Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
þ
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2017
 
or
 
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission file number: 001-34006
 
CARTESIAN, INC.
(Exact name of registrant as specified in its charter)
 
DELAWARE
 
48-1129619
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
7300 COLLEGE BLVD., SUITE 302, OVERLAND PARK, KS
 
66210
(Address of principal executive offices)
 
(Zip Code)
 
913-345-9315
Registrant’s telephone number, including area code
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 þ      No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ      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.
 
Large accelerated filer ¨
 
 Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
 
 
Smaller reporting company þ
 
 
Emerging growth company ¨
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 þ
 
As of October 28, 2017, Cartesian had outstanding 9,447,069 shares of common stock.







CARTESIAN, INC. INDEX
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I. FINANCIAL INFORMATION
 
ITEM 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
CARTESIAN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
  
 
 
September 30,
2017
(unaudited)
 
December 31,
2016
ASSETS
 
 

 
 

CURRENT ASSETS:
 
 

 
 

Cash and cash equivalents
 
$
2,474

 
$
4,131

Accounts receivable (net of allowance for doubtful accounts of $204 and $398, respectively)
 
13,624

 
13,680

Inventory, net
 
226

 
362

Prepaid and other current assets
 
1,165

 
1,591

Total current assets
 
17,489

 
19,764

 
 
 
 
 
NONCURRENT ASSETS:
 
 

 
 

Property and equipment, net
 
1,911

 
2,056

Intangible assets, net
 
390

 
557

Deferred income tax assets
 

 

Other noncurrent assets
 
670

 
324

Total Assets
 
$
20,460

 
$
22,701

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

CURRENT LIABILITIES:
 
 

 
 

Trade accounts payable
 
$
2,176

 
$
1,704

Current borrowings
 
3,269

 
3,269

Liability for derivatives
 
728

 
970

Accrued payroll, bonuses and related expenses
 
2,790

 
3,752

Contingent consideration liability
 

 
1,903

Deferred revenue
 
790

 
1,327

Secured borrowing
 
4,347

 
768

Other accrued liabilities
 
1,495

 
2,117

Total current liabilities
 
15,595

 
15,810

 
 
 
 
 
NONCURRENT LIABILITIES:
 
 

 
 

Deferred income tax liabilities
 

 

Deferred revenue
 
1,009

 
471

Other noncurrent liabilities
 
573

 
588

Total noncurrent liabilities
 
1,582

 
1,059

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES (Note 10)
 


 


 
 
 
 
 
Retained earnings
 
(172,039
)
 
(167,781
)
Other stockholders' equity
 
175,322

 
173,613

Total Stockholders' Equity
 
3,283

 
5,832

Total Liabilities and Stockholders’ Equity
 
$
20,460

 
$
22,701

See notes to unaudited condensed consolidated financial statements.

3



CARTESIAN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
(unaudited)
 
 
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
 
 
September 30,
2017
 
October 1,
2016
 
September 30,
2017
 
October 1,
2016
 
Revenues
 
$
12,785

 
$
17,335

 
$
40,049

 
$
56,551

 
Cost of services
 
8,665

 
11,224

 
27,511

 
37,128

 
Gross profit
 
4,120

 
6,111

 
12,538

 
19,423

 
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative expenses (includes non-cash share-based compensation expense of $34 and $33 for the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively, and $25 and $222 for the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively)
 
5,416

 
6,031

 
16,779

 
22,032

 
Goodwill impairment
 

 

 

 
10,830

 
(Loss) income from operations
 
(1,296
)
 
80

 
(4,241
)
 
(13,439
)
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 

 
 

 
 

 
 

 
Interest expense, net
 
(91
)
 
(68
)
 
(233
)
 
(190
)
 
Change in fair value of warrants and derivative liabilities
 
100

 
114

 
242

 
65

 
Incentive warrants expense
 
(7
)
 
(9
)
 
(48
)
 
(43
)
 
Other income (expense)
 

 
(23
)
 

 
45

 
Total other income (expense)
 
2

 
14

 
(39
)
 
(123
)
 
 
 
 
 
 
 
 
 
 
 
(Loss) income before income taxes
 
(1,294
)
 
94

 
(4,280
)
 
(13,562
)
 
Income tax (provision) benefit
 
(50
)
 
(89
)
 
22

 
(221
)
 
Net (loss) income
 
(1,344
)
 
5

 
(4,258
)
 
(13,783
)
 
Other comprehensive income (loss):
 
 

 
 

 
 
 
 
 
Foreign currency translation adjustment
 
179

 
56

 
320

 
(1,177
)
 
 
 
 
 
 
 
 
 
 
 
Comprehensive (loss) income
 
$
(1,165
)
 
$
61

 
$
(3,938
)
 
$
(14,960
)
 
 
 
 
 
 
 
 
 
 
 
Net (loss) income per common share:
 
 

 
 

 
 
 
 
 
Basic
 
$
(0.15
)
 
$
0.00

 
$
(0.48
)
 
$
(1.60
)
 
 
 
 
 
 
 
 
 
 
 
Diluted
 
$
(0.15
)
 
$
0.00

 
$
(0.48
)
 
$
(1.60
)
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares used in calculation of net (loss) income per common share:
 
 

 
 

 
 
 
 
 
Basic
 
9,089

 
8,637

 
8,833

 
8,639

 
 
 
 
 
 
 
 
 
 
 
Diluted
 
9,089

 
8,650

 
8,833

 
8,639

 
 
See notes to unaudited condensed consolidated financial statements.
 


