being applied to arrangements for certain incomplete services and unshipped custom signage materials. Among our contracts with an expected duration of greater than one year, we anticipate that revenue of $28,000 and $57,000 related to performance obligations that are unsatisfied (or partially unsatisfied) as of September 30, 2022 will be recognized during the remainder of fiscal 2022 and 2023, respectively. 

3. Leases. As of September 30, 2022 the Company leases space under two non-cancelable operating leases for its corporate headquarters and for warehouse space. Both leases have escalating lease payment terms but neither contains a contingent rent provision. The Company also had a lease for additional office space under an operating lease that expired August 31, 2021. The leases for both the Company’s corporate headquarters and its warehouse include both lease and non-lease components which are accounted for as a single lease component as the Company has elected the practical expedient to group lease and non-lease components for all leases. The headquarters lease required the Company to provide a letter of credit, which is supported by $85,000 reflected as restricted cash on the balance sheet.

The Company’s leases include options to renew. The exercise of lease renewal options is at the Company’s sole discretion.  Therefore, the renewals to extend the lease terms are not included in the Company’s right of use assets and lease liabilities as they are not reasonably certain of exercise. The Company regularly evaluates the renewal options and when they are reasonably certain of exercise, the Company includes the renewal period in its lease term.

The Company used its incremental borrowing rate of approximately 4.8% in determining the present value of the lease payments based on the information available at the lease commencement date.

The cost components of the Company’s operating leases were as follows:

Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs which are paid based on actual costs incurred by the lessor.

Maturities of the Company’s lease liabilities for is corporate headquarters and its warehouse operating leases are as follows as of September 30, 2022:

The remaining lease terms as of September 30, 2022 for the Company’s corporate headquarters and its warehouse leases were 1.8 years and 0.5 years, respectively. The discount rate for both leases is 4.8%. The cash outflow for operating leases for the three and nine months ended September 30, 2022 was $21,000 and $62,000, respectively. The cash outflow for operating leases for the three and nine months ended September 30, 2021 was $15,000 and $76,000, respectively.

4. Income Taxes. For the three and nine months ended September 30, 2022, the Company recorded income tax benefit of $190,000 and $168,000, or (1.6)% and (1.6)% of income before taxes, respectively. For the three and nine months ended September 30, 2021, the Company recorded income tax expense of $9,000 and $32,000, or 1.0% and 1.3% of loss before taxes, respectively. The income tax expense or benefit for the three and nine months ended September 30, 2022 and 2021 is comprised of federal and state taxes. The primary differences between the Company’s September 30, 2022 and 2021 effective tax rates and the statutory federal rate are nondeductible stock-based compensation, nondeductible penalties and for 2021 increases in the Company’s valuation allowance against its deferred tax assets and for 2022 decreases in the Company’s valuation allowance against its deferred tax assets and decreases in the Company’s reserve for unrecognized tax benefits.

The Company reassesses its effective rate each reporting period and adjusts the annual effective rate if deemed necessary, based on projected annual taxable income (loss).

Deferred income taxes are determined based on the estimated future tax effects of differences between the financial statements and tax basis of assets and liabilities given the provisions of enacted tax laws. In providing for deferred taxes, the Company considers tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustment to the carrying value of deferred tax assets and liabilities may be required. Valuation allowances are recorded related to deferred tax assets based on the “more likely than not” criteria.

At September 30, 2022, and December 31, 2021, the Company had unrecognized tax benefits totaling $52,000 and $711,000, respectively, including interest, which relates to state nexus issues. The amount of the unrecognized tax benefits, if recognized, that would affect the effective income tax rates of future periods is $52,000. The Company recorded a decrease of approximately $679,000 in unrecognized tax benefits related to state income tax exposure in the third quarter of 2022, which reduced accrued income taxes and increased income tax benefit. The Company has determined it is no longer more likely than not that the Company will realize the tax expense.

At December 31, 2021, the Company had Federal net operating loss (NOL) to carry forward of approximately $9,700,000. As of September 30, 2022 the Company estimates remaining Federal NOL carryforwards to be approximately $2,000,000. The federal NOL utilization was limited to 80% of estimated taxable income. The estimated NOL carry-forward will be adjusted at year end for fourth quarter results.

5. Concentrations. During the nine months ended September 30, 2022, three customers accounted for 19%, 12% and 11% respectively, of the Company’s total net sales. During the nine months ended September 30, 2021, two customers accounted for 16% and 10% respectively, of the Company’s total net sales. At September 30, 2022, two customers represented 20% and 12% respectively, of the Company’s total accounts receivable. At December 31, 2021, two customers represented 25% and 19% of the Company’s total accounts receivable.

