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 Months Ended | | | Nine Months Ended | |
| | September 30 | | | September 30 | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Net sales | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
Cost of sales | | | 82.8 | | | | 84.4 | | | | 82.2 | | | | 82.1 | |
Gross profit | | | 17.2 | | | | 15.6 | | | | 17.8 | | | | 17.9 | |
Operating expenses: | | | | | | | | | | | | | | | | |
Selling | | | 6.0 | | | | 12.2 | | | | 6.5 | | | | 9.4 | |
Marketing | | | 5.1 | | | | 7.6 | | | | 5.5 | | | | 5.1 | |
General and administrative | | | 15.5 | | | | 22.3 | | | | 16.2 | | | | 27.0 | |
Total operating expenses | | | 26.6 | | | | 42.1 | | | | 28.2 | | | | 41.5 | |
Gain from litigation settlement, net | | | 246.4 | | | | — | | | | 84.1 | | | | — | |
Operating income (loss) | | | 237.0 | | | | (26.5 | ) | | | 73.7 | | | | (23.6 | ) |
Other income | | | 1.5 | | | | 0.4 | | | | 0.7 | | | | 6.8 | |
Income (loss) before taxes | | | 238.5 | | | | (26.1 | ) | | | 74.4 | | | | (16.8 | ) |
Income tax expense (benefit) | | | (3.9 | ) | | | 0.3 | | | | (1.1 | ) | | | 0.2 | |
Net income (loss) | | | 242.4 | % | | | (26.4 | )% | | | 75.5 | % | | | (17.0 | )% |
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:
Balance at December 31, 2021 | | $ | 711,000 | |
Increase due to interest and state tax | | | 20,000 | |
Decrease in prior year interest and state tax | | | (679,000 | ) |
Balance at September 30, 2022 | | $ | 52,000 | |
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:
| · | allowance for doubtful accounts; |
| · | sales tax; |
| · | income taxes; and |
| · | stock-based compensation. |
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.