4



CARTESIAN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
 
 
 
For the Thirty-nine Weeks Ended
 
 
September 30, 2017
 
October 1, 2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net loss
 
$
(4,258
)
 
$
(13,783
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Depreciation
 
921

 
759

Amortization of intangible assets
 
204

 
235

Share-based compensation
 
25

 
222

Deferred tax benefit
 

 
42

Goodwill impairment
 

 
10,830

Inventory adjustment
 
136

 
156

Bad debt expense
 
(29
)
 
127

Change in fair value of warrants and derivative liabilities
 
(242
)
 
(65
)
Fair value adjustment to contingent consideration
 
365

 
(235
)
Incentive warrants expense
 
48

 
43

Other changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
913

 
(465
)
Prepaid and other assets
 
116

 
60

Trade accounts payable
 
356

 
(1,247
)
Deferred revenue
 
(37
)
 
(167
)
Accrued severance liability and related costs
 

 
371

Accrued liabilities
 
(1,679
)
 
741

Contingent consideration paid
 
(158
)
 

Net cash used in operating activities
 
(3,319
)
 
(2,376
)
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Business acquisition, net of cash acquired
 

 
(270
)
Acquisition of property and equipment
 
(948
)
 
(650
)
Net cash used in investing activities
 
(948
)
 
(920
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Secured borrowing
 
3,579

 
886

Contingent consideration paid
 
(792
)
 

Repurchase of common stock
 

 
(85
)
Issuance of common stock
 
1

 
19

Net cash provided by financing activities
 
2,788

 
820

Effect of exchange rate on cash and cash equivalents
 
(178
)
 
(239
)
Net decrease in cash and cash equivalents
 
(1,657
)
 
(2,715
)
Cash and cash equivalents, beginning of period
 
4,131

 
6,879

Cash and cash equivalents, end of period
 
$
2,474

 
$
4,164

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during period for interest
 
$
243

 
$
201

Cash paid during period for taxes
 
$
131

 
$
45

Non-cash investing and financing transactions:
 
 
 
 
Accrued property and equipment additions
 
$
184

 
$
195

Change in fair value of warrants and derivative liabilities
 
$
(242
)
 
$
(65
)
Contingent consideration liability
 
$
(1,318
)
 
$

See notes to unaudited condensed consolidated financial statements.

5



CARTESIAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(UNAUDITED)
 
1. Basis of Reporting
  
The condensed consolidated financial statements and accompanying notes of Cartesian, Inc. and its subsidiaries ("Cartesian," "we," "us," "our" or the "Company") as of September 30, 2017, and for the thirteen weeks and thirty-nine weeks ended September 30, 2017 and October 1, 2016, are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the Company’s condensed consolidated financial position, results of operations, and cash flows as of these dates and for the periods presented. The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Consequently, these statements do not include all the disclosures normally required by U.S. GAAP for annual financial statements nor those normally made in the Company’s Annual Report on Form 10-K. Accordingly, reference should be made to the Company’s annual consolidated financial statements and notes thereto for the fiscal year ended December 31, 2016, included in the 2016 Annual Report on Form 10-K (“2016 Form 10-K”) for additional disclosures, including a summary of the Company’s accounting policies. The Condensed Consolidated Balance Sheet as of December 31, 2016 included in this report has been derived from the audited Consolidated Balance Sheet at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The Company has evaluated subsequent events for recognition or disclosure through the date these unaudited condensed consolidated financial statements were issued.
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for the thirteen weeks and thirty-nine weeks ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year ending December 30, 2017.

Going Concern - The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the twelve-month period following the date of issuance of these consolidated financial statements.

The Company's cash resources and cash flows from operations have been sufficient to pay its obligations and debts as they become due. However, the Company's current capital resources may not be sufficient to repay a promissory note payable to Elutions Capital Ventures S.à r.l, a subsidiary of Elutions, in an aggregate original principal amount of $3.3 million ("Elutions Note"), if it were to be called for redemption, and to fund the Company's operations going forward. The Elutions Note matures on March 18, 2019, but may be called for redemption by the holder at any time and is payable 30 days after it is called for redemption. In addition, Cartesian was obligated to pay the full amount of the earn-out consideration that was payable in connection with the acquisition of the Farncombe Entities in 2015 which equaled £719,483 pounds sterling (approximately US$1.0 million based on an exchange rate of £1.000 = US$1.320 as of July 31, 2017) and 461,055 shares of Company common stock (approximately £1,024,765 pounds sterling or US$1.3 million based on an exchange rate of £1.000= US$1.320 as of July 31, 2017). The earn-out consideration was paid in full during the third quarter of fiscal 2017. The Company is not in default under the Elutions Note and does not have any reason to currently expect that the Elutions Note will be called for redemption, given that the Company is paying its debts as they become due (including making timely payments of interest on the Elutions Note), and a call by the holder of the Elutions Note would cause Elutions to no longer have the right to purchase shares of stock pursuant to the Tracking Warrant if the Elutions Note is called for redemption. Under the Tracking Warrant, Elutions has the right to purchase up to 996,544 shares of common stock of the Company for $3.28 per share. The Tracking Warrant expires March 18, 2020. See Note 2, Acquisition and Note 3, Strategic Alliance and Investment by Elutions, Inc., for additional discussion related to the earn-out and the Elutions Note, respectively.

The Company has entered into receivable financing and factoring arrangements with respect to certain accounts receivable, provided that the ability to finance receivables is subject to limitations, including in certain arrangements the willingness of the purchaser to purchase individual accounts receivable that are offered by the Company. If the Elutions Note is called for redemption by the holder or if the Company realizes significant negative cash flows from operations, it will be required to seek additional debt or equity financing. Elutions has certain rights of first offer in connection with debt financings by us, subject to certain exceptions. In addition, if we obtain debt financing from other lenders, subject to certain exceptions, Elutions may

6



require us to redeem the Elutions Note and to repurchase the shares of our common stock originally acquired by Elutions at a price based upon market prices over 15 trading days prior to the repurchase. In addition, Elutions has certain preemptive rights in connection with equity issuances by the Company, subject to certain exceptions, and Cartesian and its subsidiaries may not, without the prior written consent of Elutions, issue options, warrants or similar rights or convertible securities, other than with respect to certain excluded issuances.