6. Legal Proceedings. In July 2019, the Company filed suit against News Corporation, News America Marketing FSI L.L.C., and News America Marketing In-Store Services L.L.C. (collectively, “News America”) in the U.S. District Court in Minnesota, alleging violations of federal and state antitrust and tort laws by News America.

On July 1, 2022, the Company entered into a $20 million settlement agreement with News America. The agreement memorializes the amicable settlement of the Company’s outstanding lawsuit against News America. The agreement resulted in net proceeds before income tax of $12,000,000 for the Company, which was recorded as a gain on litigation settlement in operations in the three months ended September 30, 2022.

7. Loan. In April 2020, the Company entered into a promissory note (the “Note”) with Alerus Financial, N.A. The Note evidenced a loan to the Company in the amount of $1,054,000 pursuant to the Paycheck Protection Program (the “PPP”) of the CARES Act administered by the U.S. Small Business Administration (the “SBA”).

In accordance with the requirements of the CARES Act, the Company used the proceeds from the loan exclusively for qualified expenses under the PPP, including payroll costs, rent and utility costs. Interest was accrued on the outstanding balance of the Note at a rate of 1.00% per annum. The Note was scheduled to mature on April 22, 2022 and required 18 equal monthly payments of principal and interest.

The Company’s application for forgiveness of the amount due under the Note, including accrued interest, was approved by the SBA on January 29, 2021. Accordingly, for the year ended December 31, 2021 the debt of $1,054,000, plus accrued interest of $8,000 was eliminated with a gain on debt extinguishment included in other income.

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

The following discussion should be read in conjunction with the Company’s financial statements and related notes. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated due to various factors discussed under “Cautionary Statement Regarding Forward-Looking Statements” and elsewhere, including Part II, Item 1A, in this Quarterly Report on Form 10-Q and the “Risk Factors” described in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, our Current Reports on Form 8-K and our other SEC filings.

Company Overview

Insignia Systems, Inc. (“Insignia,” “we,” “us,” “our” and the “Company”) was incorporated in Minnesota in 1990.  We are a leading provider of in-store advertising solutions to brands, retailers, shopper marketing agencies and brokerages (“clients”). We believe our products and services are attractive to our clients because of our ability to navigate the complex retail landscape, to customize our solutions down to store level, to execute with excellence and the results our solutions deliver. Our leadership and employees have extensive industry knowledge, including direct experience through former positions at consumer-packaged goods (“CPG”) manufacturers and retailers. We provide marketing solutions to brands spanning from some of the largest multinationals to new and emerging brands.

For retailers and brands working in an environment that is tighter, more competitive, and more complex every day, Insignia positions itself as the shopper marketing ally that combines best-in-class execution with imagination, responsiveness, and hunger to help move business forward. We take the relationships we have with our clients and vendor partnerships very seriously by having our team stretch the extra mile to ensure flawless execution. We sincerely approach our projects with the same passion as our clients do. These relationships are built with our brand-led, retailer centric mindset, our ability to be nimble and flexible to the ever-changing industry landscape and our delivery of superior customer service that our clients deserve. Our in-store solutions are executed in retailers spanning from some of the largest national retailers to regional US wholesalers and independents who are leaders in their respective channels and geographies. 

Up until 2020, our primary solution had been in-store signage, specifically Point-Of-Purchase Services (POPS®). The Insignia POPS solution is a national, account-specific, shelf-edge advertising and promotion tactic. Primarily as a result of competitive pressures and also due to COVID-19, our in-store signage business has declined and become less of a focus in our growth. Beginning in 2018 we began developing and offering an expanded portfolio of solutions including on-pack, merchandising and digital solutions in addition to our core business. Our expanded portfolio allows us to meet the needs of brands, retailers and their agents as their business strategies evolve behind an ever-changing retail landscape. Over the course of 2021 based on client feedback, business results and expanded team capabilities our primary focus is now on in-store solutions, resulting in our decision to exit digital solutions in addition to right-sizing our in-store signage portfolio. With our diversification of business, we now recognized over 90% of our revenue from these recently developed solutions in the nine months ended September 30, 2022.

