Creative Realities, Inc. Q2 FY2022 Earnings Call

Good morning. My name is Josh, and I will be your conference operator today. I would like to welcome everyone to the Creative Realities Inc. Second Quarter Earnings Conference Call. This call will be recorded, and a copy will be available on the Company's website following the completion of the call. All lines have been muted to prevent background noise. The company has prepared remarks summarizing the second quarter results along with additional industry and company updates. After the prepared remarks, there will be a live question and answer session. Alternatively, questions can be submitted during the call via email. Joining me on the call today is Rick Mills, CEO, and Will Logan, CFO. Thank you very much. Mr. Logan, you may begin.

Thanks, Josh. Good morning. This is Will Logan, Chief Financial Officer of Creative Realities Inc. Welcome to our financial results and earnings call for the three and six months ended June 30, 2022. I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. The words anticipated, believes, expects, intends, plans, estimates, projects, should, may propose, and similar expressions or the negative versions of such words or expressions, as they relate to us or our management, are intended to identify forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in our quarterly financial statements on Form 10-Q and in our annual report on Form 10-K filed with the SEC on March 22, 2022. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our public filings and in our earnings release that was released yesterday. It is now my pleasure to introduce Rick Mills, CEO of Creative Realities Inc.

Thanks, Will. Good morning, everybody. I do want to let everyone on the call know that I am located remotely today. If for any reason I've dropped off, Will Logan will continue with my prepared remarks as I try to rejoin the call. So with that said, I want to start this call and tell you we are very pleased to announce our Q2, 2022 results and our continued progress towards our goals this year. Specifically, I'm going to highlight the following three key points. First, we had record revenue of $10.9 million during Q2, representing an increase of $7.6 million or 233% year-over-year. This brings our year-to-date revenue to $21.7 million, which is also a record for the six months ended June 30 and represents an increase of 162% year-over-year. While the acquisition of Reflect in February is contributing to these results, the combined company has grown organically greater than 58% as compared to the pro forma results of the combined companies through June 30, 2021. These results are in line with our previously stated target of achieving at least $43 million of revenue in the current year, which is a 40% organic growth rate from the pro forma combined company results in 2021. Second, EBITDA and adjusted EBITDA for Q2, 2022 were $2.8 million and $933,000 respectively, improving our adjusted EBITDA margin from $5.9 in Q1 to $8.5 in Q2, bringing year-to-date adjusted EBITDA for the six months ended June 30 to $7.2 million. As we discussed in our prior call, we expect to continue to drive improvements in adjusted EBITDA as we scale this business and complete the integration of Reflect. Third, the key strategic initiative of our management team is to continue to grow our annual recurring revenue or ARR, which is primarily comprised of Software-as-a-Service or SaaS subscriptions to our enterprise-grade digital signage solutions. Our stated goal as we entered 2022 was to increase our ARR run rate by 25% from approximately $12 million on a pro forma consolidated basis for Reflect and Creative Realities exiting 2021. We expected that our goal was to grow it to $15 million entering 2023. Through June 30, 2022 we have grown our ARR run rate in excess of $14.5 million achieving 83% of our target growth for the year through the first half of the year. We expect to continue to drive increases in our ARR run rate throughout the remainder of the year and expect to easily eclipse our $15 million target. Will Logan and I are going to provide more detail around our Q2 results, but first I would like to reiterate what we do and how we create value so everybody on this call understands everything that we do. We operate in the digital signage and media industry and importantly, several key high-value adjacencies. We sell installed digital signage and related technology along with a considerable array of services that build off that installation base. We own several proprietary software platforms, which generate significant Software-as-a-Service or SaaS revenue. We serve market-leading companies across many prominent verticals. We have a large number of revenue sources, including managed services, which primarily represent sticky long-term contractual agreements comprised of software licensing and support services for our signage software platforms. We surround that with other services, which include assisting our customers in the design and engineering of a solution to fit their specific space, hardware installation, content development, content scheduling, and occasionally custom software development. We also provide post-deployment network and field support services, which we commonly refer to as day-to-day services. Our third bucket of revenue is media sales and ad tracking, the business through which we conduct the direct and indirect sourcing of advertising revenue for client-owned networks. This was acquired through the Reflect transaction and is a major growth area for the company. This is both a critical technology and capability for the company's entry into a high-margin, high-growth space to deliver network monetization products for our customers. The fourth and final bucket of revenue is the actual hardware, primarily screens or displays, media players, and related equipment. While these revenues typically carry lower margins, the long tail on hardware sales is an essential leading indicator of future growth in SaaS, media, and other high-margin services downstream, affecting the sales mix