The Company is exploring alternatives to address its liquidity needs in the event the Elutions Note is called for redemption. However, there can be no assurance that financing will be available in amounts or on terms acceptable to the Company, if at all. The Company's ability to secure new financing may be impacted by economic and financial market conditions. If financing is obtained through the sale of additional equity securities or debt securities with equity features, it could result in dilution to the Company's stockholders. If adequate funds were not available on acceptable terms, our business, results of operations, cash flows, and financial condition could be materially adversely affected.

In the fourth quarter of 2016, the Company adopted Accounting Standards Update 2014-15, Presentation of Financial Statements - Going Concern that requires management to assess conditions or events that raise substantial doubt about an entity's ability to continue as a going concern within one year after the financial statements are issued. Management has concluded under ASU 2014-15 that there is substantial doubt about the Company's ability to continue as a going concern if the Company is unable to arrange financing sufficient to pay off the Elutions Note upon a call for redemption. However, the Company currently expects that such financing can be obtained if necessary, subject to market conditions and the Company's financial condition at the time the Company seeks such financing.

If the Company becomes unable to continue as a going concern, it may have to (i) initiate litigation or seek protection under bankruptcy reorganization laws, or (ii) liquidate its assets and the values it receives for its assets in liquidation or dissolution could be significantly lower than the values reflected in the consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty, including any adjustments to reflect the possible future effects of the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
 
Revenue Recognition - The Company recognizes revenue from time and materials consulting contracts in the period in which its services are performed. In addition to time and materials contracts, the Company also has fixed fee contracts. The Company recognizes revenues on milestone or deliverables-based fixed fee contracts and time and materials contracts not to exceed contract price using the percentage of completion-like method described by Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 605-35, "Revenue Recognition - Construction-Type and Production-Type Contracts". For fixed fee contracts where services are not based on providing deliverables or achieving milestones, the Company recognizes revenue on a straight-line basis over the period during which such services are expected to be performed. In connection with some fixed fee contracts, the Company may receive payments from customers that exceed revenues up to that point in time. The Company records the excess of receipts from customers over recognized revenue as deferred revenue. Deferred revenue is classified as a current liability to the extent it is expected to be earned within twelve months from the date of the balance sheet.
 
The FASB ASC 605-35 percentage-of-completion methodology involves recognizing revenue using the percentage of services completed, on a current cumulative cost to total cost basis, using a reasonably consistent profit margin over the period. Due to the longer term nature of these projects, developing the estimates of costs often requires significant judgment. Factors that must be considered in estimating the progress of work completed and ultimate cost of the projects include, but are not limited to, the availability of labor and labor productivity, the nature and complexity of the work to be performed, and the impact of delayed performance. If changes occur in delivery, productivity or other factors used in developing the estimates of costs or revenues, the Company revises its cost and revenue estimates, which may result in increases or decreases in revenues and costs, and such revisions are reflected in income in the period in which the facts that give rise to that revision become known.
 

7



Managed Services Implementation Revenues and Costs - Managed service arrangements provide for the delivery of a software or technology based solution to clients over a period of time without the transfer of a license or a software sale to the customer. For long-term managed service agreements, implementation efforts are often necessary to develop the software utilized to deliver the managed service. Costs of such implementation efforts may include internal and external costs for coding or customizing systems and costs for conversion of client data. The Company may invoice its clients for implementation fees at the go-live date of the underlying software. Lump sum implementation fees received from clients are initially deferred and recognized on a pro-rata basis as services are provided. Specific, incremental and direct costs of implementation incurred prior to the services going live are deferred pursuant to FASB ASC 605-35-25 and amortized over the period that the related ongoing services revenue is recognized to the extent that the Company believes the recoverability of the costs from the contract is probable. If a client terminates a managed services arrangement prior to the end of the contract, a loss on the contract may be recorded, if applicable, and any remaining deferred implementation revenues and costs would then be recognized into earnings generally over the remaining service period through the termination date. During the thirteen weeks ended September 30, 2017, there were no implementation costs deferred and during the thirty-nine weeks ended September 30, 2017, $536,000 of implementation costs related to managed service contracts were deferred. During each of the thirteen weeks and thirty-nine weeks ended October 1, 2016, $403,000 of implementation costs related to managed service contracts were deferred. Unamortized deferred implementation costs were $714,000 and $318,000 as of September 30, 2017 and December 31, 2016, respectively.
 
Research and Development and Software Development Costs - During the thirteen weeks ended September 30, 2017 and October 1, 2016, internal use software development costs of $102,000 and $89,000, respectively, were expensed as incurred. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, internal use software development costs of $279,000 and $364,000, respectively, were expensed as incurred. During the thirteen weeks ended September 30, 2017 and October 1, 2016, $48,000 and $32,000, respectively, of internal use software development costs were capitalized. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, $231,000 and $389,000, respectively, of internal use software development costs were capitalized.
 