Over the last two years we have significantly reduced operating costs and retailer commitments. In the last half of 2020 we outsourced most of our printing and IT operations. In 2021 we relocated our headquarters and operations, both to smaller, more efficient leased spaces, and also restructured operations in December 2021. These changes contributed to reduced expenses in the nine months ended September 30, 2022 and are expected to continue to drive savings for the remainder of 2022 compared to 2021.

On July 1, 2022, the Company entered into a $20 million settlement agreement with News America. The agreement memorializes the amicable settlement of the Company’s outstanding lawsuit against News America. The agreement resulted in net proceeds before income tax of $12,000,000 for the Company, which was recorded as a net pretax gain from litigation settlement in operations in the three months ended September 30, 2022.

We are also continuing to explore strategic options to maximize shareholder value. Potential strategic alternatives that may be evaluated include, but are not limited to, an acquisition, merger, business combination, in-licensing, or other strategic transaction. There can be no assurance that this process will result in any transaction.

Business Overview

Summary of Financial Results

For the quarter ended September 30, 2022, the Company generated net sales of $4,869,000, as compared with revenues of $3,493,000 for the quarter ended September 30, 2021. For the nine months ended September 30, 2022, the Company generated revenues of $14,271,000, as compared with revenues of $14,975,000 in the nine months ended September 30, 2021. Income before taxes for the quarter ended September 30, 2022 was $11,611,000, which included $12,000,000 from the net gain on litigation settlement, as compared to net loss before taxes of $912,000 for the quarter ended September 30, 2021. Income before tax for the nine months ended September 30, 2022 was $10,611,000, which included $12,000,000 from the net gain on litigation settlement, as compared to net loss before taxes of $2,520,000 for the nine months ended September 30, 2021.  Revenue from our non-POPS solutions increased significantly for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, partially offset by continued declines in our signage business due to competitive pressures.  For the nine months ended September 30, 2022 net sales have declined $704,000, primarily due to continued declines in our signage business, partially offset by increases in non-POPS solutions revenue.  During the first nine months of 2021, litigation expenses increased significantly compared to prior quarters. Litigation expenses for 2022 decreased in comparison to 2021 culminating with the litigation settlement on July 1, 2022.  We also recognized a gain of $1,062,000 on the forgiveness of our Paycheck Protection Program (“PPP”) loan during the first quarter of 2021.  Income tax benefit for the three and nine months ended September 30, 2022 included a benefit from a reduction in unrecognized tax benefits of $679,000, partially offset by income tax on income before tax.

During the nine months ended September 30, 2022, cash and cash equivalents and restricted cash increased $10,402,000 from $3,851,000 at December 31, 2021, to $14,253,000 at September 30, 2022, due to the proceeds from the litigation settlement. The Company had no debt other than its lease obligations at September 30, 2022. Working capital increased $10,284,000 from $3,716,000 at December 31, 2021 to $14,000,000 at September 30, 2022.

Results of Operations

The following table sets forth, for the periods indicated, certain items in our Condensed Statements of Operations as a percentage of total net sales.

Three and Nine months Ended September 30, 2022 Compared to Three and Nine months Ended September 30, 2021

Net Sales.  Net sales for the three months ended September 30, 2022 increased 39.4% to $4,869,000 compared to $3,493,000 for the three months ended September 30, 2021. Net sales for the nine months ended September 30, 2022 decreased 4.7% to $14,271,000 compared to $14,975,000 for the nine months ended September 30, 2021.  For the three months ended September 30, 2022 non-POPS revenue increased 100.7%, partially offset by a 81.4% decrease in POPS solutions revenue. For the nine months ended September 30, 2022, non-POPS revenue has increased 22.0%, partially offset by a 82.3% decrease in POPS solutions revenue.  The increase in non-POPS revenue is due to both new client acquisition as well as repeat business from existing clients.  Due to sales cycles within the retailers that our non-POPS solutions execute we anticipate seasonality in sales, with those sales being relatively stronger in the first quarter of the year. Our display business generally consists of larger contracts versus our historical signage business. As a result, our revenue may be prone to variances on a year over year basis.  Competitive pressures, including the expiration in April 2021 of our 10-year selling agreement with News America have resulted in decreased POPS solutions revenue for three and nine months ended September 30, 2022 versus the three and nine months ended September 30, 2021. We expect POPS revenue will continue to decline in 2022 in comparison to 2021 as we have reduced the number of stores in our network.