and temporarily margin mix in the short run. To put it very succinctly, folks, it's all about getting that screen sold to a customer and putting it on a wall. Because the moment that screen goes up on the wall, it starts generating SaaS revenue for our company. As a SaaS and media company, we're excited about how we are favorably positioned to acquire and defend significant market share in a highly fragmented industry owing to our extended product set, our technology stack, and people, all driven by a compelling business model. We are built for scale and ultimately, profit and free cash flow. We will get into the Q2 results in more detail, but before we do, I wanted to speak about two important events for which we recently issued press releases. On June 28, the company announced a marketing partnership with the Bowling Proprietors Association of America or BPAA, and Strike Ten Entertainment, whereby Creative Realities will become the official digital signage and digital menu board provider of the BPAA. The partnership was announced at the Expo Convention in Las Vegas during the last week of June. This is significant for several reasons. The BPAA has more than 3,000 member bowling alleys for whom CRI is the exclusive digital signage and digital menu board provider. We will be launching a campaign offering digital menu boards to these proprietors and will continue to be published in BPAA magazine and participate with menu board-related activities, booths, etc., at their industry trade shows. Strike Ten Entertainment is the service centralized sponsor activation arm of the bowling industry, and the BPAA have announced plans to roll out a bowling-specific digital network, which will feature advertising in addition to circuit and location-specific content. Strike Ten and the BPAA have significant plans for this network. While the contract remains pending for deploying the network, the program has launched and more information can be found via the Strike Ten website at bowlingcentertv.com. This event is important for many reasons. Helping clients monetize their networks is a key part of our strategy. We will do this by trafficking ads to clients' screens to take advantage of significant on-premise attendance. Sometimes we traffic the ads to the screens and sell the software on a SaaS basis to do this. However, in other instances, we also bring advertisers to our clients and actually sell the media. This is one reason why the Reflect systems and our merger with Reflect this past February was so important. We acquired an advertising trafficking platform called AdLogic, which is at the forefront of our media capabilities. Our work with BPAA and Strike Ten is yet another example of how we can effectively power client networks in a way where our screens generate profit and are not simply a cost. The company is currently doing this with other entertainment venue customers. In fact, our strategy to support, aggregate, and power networks for our customers is a key driver of value creation for the company. There are quite a number of client networks out there which are not currently being monetized in this manner, but the demand is absolutely there. With our products and capabilities, we anticipate being able to acquire and defend substantial share directly and indirectly in this rapidly growing space. Additionally, we've recently issued a press release highlighting our growing relationship with Freddy's Frozen Custard & Steakburgers, a long-time customer of the company. Let's discuss why this was such an important announcement and what it could mean for the company. This represents a new product launch for CRI in the form of design optimized digital menu boards for outdoor drive-thru and walk-up locations. This solution can start as static, then be upgraded to digital over time, further assisting clients in managing the cost of converting to digital deployment. This data-driven product is all about helping quick service restaurants or QSR, such as Freddy's, reduce ordering friction points, thereby improving cycle and fulfillment times, which are key to profitability for this industry. As many of you know, the QSR industry was already in the middle of a transformation prior to the pandemic, which has further accelerated the need for efficient order processing and reduced cycle times. This has placed additional emphasis on drive-thru, curbside delivery, and takeout. CRI intends to be at the forefront of enabling this unit-level transformation, and the deployment of our recently announced new drive-thru solution is a key part of the strategy. Scale matters. Freddy's alone has 420 restaurants across 32 states and has publicly stated its intention to drive its unit count to 800 by 2026. All new Freddy's locations going forward will be adopting our solution. We believe there's a tremendous opportunity to deploy our solution at pre-existing sites through a retrofit program. To understand the math, 800 sites is an example. The digital outdoor menu board program represents an opportunity for up to $24 million in revenue. And that's just one solution for one customer. There are over 200,000 drive-thru operations in the U.S., with Americans visiting drive-thru lanes about 6 billion times each year by some counts. As you can see from these two announcements, CRI is well-positioned to exploit high-growth opportunities in the marketplace. On our last earnings call, we discussed our strategy for value creation, and we introduced our six-point plan for value creation, which remains a focus of the company's multi-year strategic planning. As a reminder, our value creation focus includes the following: 1) grow revenue; 2) improve margins; 3) grow our annual recurring revenue; translate ARR to EBITDA and free cash flow; 4) pursue capital stack plays for optimal structure and growth; 5) scale high-margin SaaS services and media; and 6) opportunistically pursue accretive M&A. I'll discuss the specifics around each of these value creation points and relate them to our Q2 numbers after Will Logan provides the Q2, 2022 results. Will, I'll turn it back over to you.