Foreign Currency Transactions and Translation - Cartesian Limited, the international operations of Cambridge Strategic Management Group, Inc., Farncombe France SARL, Farncombe Technology Limited, and Farncombe Engineering Services Limited conduct business primarily denominated in their respective local currency, which is their functional currency. Assets and liabilities have been translated to U.S. dollars at the period-end exchange rates. Revenues and expenses have been translated at exchange rates which approximate the average of the rates prevailing during each period. Translation adjustments are reported as a separate component of other comprehensive income (loss) in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Accumulated other comprehensive loss resulting from foreign currency translation adjustments totaled $6.5 million and $6.8 million as of September 30, 2017 and December 31, 2016, respectively, and is included in Total Stockholders’ Equity in the Condensed Consolidated Balance Sheets. Assets and liabilities denominated in other than the functional currency of a subsidiary are re-measured at rates of exchange on the balance sheet date. Resulting gains and losses on foreign currency transactions are included in the Company’s results of operations. During the thirteen weeks ended September 30, 2017, realized and unrealized exchange gains of $113,000 were included in our results of operations and for the thirteen weeks ended October 1, 2016, realized and unrealized exchange losses of $77,000 were included in our results of operations. During the thirty-nine weeks ended September 30, 2017, realized and unrealized exchange gains of $305,000 were included in our results of operations and for the thirty-nine weeks ended October 1, 2016, realized and unrealized exchange losses of $399,000 were included in our results of operations.
 
Loss Per Share - The Company calculates and presents earnings (loss) per share using a dual presentation of basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. The weighted average number of common shares outstanding excludes treasury shares held by the Company. Diluted earnings (loss) per share is computed in the same manner except that the weighted average number of shares is increased for dilutive securities. The following table illustrates the computation of basic and diluted EPS for the thirteen weeks ended October 1, 2016 (in thousands, except share and per share data).


8



 
 
For the Thirteen Weeks Ended October 1, 2016
 
 
Income (Numerator)
 
Shares (Denominator)
 
Per Share Amount
Basic EPS
 
 
 
 
 
 
Net income available to common stockholders
 
$
5

 
8,637

 
$
0.00

 
 
 
 
 
 
 
Effect of Dilutive Securities
 
 
 
 
 
 
Non-vested shares
 

 
13

 
 
 
 
 
 
 
 
 
Diluted EPS
 
 
 
 
 
 
Net income available to common stockholders
 
$
5

 
8,650

 
$
0.00


In accordance with the provisions of FASB ASC 260, "Earnings per Share", the Company uses the treasury stock method for calculating the dilutive effect of employee stock options, non-vested shares and warrants. The employee stock options, non-vested shares and warrants will have a dilutive effect under the treasury stock method only when average market value of the underlying Company common stock during the respective period exceeds the assumed proceeds. For share-based payment awards with a performance condition, the Company must first use the guidance on contingently issuable shares in FASB ASC 260-10 to determine whether the awards should be included in the computation of diluted earnings per share for the reporting period. For all non-vested performance-based awards, the Company determines the number of shares, if any, that would be issuable at the end of the reporting period if the end of the reporting period were the end of the contingency period. In applying the treasury stock method, assumed proceeds include the amount, if any, the employee must pay upon exercise, the amount of compensation cost for future services that the Company has not yet recognized, and the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the options and the vesting of non-vested shares. For the thirteen weeks ended September 30, 2017, approximately 71,000 shares related to outstanding stock options, non-vested shares and warrants that otherwise would have been included in the diluted earnings per share calculation were not included because they would have been anti-dilutive due to our net loss for those periods. For the thirteen weeks ended October 1, 2016 there were no shares related to outstanding stock options, non-vested shares and warrants that otherwise would have been included in the diluted earnings per share calculation that would have been anti-dilutive. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, approximately 67,000 shares and 55,000 shares related to outstanding stock options, non-vested shares and warrants that otherwise would have been included in the diluted earnings per share calculation were not included because they would have been anti-dilutive due to our net loss for those periods.
 
Accounts Receivable - The Company has entered into agreements with third-party financial institutions under which it can selectively elect to transfer to the financial institutions accounts receivable with certain of the Company’s largest, international customers on a non-recourse basis. These agreements give the Company optionality to convert outstanding accounts receivable to cash. For any transfer of accounts receivable under these agreements that qualifies as a sale, the Company applies the guidance in FASB ASC 860, “Transfers and Servicing – Sales of Financial Assets”, which requires the derecognition of the carrying value of those accounts receivable on the Condensed Consolidated Balance Sheets and recognition of a loss on the sale of an asset in operating expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The loss is determined at the date of transfer based upon the amount at which the accounts receivable are transferred less any fees, discounts and other charges provided under the agreements. During the thirteen weeks ended September 30, 2017 and October 1, 2016, $3.1 million and $4.9 million, respectively, in accounts receivable were transferred pursuant to these agreements which qualified as sales of receivables and the related carrying amounts were derecognized. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, $9.0 million and $15.6 million, respectively, in accounts receivable were transferred pursuant to these agreements which qualified as sales of receivables and the related carrying amounts were derecognized. The loss on the sale of these accounts receivable recorded in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) was immaterial for each of the thirteen weeks ended September 30, 2017 and October 1, 2016 and was $39,000 and $59,000 for the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively.

In 2016 the Company entered into a Factoring Agreement ("Factoring Agreement") with RTS Financial Service, Inc. ("RTS"). Pursuant to the terms of the Factoring Agreement, the Company may offer for sale, and RTS may purchase, certain accounts receivable of the Company on an account by account basis (such purchased accounts, the "Purchased Accounts"). Under the Factoring Agreement, upon purchase RTS becomes the absolute owner of the Purchased Accounts, which are payable directly to RTS, subject to certain repurchase obligations of the Company. Proceeds from transfers under the Factoring Agreement reflect the face value of the account receivable less a factor’s fee. The factor’s fee is computed on a daily basis until the amount