Gross Profit. Gross profit for the three months ended September 30, 2022 increased 53.8% to $838,000 compared to $545,000 for the three months ended September 30, 2021.  The increase in gross profit was primarily due to the increase in net sales.  Gross profit as a percentage of total net sales increased to 17.2% for the three months ended September 30, 2022 compared to 15.6% for the three months ended September 30, 2021.  The increase was primarily due to the impact fixed costs have on gross profit percentage when sales increase, partially offset by the mix of net sales as our non-POPS solutions typically have lower margins.

Gross profit for the nine months ended September 30, 2022 decreased 5.5% to $2,534,000 compared to $2,682,000 for the nine months ended September 30, 2021.   The decrease in gross profit was primarily due to the decline in net sales.  Gross profit as a percentage of total net sales decreased to 17.8% for the nine months ended September 30, 2022 compared to 17.9% for the nine months ended September 30, 2021.

Operating Expenses

Selling.  Selling expenses for the three months ended September 30, 2022 decreased 30.8% to $294,000 compared to $425,000 for the three months ended September 30, 2021. Selling expenses for the nine months ended September 30, 2022 decreased 34.1% to $926,000 compared to $1,406,000 for the nine months ended September 30, 2021. The decreases for both periods were primarily due to decreased staff and staff related expenses. 

Selling expenses as a percentage of total net sales decreased to 6.0% for the three months ended September 30, 2022 compared to 12.2% for the three months ended September 30, 2021. The decrease was primarily due to decreased staff and staff related expenses, in addition to increased sales.  Selling expenses as a percentage of net sales decreased to 6.5% for the nine months ended September 30, 2022 compared to 9.4% for the nine months ended September 30, 2021. The decreases were primarily due to decreased staff and staff related expenses, partially offset by decreased sales.

Marketing.  Marketing expenses for the three months ended September 30, 2022 decreased 6.4% to $249,000 compared to $266,000 for the three months ended September 30, 2021.  Marketing expense for the nine months ended September 30, 2022 increased 3.4% to $787,000 compared to $761,000 for the nine months ended September 30, 2021.

Marketing expenses as a percentage of total net sales decreased to 5.1% for the three months ended September 30, 2022 compared to 7.6% for the three months ended September 30, 2021. The decrease was due to increased sales. Marketing expenses as a percentage of net sales increased to 5.5% for the nine months ended September 30, 2022 compared to 5.1% for the nine months ended September 30, 2021. The increase was due to decreased sales.

General and administrative.  General and administrative expenses for the three months ended September 30, 2022 decreased 3.0% to $756,000 compared to $779,000 for the three months ended September 30, 2021.  Increased expenses for the strategic alternatives process were substantially offset by decreased litigation expenses.  General and administrative expenses for the nine months ended September 30, 2022 decreased 43.0% to $2,310,000 compared to $4,052,000 for the nine months ended September 30, 2021.  The decreases for both periods were primarily due to higher expenses incurred in the prior year period as a result of litigation with News America.  Following the litigation settlement on July 1, 2022, the Company does not expect to incur further expenses related to the legal proceedings with News America.

General and administrative expenses as a percentage of total net sales decreased to 15.5% for the three months ended September 30, 2022 compared to 22.3% for the three months ended September 30, 2021. The decrease was primarily due to increased sales. General and administrative expenses as a percentage of net sales decreased to 16.2% for the nine months ended September 30, 2022 compared to 27.0% for the nine months ended September 30, 2021. The decrease was due to the factors described above, partially offset by decreased sales.

Gain from litigation settlement.  On July 1, 2022, the Company entered into a $20,000,000 settlement agreement with News America, with net proceeds after expenses of $12,000,000.  The agreement memorializes the amicable settlement of the Company’s outstanding lawsuit against News America.

Other Income.  Other income for the three months ended September 30, 2022 was $72,000 compared to other income of $13,000 for the three months ended September 30, 2021, primarily due to interest income. Other income for the nine months ended September 30, 2022 was $100,000 compared to other income of $1,017,000 for the nine months ended September 30, 2021. The significantly higher income in the prior year period reflects the gain on forgiveness of debt and accrued interest of $1,062,000 from the SBA forgiving the Company’s loan pursuant to the Paycheck Protection Program (“PPP”) of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act.