Great. Thanks, Rick. I'll now summarize our financial results for the three months ended June 30, 2022, as compared to the same period for 2021. Regarding the 2022 results, we note that the MD&A section of our quarterly report on Form 10-Q provides unaudited quarterly financial information derived from the company's annual and quarterly financial statements. We've also provided a reconciliation of GAAP net income to non-GAAP quarterly EBITDA and adjusted EBITDA for the current and previous four quarters there. With respect to our revenue, gross profit, and gross margin in the period, revenues for the three months ended June 30, 2022, were $10.9 million, representing an increase of $7.6 million or 233% as compared to the same period in 2021, driven in part by the merger with Reflect Systems on February 17, 2022, and the company's successful sales activities as a combined company post-merger. During the three months ended June 30, 2021, the pro forma combined results of Creative Realities and Reflect Systems produced $6.3 million in revenues. The current year combined company results for the three months ended June 30, 2022, represent an increase of $4.7 million or 74% over the pro forma combined results for the same period in 2021. Revenues for the six months ended June 30, 2022, were $21.7 million, representing an increase of $13.4 million or 162% as compared to the same period in 2021, driven in part by the merger with Reflect and our continued success post-merger. During the six months ended June 30, 2021, the pro forma combined results of CRI and Reflect produce $13.7 million in revenues. The current year combined company results for the six months ended June 30, 2022, represent an increase of $8 million or 58% over the pro forma combined results for the same period in 2021. Effectively, the organic growth rate for the combined company through six months ended June 30, 2022, is 58%. This is in line with the previously stated expectations to produce organic growth of 40% for the full year 2022. Hardware revenues were $5.7 million in the three months ended June 30, 2022, representing an increase of $4.4 million or 337% as compared to the prior year, driven by the merger with Reflect and the continued growth in large-scale LED deployment in the quarter by multiple customers. Services and other revenues were $5.3 million in the three months ended June 30, 2022, an increase of $3.3 million or 165%. These managed services revenue include both Software-as-a-Service (SaaS) revenue and our help desk technical subscription services, which were $3.8 million in the three months ended June 30, 2022, as compared to $1.4 million in the same period in 2021, driven by the merger with Reflect and the continued expansion in our SaaS software subscription base. This represents a year-over-year growth rate of 175%, with our higher margin, typically subscription-based managed services revenue. Gross Profit increased by $2.8 million or 147% during the three months ended June 30, 2022, as compared to the same period in 2021, driven by an increase in revenue and part as a result of the merger with Reflect, but offset by a reduction in gross profit margin. Gross profit margin decreased to 42.7% from 57.2%, driven primarily by a shift in revenue mix to 52% hardware during the three months ended June 30, 2022, from 40% hardware during the three months ended June 30, 2021, related to several material customer hardware rollout activities during the first half of the current year. We expect gross profit margin to stabilize as we move into the second half of 2022 and beyond, as was the case from first quarter to the second quarter of 2022. The gross profit margin increase for the three months ended June 30, 2022, to 42.7% from 36.2% in the three months ended March 31, 2022, which experienced significant short-term pressure from a single large-scale hardware heavy deployment. We continue to view the long tail of hardware revenue as a leading indicator of future SaaS and other services revenue. We believe the gross profit margin for the three months ended June 30, 2022, is more representative of our normalized gross profit margins. With respect to our operating expenses, sales and marketing expenses generally include the salaries, taxes, and benefits of our sales and marketing personnel as well as tradeshow activities, travel, and other related sales and marketing costs. These expenses increased by $1 million or 597%, driven primarily by the inclusion in the prior year of a benefit of $0.2 million related to employee retention credits that did not recur in the current year. Second, the merger with Reflect on February 17, 2022, and third, the company's enhanced investments into sales and marketing activities post-COVID-19 pandemic, as related limitations on such activities have eased. Excluding the impact of the ERC, the increase was $0.8 million or 371%. Immediately following the merger with Reflect, the company integrated the sales and marketing functions and did not disaggregate expenses between the two legacy companies. Following the merger and through integration activities, the company has adopted certain tools, technology, and processes, particularly with respect to lead generation and brand marketing that were underutilized historically by the company. Additionally, the company engaged an Investor Relations firm and has increased these IR activities, including conferences and presentations. As a result, we expect the sales and marketing expenses of the company for the three months ended June 30, 2022, to adequately reflect the pace for these expenses in future periods. Research and development expenses increased by $0.4 million or 621% in 2022, driven by a combination of the inclusion in the prior year of a $0.1 million benefit related to the ERC, which did not recur in the current year, and the merger with Reflect. Excluding the impact of the ERC, the increase was $0.2 million or 367%. Through the merger with Reflect, we acquired a fully staffed, experienced software development team and elected to keep that team intact in full, particularly given employment market conditions with respect to talented software engineers. We have integrated the pre-existing CRI development team with the acquired team and have experienced enhanced speed to market on new features and functionality development activities from increasing this resource pool. We expect this level of expense during the three months ended June 30, 2022, to be representative of our future operations, as we continue to develop and enhance our current and future products. General and Administrative expenses increased by $0.8 million or 49%, driven again by the inclusion of a prior year benefit of $0.5 million related to ERC credits that did not recur in the current year, increased headcount and operations as a result of the merger with Reflect. Excluding the impact of ERC, the increase was $0.3 million or 19.8%. While the company anticipates carrying higher G&A expenses moving forward compared to its history as a result of the merger with Reflect, our integration activities include numerous projects targeted at controlling further expansion and/or reducing these expenses from the level realized in the three months ended June 30, 2022. Those projects primarily focus on consolidation, rationalization of our content management platforms, cloud hosting environments, IT tools, and leased office spaces. With respect to operating loss and EBITDA, operating income was $30,000 during the three months ended June 30, 2022, inclusive of $0.4 million in non-cash charges for both the amortization of intangible assets and non-cash employee and director stock compensation. Net income was $1.2 million during the three months ended June 30, 2022, which included a $2.4 million gain on marking outstanding liability warrants to fair value prior to the conversion to equity warrants, a $0.3 million charge related to the amendment of outstanding warrants through extension of useful life, and $0.8 million of interest expense, about half of which represents the amortization of debt discounts, which is non-cash. EBITDA was $2.8 million and adjusted EBITDA was $0.9 million for the three months ended June 30, 2022, with an adjusted EBITDA margin of 8.3% during this period. A reconciliation of the GAAP basis net income and adjusted EBITDA is provided in tabular format in our earnings release filed yesterday. A couple of other highlights from the quarter. First, I wanted to note the plan changes in fair value of warrant liability and loss on warrant amendment that were included in the second quarter. During the six months ended June 30, 2022, the company recorded a gain of $7.9 million, as a result of assessing the fair value of warrant liabilities associated with our issuance of those warrants and our debt and equity offerings completed in February 2022 to finance the merger. Those warrants were initially assessed at fair value through Black Scholes calculations and were subsequently reassessed at each reporting date that resulted in the gain. Effective June 30, 2022, the company amended the terms of those warrants resulting in a one-year extension in the warrant expiration date, and changed the holders' exercise options for the election of the strike price. As a result of the extension in term provided in exchange for the amendment, the company reassessed the fair value of those warrants, resulting in the company recording a non-cash loss on the fair value of those warrants of $345,000. The foregoing amendments to the warrants resulted in such warrants being accounted for as equity instruments in the company's financial statements as of June 30, 2022. As such, following recording the gains and losses with respect to these warrant amendments, the company permanently reclassified its $5.7 million warrant liability from non-current liabilities to additional paid-in-capital as of June 30, 2022. With respect to our cash position, as of June 30, we had approximately $3 million in cash, which we believe, when combined with our accounts receivable and SaaS contract billings, provides sufficient runway to service our debt and operate our business. Additionally, we believe that our share price will return to a rational valuation, which will result in the exercise of the previously discussed warrants generating cash to pay down debt and/or enter strategic partnerships or acquisitions. If all outstanding warrants with a strike price of $2 per share or lower were exercised on a cash basis, it would generate an excess of $20 million cash for the company. At this point, I'll turn the call back over to our CEO, Rick Mills.