9



of the Purchased Account is paid to RTS, and equals the amount of the Purchased Account multiplied by the sum of the prime rate then in effect plus 6.49% divided by 360. Upon purchase of a Purchased Account, RTS will pay to the Company the amount of the Purchased Account, less a reserve of 20% of that amount, which reserve (less the total fee calculated) is payable to the Company upon collection of the Purchased Account by RTS. The fee is recorded as interest expense within the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) in the period the fee becomes payable. During the thirteen weeks ended September 30, 2017 and October 1, 2016, the Company factored $2,084,000 and $886,000, respectively, of accounts receivable under the Factoring Agreement. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, the Company factored $3,953,000 and $1,533,000, respectively, of accounts receivable under the Factoring Agreement. As of September 30, 2017 and December 31, 2016, the Company recognized a liability of $1,457,000 and $768,000, respectively, which is recorded as Secured borrowing on the Condensed Consolidated Balance Sheets. Until received, the reserve amount withheld at the time of transfer is recorded as a receivable and is included in Prepaid and other current assets on the Condensed Consolidated Balance Sheets. As of September 30, 2017 and December 31, 2016 the amount recorded as a receivable for the reserve withheld by RTS was $291,000 and $154,000, respectively. The amount of fees recorded as interest expense were immaterial for the thirteen weeks ended September 30, 2017 and October 1, 2016 and the thirty-nine weeks ended September 30, 2017 and October 1, 2016.

Also in 2016, Cartesian Limited, a U.K. subsidiary of Cartesian, Inc., entered into an Invoice Discounting Agreement, a Debenture (security agreement) and certain related agreements (collectively, the "Agreement") with RBS Invoice Finance Limited ("RBS"). In April 2017, the Company entered into agreements with RBS to include Farncombe Engineering Services Ltd. and Farncombe Technology Limited as companies that could assign eligible accounts receivable to RBS.   Pursuant to the terms of the Agreement, Cartesian Limited, Farncombe Engineering Services Ltd., and Farncombe Technology Limited may assign to RBS certain eligible accounts receivable (such purchased accounts, the "U.K. Purchased Accounts").

The Agreement has a maximum funding level of £3,000,000 with respect to Cartesian Limited, a combined £1,000,000 maximum funding level with respect to Farncombe Engineering Services Ltd. and Farncombe Technology Limited, and a combined £3,000,000 maximum funding level with respect to the three entities. At the time of the purchase of a U.K. Purchased Account, RBS will make an initial payment to the applicable entity of no more than 50% of the U.K. Purchased Account. Upon collection of a U.K. Purchased Account, RBS will pay to the applicable entity the amount of the U.K. Purchased Account, less the initial payment and a discounting charge. The discounting charge is computed on a daily basis until the amount of the U.K. Purchased Account is paid to RBS, and equals the amount of the U.K. Purchased Account multiplied by the sum of the National Westminster Bank Plc base rate then in effect plus 1.75% divided by 365. The Agreement for Cartesian Limited includes a fixed fee service charge of £833 per month and the agreement for Farncombe Engineering Services Ltd. includes a fixed fee service charge of £250 per month. The agreements have loan concentration limits regarding the obligors on U.K. Purchased Accounts. The discounting charges are recorded as interest expense within the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) in the period the fee becomes payable.

The entities obligations under the agreements are secured by certain assets of the entities, including all equipment and intellectual property, all stock of subsidiaries held by them and certain accounts receivable. Each of the three entities guarantees the obligations of the other entities. Under the Agreement, Cartesian Limited's net worth, as measured by issued share capital and retained earnings, less all intangible assets, may not fall below £7,500,000 in any 12 month period.

RBS may require the applicable entity to repurchase U.K. Purchased Accounts upon a number of specified events, including if the entity breaches or defaults on any of its obligations under the Agreement or if in the case of Cartesian Limited it fails to meet the net worth requirement. The entities are in compliance with those obligations and Cartesian Limited meets the net worth requirement.

The agreements have an initial term of 12 months and continue after the initial term until terminated by either the applicable entity or RBS. Each entity may terminate its agreement at any time during the initial term upon approval of RBS or upon six months' notice of intent to terminate (three months' notice in the case of the Farncombe entities). RBS may terminate the agreements upon certain other events or conditions included in the agreements.

During the thirteen weeks and thirty-nine weeks ended September 30, 2017, the entities factored $7.5 million and $19.4 million, respectively, under the agreements and as of September 30, 2017 recognized a liability of $2.9 million which is recorded as Secured borrowing on the Condensed Consolidated Balance Sheets. No amounts were factored under the Agreement during fiscal 2016.
 
Inventory – In accordance with the provisions of FASB ASC 330, “Inventory”, the Company’s inventory is stated at the lower of cost, using the first-in, first-out (FIFO) method, or fair value. As of September 30, 2017 and December 31, 2016, the Company had $0.2 million and $0.4 million in inventory, respectively, all of which was finished goods. All of the inventory

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was purchased in July 2014 from Elutions, Inc. (“Elutions”), which owns more than five percent of the outstanding shares of common stock of the Company. See Note 3, Strategic Alliance and Investment by Elutions, Inc.
 
Long-lived Assets - The Company reviews long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets might not be recoverable in accordance with the provisions of FASB ASC 360, “Property, Plant and Equipment”. There was no impairment of long-lived assets during the thirteen weeks or thirty-nine weeks ended September 30, 2017.
 
Recent Accounting Pronouncements – In May 2017, the FASB issued Accounting Standards Update ("ASU") 2017-09, "Scope of Modification Accounting", which amends the scope of modification accounting for share-based payment arrangements, provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. For all entities, the ASU is effective for annual reporting periods, including interim periods within those annual reporting periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. The Company is currently evaluating the impact the application of ASU 2017-09 will have on the Company’s condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments", which will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, and the ASU requires adoption on a retrospective basis. Early adoption is permitted. The Company is currently evaluating the impact the application of ASU 2016-15 will have on the Company’s condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-9, “Improvements to Employee Share-Based Payment Accounting”, which simplifies several aspects of the accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. A modified retrospective approach is required on the balance sheet by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. A retrospective or prospective approach can be used for the cash flow statement and a prospective approach is required for the statement of operations. The Company adopted this guidance beginning in fiscal year 2017 and its adoption did not have a material impact on the Company’s consolidated financial statements.
 