Income Taxes.  For the three and nine months ended September 30, 2022, the Company recorded income tax benefit of $190,000 and $168,000, or (1.6)% and (1.6)% of income before taxes, respectively. For the three and nine months ended September 30, 2021, the Company recorded income tax expense of $9,000 and $32,000, or 1.0% and 1.3% of loss before taxes, respectively. The income tax expense or benefit for the three and nine months ended September 30, 2022 and 2021 is comprised of federal and state taxes. The primary differences between the Company’s September 30, 2022 and 2021 effective tax rates and the statutory federal rate are expenses related to stock-based compensation, nondeductible penalties and for 2021 increases in the Company’s valuation allowance against its deferred tax assets and for 2022 decreases in the Company’s valuation allowance against its deferred tax assts and decreases in the Company’s reserve for unrecognized tax benefits. 

The Company reassesses its effective tax rate each reporting period and adjusts the annual effective rate if deemed necessary, based on projected annual taxable income (loss).

Deferred income taxes are determined based on the estimated future tax effects of differences between the financial statements and tax basis of assets and liabilities given the provisions of enacted tax laws.  In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies.  If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustment to the carrying value of deferred tax assets and liabilities may be required. Valuation allowances are recorded related to deferred tax assets based on the “more likely than not” criteria. 

In the third quarter of 2022, the Company recognized an income tax benefit of approximately $2,128,000 due to the partial reversal of its valuation allowance on deferred tax assets.  This partial reversal of the valuation allowance is based on the Company’s expected ability to utilize a portion of its federal and state net operating losses carried forward against 2022 federal and state income tax liabilities.  The Company will continue to assess the potential realization of its remaining deferred tax assets in the future to determine if sufficient evidence exists to remove all or a portion of the Company’s valuation allowance on its deferred tax assets. 

As a result of the Company’s future outlook, management has concluded that the uncertainties related to the realization of its deferred tax assets are unfavorable. Management has considered positive and negative evidence for the potential utilization of the deferred tax assets and has concluded, as of September 30, 2022, that it is more likely than not that Company will not realize the full amount of its net deferred tax assets.  Therefore, the valuation allowance on deferred tax assets not recognized in 2022 will remain. 

As of September 30, 2022, and December 31, 2021, the Company had unrecognized tax benefits totaling $52,000 and $711,000, respectively, including interest, which relates to state nexus exposure. The amount of the unrecognized tax benefits, if recognized, that would affect the effective income tax rates of future periods is $52,000. The Company has recorded a decrease of approximately $679,000 in unrecognized tax benefits related to state exposure in the third quarter of 2022, which will reduce accrued income taxes and increase the current income tax benefit.  The Company has determined it is no longer more likely than not that the Company will realize the tax expense.

A reconciliation of the beginning and ending amount of unrecognized income tax benefit is as follows:

At December 31, 2021, the Company had Federal net operating loss (NOL) to carry forward of approximately $9,700,000. As of September 30, 2022 the Company estimates remaining Federal NOL carryforwards to be approximately $2,000,000.  The federal NOL utilization was limited to 80% of estimated taxable income. The estimated NOL carry-forward will be adjusted at year end for fourth quarter results.

Net Income (Loss).  For the reasons stated above, net income for the three and nine months ended September 30, 2022 was $11,801,000 and $10,779,000, respectively, compared to net loss of $921,000 and $2,552,000, respectively, for the three and nine months ending September 30, 2021.

Liquidity and Capital Resources

The Company has financed its operations with proceeds from stock sales and sales of its services and products. At September 30, 2022, working capital was $14,000,000 (defined as current assets less current liabilities) compared to $3,716,000 at December 31, 2021. During the nine months ended September 30, 2022, cash and cash equivalents and restricted cash increased $10,402,000 from $3,851,000 at December 31, 2021, to $14,253,000 at September 30, 2022.  These increases were the result of the net proceeds of $12,000,000 from the litigation settlement.

Operating Activities.  Net cash provided by operating activities during the nine months ended September 30, 2022, was $10,388,000. Net income of $10,779,000, plus non-cash adjustments of $87,000, less changes in operating assets and liabilities of $478,000 resulted in the $10,388,000 of cash provided by operating activities. The largest components of the change in operating assets and liabilities were accrued liabilities which decreased $740,000 from December 31, 2021 due to payment of payroll tax associated with vesting of RSUs on December 31, 2021 and a decrease to accrued director deferred compensation due to changes in our stock price from December 31, 2021, and accrued income taxes which decreased $659,000 from December 31, 2021 due to a reduction in uncertain tax positions.  In the normal course of business, our accounts receivable, accounts payable, accrued liabilities and deferred revenue will fluctuate depending on the level of revenues and related business activity, as well as billing arrangements with customers.