Thanks, Will. I hope everybody can appreciate the detail of our Q2 financial update. Let's revisit our value creation points and how we are fulfilling and building on them. First point, grow revenue. With respect to growing revenue, this Q2 was an all-time record quarter of $10.9 million and a 233% improvement over 2021. This is not all acquisition-related, as the company will outperform the combined CRI and Reflect pro forma combination as we've highlighted. This further evidence that the platform we have assembled has put the company in a position to enjoy revenue growth rates in excess of the industry norms in 2022 and beyond. As Will detailed, this is evident organically and strategically with our Q2 results. I previously provided 2022 guidance of at least $43 million, which is 40% more than the $30.7 million pro forma combination of CRI and Reflect in 2021. We again reiterate this guidance with confidence and see that number climbing above $52 million for 2023. Our prospects for additional revenue, profit, and growth are significantly enhanced by our achievement of an ARR run rate exceeding $14.5 million, well on pace to exceed our $15 million year-end goal and projections. Second of our key six points for value creation: improve our margins. We have previously communicated our expectations for an adjusted EBITDA margin of approximately 5% of revenue for 2022. Adjusted EBITDA for Q2 totals $933,000, improving our adjusted EBITDA margin from 5.9% in the first quarter to 8.5% in Q2, bringing the combined full year to 7.2%. This demonstrates the achievability and likely outperformance of our profitability targets in 2022 and 2023 owing to scale and merger synergies, ARR, and disciplined financial management. We expect ongoing margin expansion throughout 2022 into 2023. Additionally, keep in mind, we have a long tail of hardware sales, which produce additional SaaS media sales and other high-margin services downstream that affect the sales mix and temporarily the margin mix in the short run. As we scale organically and realize the value of the merger while scaling new business lines, we now expect to see adjusted EBITDA margins above 15% as soon as 2023, and certainly exceeding 20% for 2024. At scale, which we believe is $100 million in revenue, we believe this is a 30% adjusted EBITDA margin business, which will further deliver significant free cash flow. The third point: grow our annual recurring revenue, translating ARR to EBITDA and free cash flow. We have previously conveyed an ARR run rate of $13.5 million at the end of Q1, building off the $12 million run rate at the end of 2021, targeting $15 million by the end of the year. We are now at a record run rate in excess of $14.5 million, approaching our year-end target two quarters ahead of projections. I cannot overemphasize the importance of this metric for the company. Our objective is to scale ARR to cover our entire OpEx on a run rate basis in 2023. Once OpEx is covered by ARR, every incremental revenue dollar flows to the bottom line and significantly improved incremental margin percentage. In this manner, ARR will translate into EBITDA at an increasing marginal rate, and scaling ARR should have a beneficial impact on revenue predictability and volatility, which are key reasons why fast-growing companies trade at attractive multiples. Fourth, capital stack plays for optimal structure and growth. As previously stated, the majority of our debt is non-amortizing for 2022. We have $3 million in cash at the end of Q2, which provides a runway to realize the aforementioned effects to grow revenue while improving EBITDA. We see our leverage reducing to less than 3x EBITDA during 2023 and further by 2024. Regarding equity, we previously reported that the majority of outstanding warrants do not have a cashless exercise feature, and if exercised, would generate significant cash, which could substantially reduce our debt. As we scale the business, we intend to optimize our capital structure in a way aligned with our business growth plans. Fifth: we have previously discussed that the company is much more than a pure-play digital signage infrastructure company, especially given our expanded product set with high-margin services and media sales. This is a competitive advantage over the majority of pure-play infrastructure competitors. Many enterprise customers require a one-stop shop and single vendor model for their digital signage and media needs, which the competition simply cannot offer. Indeed, many of them require business solutions beyond the basic digital sign. CRI provides such integrated offerings and technology, allowing us to upsell or cross-sell other products. A great example is our network monetization program, which provides services that allow our clients to traffic paid content to their networks. We have an entire team led by Lee Summers, who is President of our Media Division, helping clients to realize new revenue streams from reaching millions of impressions from their network. The company has other solutions for omni-channel and ad-tech that also expand our capabilities, and there is optionality to grow from this core. The company is best viewed as a highly synergistic entity that covers far more than just hardware sales. Lastly, point number six: opportunistically pursue accretive M&A. The platform for organic growth is in place with significant prospects to scale. As we execute our plan, the company will also continue to look for opportunistic strategic plays that are accretive. I previously communicated a vision to scale the business to a $150 million global marketing solutions provider. Our management team is focused on creating value in conjunction with this growth. Will, do you have any additional remarks regarding these activities related to our value creation plan?