In February 2016, the FASB issued ASU 2016-2, “Leases” which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. The Company is currently evaluating the effects that the adoption of ASU 2016-2 will have on the Company’s consolidated financial statements.
 
In July 2015, the FASB issued ASU 2015-11 which requires entities to measure most inventory at the lower of cost and net realizable value thereby simplifying the existing guidance which required entities to measure inventory at the lower of cost or market. Under the current guidance, market is defined as replacement cost, net realizable value or net realizable value less a normal profit margin. The newly issued guidance eliminates the requirement to determine replacement cost and defines net realizable value as the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. This new guidance is effective for the Company beginning in fiscal 2017. The adoption of this standard did not have a material effect on the Company's consolidated financial statements.
 
In May 2014, the FASB issued ASU 2014-9, Revenue from Contracts with Customers. This standard update clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The standard update intends to provide a more robust framework for addressing revenue issues; improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; and provide more useful information to users of financial statements through improved disclosure requirements. In July 2015, the FASB voted to defer the effective date of this new standard by one year and to permit early adoption beginning as of the original effective date of the new standard. The provisions of FASB ASU 2014-9 will now be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and are to be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption.

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The Company has established an implementation team to evaluate and implement the new standard related to the recognition of revenue from contracts with customers. The Company provides consulting services and currently recognizes revenue from time and materials consulting contracts in the period in which its services are performed. In addition to time and materials contracts, the Company also has fixed fee contracts. The Company recognizes revenues on milestone or deliverables-based fixed fee contracts and time and materials contracts not to exceed contract price using the percentage of completion-like method at point of sale or delivery. We are completing an analysis of revenue streams and expect to combine a majority of contracts into various portfolios under the practical expedient permitted by ASU 2014-9. We currently expect to substantially finalize our accounting policy during the fourth quarter of fiscal 2017 and implement any necessary changes to processes and controls prior to adoption of the new standard. The Company expects to use the modified retrospective adoption method. The Company will present expanded disclosure in accordance with the requirements of the standard. Based upon its analysis to date, the Company has not yet identified any material differences. The Company will continue to evaluate the impacts of the pending adoption of ASU 2014-09 and the preliminary assessments are subject to change.

 
2. Acquisition
 
On July 22, 2015, the Company entered into a Share Purchase Agreement (the “Purchase Agreement”) and completed the acquisition of all of the outstanding shares of capital stock of Farncombe France SARL, an entity formed under the laws of France, and Farncombe Technology Limited, a company incorporated and registered in England and Wales (collectively, the “Farncombe Entities”). The Farncombe Entities operate primarily in the U.K. and Europe and are in the business of providing strategic consultancy, content security, testing and implementation services for broadcast and broadband internet digital television. Farncombe’s experience in these areas along with Cartesian’s strategic, operational and technical capabilities in serving global service providers strengthens the Company’s ability to support convergence and quad play offerings in this growing market.
 
The total purchase price, subject to adjustment in accordance with the terms of the Purchase Agreement, was £4,360,620 pounds sterling (approximately US$6.8 million based on an exchange rate of £1.000 = US$1.556 as of July 21, 2015) comprised of:
 
Cash paid at the closing in the amount of £654,093 pounds sterling (approximately US$1.0 million based on an exchange rate of £1.000 = US$1.556 as of July 21, 2015) which was funded from our available cash on hand and represents 15% of the purchase price.

£1,308,186 pounds sterling (approximately US$2.0 million based on an exchange rate of £1.000 = US$1.556 as of July 21, 2015) settled by the issuance of 588,567 shares of Company common stock at the closing which equals 30% of the purchase price. The number of shares issued at the closing was calculated using a volume-weighted average share price for Company common stock on the Nasdaq Stock Market for the 30 days ending on the day before the date of the signing of the Purchase Agreement and based upon the average pounds sterling to dollar exchange rate recorded by the Financial Times for the 30 days ending on the day before the date of signing of the Purchase Agreement. The share price resulting from this calculation was £2.22 pounds sterling per share (US$3.46 per share).

Additional consideration in the amount of £654,093 pounds sterling (approximately US$1.0 million based on an exchange rate of £1.000 = US$1.556 as of July 21, 2015) which represents 15% of the purchase price, payable after the closing in accordance with the Purchase Agreement upon determination of the net working capital of the Farncombe Entities as prescribed in the Purchase Agreement, and as adjusted based upon the relative amounts of the net working capital of the Farncombe Entities as of May 31, 2015 and the closing and as compared to the target amount of net working capital as provided in the Purchase Agreement.

Earn-out consideration (the “Earn-Out”) which was payable in cash and/or shares of Company common stock as elected by each Seller in the Purchase Agreement and represents 40% of the purchase price as described below.

On April 17, 2017, the Company entered into a letter agreement (the “Letter Agreement”) with the former shareholders of the Farncombe Entities (the “Sellers”). In the Letter Agreement, the parties agreed to a final determination of the Earn-Out and the consideration payable related to net working capital as adjusted, pursuant to which the Company agreed to pay to Sellers an additional amount equal to any amount received by the Company following the date of the Letter Agreement in respect of repayment of a loan of €50,000 (approximately US$59,000 based on an exchange rate of €1.000 = US$1.191 as of September 30, 2017) made to a third party by Farncombe Technology Limited prior to the closing under the Purchase Agreement. The parties also agreed that the Earn-Out target was expected to be achieved, and that the Company would pay 100% of the Earn-Out consideration described above to the Sellers. The Company also agreed in separate agreements that performance-based

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awards granted to two of the Sellers as employees of the Company based upon achievement of the Earn-Out would be paid in full.