Investing Activities.  Net cash used in investing activities during the nine months ended September 30, 2022 was $25,000, which related to purchase of property and equipment.

Financing Activities.  Net cash used in financing activities during the nine months ended September 30, 2022 was $39,000, which related to proceeds from the issuance of common stock under the employee stock purchase plan and exercised stock options. 

Primarily as a result of the net proceeds from the litigation settlement of $12 million in the three months ended September 30, 2022, cash and cash equivalents plus restricted cash at September 30, 2022 were $14.3 million.  The Company believes that based upon current business conditions and plans, its cash balance will be sufficient for its cash requirements for at least the twelve-month period subsequent to the filing of this Form 10-Q. 

Critical Accounting Estimates

Our discussion of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with GAAP. During the preparation of these financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those related to allowance for doubtful accounts, income taxes, sales tax, and stock-based compensation expense. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our financial statements.

Our significant accounting policies and estimates are described in Note 1 to the annual financial statements included in Part II, Item 8 and in Item 7 of our Annual Report on Form 10-K as of and for the year ended December 31, 2021, filed with the Securities and Exchange Commission on March 9, 2022. We believe our most critical accounting estimates include the following:

Cautionary Statement Regarding Forward-Looking Statements

Certain statements made in this Quarterly Report on Form 10-Q, in the Company’s other SEC filings, in press releases and in oral statements to shareholders and securities analysts that are not statements of historical or current facts are “forward-looking statements.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of the Company to be materially different from the results or performance expressed or implied by such forward-looking statements. The words “anticipates,” “believes,” “estimates,” “expects,” “future,” “likely,” “may,” “projects,” “seeks,” “will” and similar expressions identify forward-looking statements. Forward-looking statements include statements expressing the intent, belief or current expectations of the Company and members of our management team regarding, for instance: (i) our belief that our cash balance and cash generated by operations will provide adequate liquidity and capital resources for at least the next twelve months; and (ii) that we expect fluctuations in accounts receivable and payable, accrued liabilities, revenue deferrals and prepaid production costs. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. These statements are subject to the risks and uncertainties that could cause actual results to differ materially and adversely from the forward-looking statements. These forward-looking statements are based on current information, which we have assessed and which by its nature is dynamic and subject to rapid and even abrupt changes.

Factors that could cause our estimates and assumptions as to future performance, and our actual results, to differ materially include the following:(i) local, regional, national, and international economic conditions that have deteriorated as a result of the COVID-19 pandemic, inflation, and labor shortages, including the risks of a global recession or a recession in one or more of our key markets, and the impact they may have on us and our customers and our assessment of that impact; (ii) management’s ability to fully or successfully implement its business plan to achieve and maintain increased sales and resultant profitability in the future; (iii) the Company’s success in developing and implementing new product offerings, in a successful manner; (iv) prevailing market conditions, including pricing and other competitive pressures, in the in-store advertising industry and, intense competition for agreements with CPG retailers and manufacturers; (v) potentially incorrect assumptions by management with respect to the financial effect of current strategic decisions and the effect of current sales trends on fiscal year 2022 results; (vi) termination of all or a major portion of, or a significant change in terms and conditions of, a material agreement with a CPG manufacturer or retailer; (vii) other economic, business, market, financial, competitive and/or regulatory factors affecting the Company’s business generally; (viii) our ability to successfully manage our IT operating infrastructure outsourcing arrangement; and (ix) our ability to attract and retain highly qualified managerial, operational and sales personnel.  Our risks and uncertainties also include, but are not limited to, the risks presented in our Annual Report on Form 10-K for the year ended December 31, 2021, and any additional risks presented in our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We undertake no obligation (and expressly disclaim any such obligation) to update forward-looking statements made in this Form 10-Q to reflect events or circumstances after the date of this Form 10-Q or to update reasons why actual results would differ from those anticipated in any such forward-looking statements, other than as required by law.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company  maintains disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

The Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer and its principal accounting officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s principal executive officer and principal financial officer and its principal financial officer concluded that the Company’s disclosure controls and procedures as of September 30, 2022 were effective.

Changes in Internal Control Over Financial Reporting

No changes in the Company’s internal control over financial reporting occurred during the third quarter of 2022 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

A description of our legal proceedings, if any, is contained in Note 6 of the Notes to Condensed Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, incorporated herein by reference.

Item 1A. Risk Factors

There have been no material changes in our risk factors from those previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2021.

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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

* Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.

SIGNATURES

Pursuant to the requirements 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.