Yes. Thanks, Rick. We have a number of other noteworthy activities and achievements to share. So I'll just highlight a few that are related to the plan. First, for reference for shareholders, Alliance Global Partners or AGP did initiate analyst coverage on the company on June 2, with a $2.25 price target and a buy recommendation. This is significant for us because it's the first analyst coverage that the company has received since before the onset of the pandemic. They further reiterated their opinion on June 28, in conjunction with our announcement that the company had agreed to become the official digital signage and digital menu board partner of the BPAA. In that more recent opinion, AGP projected a potential $50 million revenue windfall for CRI through this newly minted relationship. On August 3, Taglich Brothers also initiated analyst coverage on the company with a speculative buy rating and $1.50 12-month price target, representing a second analyst with a target price in excess of two times or a 100% return over today's depressed share price. As we reported in the Q1 earnings call, the company is formally engaged with an investor relations firm and executing a robust calendar to communicate the company's strategy, strengths, and positioning of the products and platforms and our plan for material value creation for our shareholders. We continue to conduct one-on-one interactions with existing and prospective investors. We're conducting over 30 investor presentations since the start of Q2. We've attended both the LD Micro Conference this past June and we're scheduled to present at the H.C. Wainwright Annual Global Conference from September 12 to 14, and the next LD Micro Conference on October 25 and 26. To complement the IR program, we are revamping our website, which is undergoing a complete overhaul as we speak to combine our legacy site with the legacy Reflect site, driving improved lead generation and search engine optimization. Thus far, we've completed the IR site, which has been launched and can be reached at investors.cri.com. It has been rebranded and features information and resources for existing and new investors, including company presentations, press releases, filings, and upcoming events. As you can see, there are a number of active initiatives and we are focused on building and sharing a terrific growth story. Josh, I'll turn it back to you for the phone lines.