The aggregate amount payable pursuant to the Earn-Out consists of cash in an amount up to £719,483 pounds sterling (approximately US$1.0 million based on an exchange rate of £1.000= US$1.321 as of July 31, 2017) and up to 461,055 shares of Company common stock (approximately £1,024,765 pounds sterling or US$1.3 million based on an exchange rate of £1.000= US$1.321 as of July 31, 2017) and based upon the value of the shares as described below. Amounts payable under the Earn-Out are based upon the amounts of specified revenues attributable to the Farncombe Entities after June 1, 2015 through July 22, 2017, as defined in the Purchase Agreement. Pursuant to the Purchase Agreement, the number of shares of Company common stock payable under the Purchase Agreement at the closing and pursuant to the Earn-Out was determined based on the volume weighted average share price for Company common stock on the Nasdaq Stock Market for the 30 days ending on the day before the date of signing of the Purchase Agreement and based upon the average pounds sterling to dollar exchange rate recorded by the Financial Times for the 30 days ending on the day before the date of signing of the Purchase Agreement. The earn-out consideration was paid in full during the third quarter of fiscal 2017.
 
In fiscal 2015 the Company paid approximately $2.1 million to the former shareholders of the Farncombe Entities with respect to the consideration payable related to net working capital as adjusted pursuant to the Purchase Agreement. This represented payment of a portion of the purchase price in the amount of £654,093 pounds sterling (approximately US$1.0 million) payable in accordance with the Purchase Agreement along with an additional £743,753 pounds sterling (approximately US$1.1 million) related to the working capital adjustment for excess working capital under the Purchase Agreement. In March 2016, the Company paid additional amounts of approximately £184,000 and €12,000 (approximately US$0.3 million) to the former shareholders of the Farncombe Entities with respect to net working capital as adjusted. In the fourth quarter of fiscal 2016 and the first quarter of fiscal 2017, the Company made payments of £20,000 (approximately US$25,000) and £48,000 (approximately US$59,000), respectively, to the former shareholders of the Farncombe Entities with respect to net working capital as adjusted.
 
Up until the effective date of the Letter Agreement, the Company had classified the Earn-Out liability as a Level 3 liability and the fair value of the Earn-Out liability was evaluated each reporting period with changes in its fair value included in the Company’s results of operations. During the thirty-nine weeks ended September 30, 2017, the change in the fair value of the Earn-Out liability was an increase of $365,000, respectively, which is included in Selling, general and administrative expenses on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). During the thirteen weeks and thirty-nine weeks ended October 1, 2016, the change in the fair value of the Earn-Out liability was an increase of $66,000 and a decrease of $235,000, respectively, which is included in Selling, general and administrative expenses on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The balance of the Earn-Out liability as of December 31, 2016 was $1,903,000, which is recorded as "Contingent consideration liability", a current liability, in the Condensed Consolidated Balance Sheets. See Note 9, Fair Value Measurements, for discussion of the determination of fair value of the Earn-Out liability.

3. Strategic Alliance and Investment by Elutions, Inc.
 
Strategic Alliance and Investment by Elutions, Inc.
 
On February 25, 2014, the Company entered into an investment agreement (the “Investment Agreement”) with Elutions, a provider of operational business intelligence solutions. Under the Investment Agreement, the Company agreed to issue and sell shares of common stock to Elutions and to issue stock purchase warrants to Elutions, and the parties agreed that a subsidiary of Elutions would loan funds to a subsidiary of the Company. On March 18, 2014, the Company and Elutions completed the closing (the "Closing") of the transactions contemplated under the Investment Agreement.
 
At the Closing, (a) the Company issued and sold 609,756 shares of common stock to Elutions at a price of $3.28 per share, for an aggregate purchase price of $2,000,000, (b) the Company's subsidiary, Cartesian Limited, issued a promissory note (the "Note") payable to Elutions Capital Ventures S.à r.l, a subsidiary of Elutions, in an aggregate original principal amount of $3,268,664, payable in equivalent Great Britain Pounds Sterling, and the Company issued to Elutions a Common Stock Purchase Warrant (Tracking) related to the Note to purchase 996,544 shares of common stock of the Company for $3.28 per share (the "Tracking Warrant"), and (c) the Company issued to Elutions a Common Stock Purchase Warrant (Commercial Incentive) pursuant to which Elutions can earn the right to purchase up to 3,400,000 shares of common stock of the Company at prices ranging from $3.85 per share to $4.85 per share based on the Company's financial results related to certain customer contracts obtained jointly by the Company and Elutions (the "Incentive Warrant"). The Incentive Warrant and the Tracking Warrant are referred to collectively below as the "Warrants".
 

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The Investment Agreement contains a number of agreements and covenants, including (i) certain affirmative and negative covenants relating to the Note applicable to the Company and its subsidiaries, (ii) an agreement of the Company to assign to Elutions certain customer contracts obtained jointly with Elutions if a competitor acquires control of the Company, (iii) confidentiality restrictions applicable to both parties, (iv) a standstill agreement of Elutions, (v) an agreement of the parties to negotiate in good faith for the purchase by Elutions of additional shares of Common Stock equal to 6.5% of outstanding shares from the Company or in open market purchases if Elutions then owns or is vested with the right to acquire 38.5% of the shares of Common Stock then outstanding, subject to any applicable stockholder approval requirements, (vi) the grant of a right of first offer to Elutions to loan funds to the Company in the future if the Company intends to incur or assume indebtedness, subject to certain exceptions, (vii) a grant of pre-emptive rights to Elutions with respect to future issuances and sales of equity securities by the Company, subject to certain exceptions, (viii) the right of Elutions to designate one member of the Board of Directors of the Company if it meets certain ownership thresholds, and (ix) restrictions on the issuance by the Company of options, warrants or similar rights or convertible securities, other than with respect to certain excluded issuances.
 