Thank you. Our first question comes from Brian Kinstlinger with Alliance Global Partners. You may proceed.

Hi, guys. Thanks for taking my questions. First, can you provide some details around that announced billing contract? I know one of the pieces that was holding the contract back was the number of bowling alleys that expressed their intention to move forward with new media players in the ad monetization. So, can you update us on where that landed? When the contract might start delivering? And then also, if I'm not mistaken, initially, I think you won't be managing the ad network. Is that right?

Rick, I'll let you take that one first.

Hey, Brian. Good morning. A couple of comments on the bowling contract. Number one, we had expected it to be executed. There had been an initial timetable to have the contract executed by August 1st. They are currently a couple of weeks behind. Number two, as of the latest count, they had over 650 bowling centers signed up to participate. So, well ahead of schedule and prepared to launch. So everybody's excited, but it has been a bit slower getting it executed. Number three, I would expect potentially some revenue in Q4. It will be minor, just because of some supply chain issues; if we start ramping up now, it's going to take a full quarter to get going. So, we would expect to see significant revenue in 2023 from that contract. Does that address all your points?

Yes. Just to make sure, initially, you won't be managing the ad network. It's an opportunity long-term, if I'm not mistaken, but initially, I think your other partners are going to take a crack at it. Is that right?

Yes. When you say managing, it is actually two points to that. Number one, yes, we will be managing the network in terms of providing the software and they'll be using our ad server technology, etc. They have chosen the entity that owns the network to have their people schedule. So we will teach them how to schedule the ads. They also have a sales team who will be primarily sales lead. We expect to execute a supplemental sales agreement to bring all of our ad partners to the table.

Right. Great. Thanks. And I've got a few questions. You've talked about upgrading and delivering media player to a large amusement park. I think, based on your guidance, nothing's changed. But it did look like Six Flags has already seen tempering demand based on the economic uncertainty based on their earnings report. So first, has there been any changes to your expected rate of deliveries or installs in this market given the attendance and profits are expected to fall a little bit? I guess in the same question applies to other large programs as it relates to the economy and deliveries and install timing in your backlog?

Yes, I think first and then Rick, do you want to add anything there? So Brian, on our end, we have not seen a slowdown in demand for conversion to digital. One of the key points is in those theme park customers today; they are customers of the monetization platform. So, we've actually seen to some degree an acceleration of the adoption of that ad monetization capability to create a secondary revenue stream within the park. So, a lot of the commentary has been around extracting more dollars per head in that industry as opposed to more folks in the park. And we see this as an avenue to support those customers. Rick, anything you'd like to add there?

Well, I'll just add, as it relates to Six Flags, it was a very specific strategic initiative by the CEO to reduce traffic count. I believe he used the phrase he was tired of being babysitters to teenage kids for parents who dropped them off at the park and they wanted to enhance the customer experience. So they made a strategic initiative to raise pricing and extract more dollars per head. But yes, we see no slowdown with our theme park customers.

Great. And then you've got quite a backlog with several large contracts. You're adding a bowling contract to the mix. Can you talk about your ability to source product to meet this demand over the next 18 months or so? Is there any concern about that?

In the long view, my answer would be no. Specifically, display capability is all there. There is no issue with display capability. There is a little bit of an issue with media players, and so media players today are running about 90 days out. So we're trying to stay ahead of the mix and really place those orders ahead of schedule, so that we have had no slowdown. So that's my answer.

Yes. On that front, we've stocked a little bit of increased inventory on our high-turn items, Brian, just so we don't get caught upside down.

Great. And then I've had several companies talk about they're beginning to see the benefits of lower global shipping container costs. Does this impact your hardware business? And if so, can you put into context how much gross margin has suffered during the pandemic from global shipping costs?

I mean, we've had a couple of orders that were severely impacted. I mean, given the cost structure, a year and a half ago, container - ocean container was about $2,000. At the height of the pandemic, it was $21,000 to $23,000. In some cases, we chose to air freight product at a cost of $200 a unit, it is now $4,000 a unit to ship. So we probably took certainly a $0.25 million cost in the first half of this year in additional freight costs. Now we see that moderating dramatically today. But we had some gross margin erosion, particularly in the first quarter. Will, do you want to augment that?

Yes. I think that's a great comment, and a lot of it has to do with the large-scale deployments of LED and kiosks. Outside of that, most of the contracts have been priced as and when they are sold. So it has more of an impact on the timing of the demand than it does on the actual margin to CRI. But Rick's correct, I put it in that same ballpark from a financial impact in the first half.

Great. Appreciate all your responses. Talk soon. Thanks.

Thanks, Brian.

Thank you. One moment for questions. Our next question comes from Howard Halpern with Taglich Brothers. You may proceed.

Congratulations, guys. Great quarter.

Thanks, Howard.

Could you just, I guess, talk a little bit in terms of the media offerings? What type of runway do you have for your existing legacy customer base, basically?

Yes. I'll start and I'll let Rick chime in. Howard, we're really in the infant stages of the media sales apparatus. I say that meaning it really just picked up steam mostly in the entertainment parts of our business. It has not really begun to roll out into QSR, C Store, and other large venues and retail. We see the beginning evidence that will materialize as most of the client interactions today include inquiries about network monetization. They may not be ready to do it yet, but they're certainly starting to look at where and how they can monetize and make this a profit center versus just a cost center. So we see that as an indicator of what's around the corner. Today, it's a very small segment of our customer population that has adopted and is moving forward. Rick, anything you'd like to add there?

Well, I would just add, everything Will said is spot on. Today, it's a small set of customers. However, we have a number of customers who have raised their hand and said: 'tell me about it'. So the number of discussions going on with our current customers is fairly extensive. So the interest is there. How they choose to move forward and how we convert them to monetization will happen over time. Current customer base, new customer base, as we talk to prospects in the marketplace, everyone is enthusiastic about the possibilities because they just simply did not know it was available. And so, there's a lot of enthusiasm as we talk to potential customers going forward.

Okay. And when you talk about potential customers, I don't know if you could really quantify it. But how many potential customers are you seeing that you wouldn't have seen before you made the Reflect acquisition?

I would tell you, our customer activity and engagement with potential new customers is clearly at an all-time high. We have made ourselves on everybody's list now. Because of our scale and size, we're one of the big players. We're getting opportunities we've not have gotten prior to the merger, simply put.

Yes. I think there are two other points there, Howard, just for reference. One is the opportunity within the existing customer base as a result of the acquisition has expanded just the capabilities and offerings for cross-sell there with hardware and installation into the legacy Reflect customer base, and then this media and ad monetization into the legacy CRI base, which leaves significant runway there.

Okay. And as all this starts to develop with, especially with recurring in the SaaS revenue, are you comfortable with that gross margin maintaining that 65% area and trending even higher as we go through this period into next fiscal year?

I think we're comfortable and confident that hardware has been right around 20%. We say that's a pretty good target. We think that the services side of the house certainly should be around or equal to what it is in the second quarter. As SaaS expands over time, we certainly expect that if that grows as a percentage of revenue, the net margin will rise because the software subscription revenue often is in excess of 80% margin. So that'll be a function of that ARR rising.

Okay. And just one last one. You anticipate in 2023 that unless you have a big hardware deployment, that recurring service revenue should exceed that 50% of total revenue?

We haven't put out a number yet, Howard, on 2023 from a mix standpoint. We expect to continue to grow the ARR in its current format, right? We're targeting $15 million, and we're targeting $43 million in aggregate for 2022. So that's 33%. We certainly will make it our goal to maintain or increase that as a percentage of the total revenue.

Okay. Okay, guys, keep up the great work.

Thanks, Howard. Appreciate the questions.

Thanks, Howard.

Thank you. One moment for questions. Our next question comes from Jack Fred, Private Investor. You may proceed.

Rick and Will, good, great quarter. Just wondering if you can elaborate on the bowling potential in the Six Flags and even that large order that we've discussed. Can you talk about the number of devices that each one could add to the 300,000 over time?

We believe that if the bowling opportunity materializes, it could lead to around 10 to 15 displays at each location, with a target network size of 1,000 locations. This presents the possibility of adding another 15,000 to 20,000 displays, along with a similar number of players managing those displays, becoming part of our devices under management.

No, I think you're spot on. It's 25,000 to 30,000 devices for bowling is the range of magnitude. Six Flags and our theme park customers, right, so we have two of the four largest theme parks in the U.S. Today, those devices, all combined are less than 10,000. We expect some growth, but it's in the several thousand. What really excites us is we look at our theme park or family entertainment network, which is really between a combination of bowling, if they roll out their media, and our two theme parks, our devices and our software and ad server will be driving ads to over 100 million consumers in just those three customer sets. When you aggregate 100 million in consumer activity, that starts to approach TV-like numbers. And so, we have tremendous opportunity to grow ad revenue in that customer segment.

Any update on the large order?

Yes, Jack, I think the answer there is the large order that we've been alluding to that we haven't named historically is the bowling announcement that has been made now. So that's the current status and update on that particular project.

Okay. Can you just kind of looking at what you're working on? And I know they're not firm orders, but what kind of dollar volume potentially are we working on? Or don't you want to say anything about that?

Rick, I'll let you comment there. I think we have not. I think we've talked about on this call what we expect the 2023 initial revenue to look like from a current customer base and expansion of known opportunities. I think it's still a little bit early potentially to talk about the aggregate. What we've talked about on this call is 1,000 sites of bowling at 13 or 15 screens a piece. From a range of magnitude, we've provided some color or attempted to on an example of Freddy's being a single QSR if they were to adopt at scale, our digital drive-thru solution would be in excess of 20 million. What's really starting to happen, Jack, is that individual opportunities for sites for customers that are 400 to 500 sites have transitioned from being a few thousand-dollar customer into $10 million-plus customer opportunity. So the opportunities themselves are getting larger over time as folks adopt digital and start to scale these networks.

No. I would just use the term our pipeline is robust. By the way, it doesn't mean we're going to win every deal. However, I'm in more discussions with more customers about more substantial networks than we have ever been in before. So, we use the term robust with meaning.

Thank you. It's exciting, really exciting what you guys are doing. And thank you.

Appreciate your questions, Jack.

Yes. Appreciate your questions and your comments. We've been working a long time to get here. Of course, we were stalled by the pandemic. Will and I joke all the time that we've worked seven years to be an overnight success, but here we are.

Thank you. That completes the questions from the line today. Mr. Logan, are there any additional inquiries from the investor relations inbox that you would like to address?

Yes. Thanks, Josh. It looks like we had just a couple of questions come in during the call.

Rick, you made reference to potential M&A targets or candidates. Any updates on M&A activities? Or how does the company anticipate financing those activities, should they come to fruition?

Well, I'll let you discuss the financing. I mean, we are in discussions ongoing and continually, not only from., but we have a gentleman who runs our buyside program, and he's been engaged with discussions with a number of folks. The inbound inquiries are continuing to increase if people want to seek a home for their business. So we have all kinds of conversations. Obviously, the challenge that we face today is our stock price. Will, let you address the financing comments.

Yes. With respect to potential financing of a transaction, it's a bit too early to say exactly how we get there. We're holding a number of theoretical discussions with potential financing partners just to pulse the market, stay current, and understand feedback. We have seen kind of an evolution here with a market pullback of a lot of creative structures on the table to help neutralize the impacts of depressed share price, convertible instruments with long runways that provide for the opportunity to share for share price recovery before there would be any kind of dilution. Those types of things are on the table. Again, we would hope that the share price will recover based on the financial results of the business. As a result of that, some of the warrants that are outstanding would naturally come in and provide opportunity and runway for us to execute. That doesn't happen. We'll see how it plays out. But what we're not going to do or what we don't plan to do is go issue a bunch of equity at today's price to close an acquisition. That doesn't work, and it's not part of our plan.

Okay. Second question here, Rick, that has come in. Has there been any consideration with respect to adding board members outside of the industry or other diverse hires?

I'll take that, and then I'll let you chime in if you have anything else. We continue to evaluate the board of directors on at least an annual basis. We had our shareholder meeting this morning, which did ratify the current board of directors, but we're highly cognizant and aware of NASDAQ and SEC rules and/or suggestions about evaluating the board from a diversity inclusion perspective and also broadening the industry expertise inside and outside of digital signage. So, it's something that we really frankly hadn't spent a lot of time on up until late 2021. But I've had several conversations about that internally in the current year, and are looking to potentially expand the board to capture some additional perspectives. Rick, anything you'd like to add there?

No, I just think we're going to look to NASDAQ as they continue to publish and push out their initiatives for board diversity, which will ultimately need minority and female representation at some point in time on our board.

Josh, that appears to be everything that we have today from the inbox, so let me conclude the call by thanking all of our shareholders, clients, partners, and support as we work together to transform CRI into the leading brand in digital signage solutions. This concludes the CRI 2Q, 2022 earnings call. Thank you.