Promissory Note
 
The Note issued at Closing by the Company's subsidiary, Cartesian Limited, in the aggregate original principal amount of $3,268,664, bears interest at the rate of 7.825% per year, payable monthly, and matures on March 18, 2019. The Note must be redeemed by Cartesian Limited within 30 days upon notification by the holder at any time (the “Holder Redemption Option”) and may be prepaid by Cartesian Limited after 18 months if the trading price of the Company's common stock exceeds $5.50 per share for a specified period of time and may be prepaid by Cartesian Limited at any time after 30 months. The obligations of Cartesian Limited under the Note are guaranteed by the Company pursuant to a Guaranty entered into by the Company at Closing and are secured by certain assets relating to client contracts involving Elutions pursuant to a Security Agreement entered into by the Company and Elutions at Closing. Amounts outstanding under the Note may be applied to the exercise price of the Company's common stock under the Tracking Warrant. Upon occurrence of an event of default, the Note would bear interest at 9.825% per year and could be declared immediately due and payable. Interest expense was approximately $64,000 and $65,000 for the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively, and was $190,000 and $193,000 for the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively.
 
Tracking Warrant
 
Under the Tracking Warrant, Elutions may acquire 996,544 shares of common stock of the Company for $3.28 per share at any time and from time to time through March 18, 2020. The Company may require Elutions to exercise or forfeit the Tracking Warrant at any time (i) after 18 months if the trading price of the Company's common stock exceeds $5.50 per share for a specified period of time and the Company meets certain cash and working capital thresholds and (ii) after 30 months if the Company meets certain cash and working capital thresholds. To the extent amounts are outstanding under the Note, Elutions and the Company (if the Company is requiring exercise of the Tracking Warrant by Elutions as described above) may offset such amounts against the exercise price for shares of common stock acquired under the Tracking Warrant. The Tracking Warrant expires if the Note is redeemed upon exercise of the Holder Redemption Option.
 
Incentive Warrant
 
Under the Incentive Warrant, Elutions can earn the right to purchase up to 3,400,000 shares of common stock of the Company at prices ranging from $3.85 per share to $4.85 per share based on the Company's financial results as described below. The Incentive Warrant expires on March 18, 2020. The right to exercise the Incentive Warrant to acquire shares is subject to satisfaction of certain performance conditions based on revenues or cash received by the Company under customer contracts acquired jointly with Elutions through a five-year period from March 18, 2014 until March 18, 2019. The Incentive Warrant may vest upon satisfaction of the performance conditions during the five-year period. The number of shares of common stock for which the Incentive Warrant may become exercisable during each year in the five-year period under the vesting provisions is determined by dividing four percent of such revenues and cash recognized or received by the Company in such year by the warrant exercise price per share for that year. In addition, the right to acquire shares may vest at the end of the five-year period for contracts that have been signed and with respect to which revenues are expected to be earned or cash is expected to be received after the end of the five-year period. The exercise price increases $0.25 per year for shares earned in each year of the five-year period and is payable in cash, provided that Elutions has the right to utilize a cashless exercise procedure to acquire shares of common stock under the Incentive Warrant for a limited period of time each year after the right to acquire such shares vests. Any shares utilized to exercise such cashless exercise right will not reduce the maximum number of shares that may be earned and acquired under the Incentive Warrant.
 

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Additional Warrant Provisions
 
Each of the Warrants has economic anti-dilution protection provisions which provide for adjustments to the exercise price and the number of shares of common stock which may be acquired pursuant to the Warrants in the event of issuances of shares of common stock by the Company at a price less than the 30-day volume weighted average trading price at the time of issuance, subject to a number of exceptions. Each of the Warrants also permits Elutions (subject to certain exceptions) to purchase shares in future equity offerings made by the Company on a pro rata basis to all stockholders, with such participation right based upon the maximum number of shares that may be purchased under the Warrant.

Registration Rights
 
At Closing, the Company and Elutions entered into a Registration Rights Agreement (the "Registration Rights Agreement"), pursuant to which the Company has obligations to register for resale the shares of common stock issued under the Investment Agreement and the Warrants. Under the Registration Rights Agreement, the Company granted certain piggyback registration rights to Elutions and agreed to file and maintain a resale shelf registration statement for the benefit of Elutions. The resale shelf registration was filed with the SEC on August 12, 2014 and was declared effective on August 26, 2014.
 
Commercial Relationship

The Investment Agreement and the agreements and instruments described above are part of a strategic relationship between the Company and Elutions. As part of the strategic relationship, the parties entered into certain commercial framework documents, including a Market Development Agreement and related Inventory Agreement, on February 25, 2014, and enter into client agreements and bilateral agreements from time to time in the ordinary course of business outlining the terms of the parties' commercial relationship with respect to business development and providing products, solutions and services to clients. The parties have agreed to a term of five years, with automatic two-year renewals unless notice is given, and subject to termination rights in certain events. The Company has agreed to restrictions during the term and for two years thereafter in regard to solutions or services that are substantially similar to or competitive with certain solutions or services of Elutions, and each party has agreed not to hire the other party's employees during the same period.
 
The parties have agreed on a general framework for pursuing, entering into and implementing customer contracts, which includes providing for joint and separate client pursuits and marketing on an initial and ongoing basis, procedures for contracting with clients, procedures for interface between the parties, limited exclusivity requirements of Elutions relating to identified prospects and clients of the Company, intellectual property rights of Elutions to its products and related restrictions, restrictions regarding use of confidential information, limitations on liability of the parties, independent contractor status of the parties, limitations on publicity by the parties, and dispute resolution, including arbitration. The parties intend that specific pricing and allocation provisions and other specific commercial terms will be included in individual client statements of work, subject to mutually agreed gross margin requirements for the benefit of the Company. The parties also agreed to a framework for certain initial inventory orders and reorders by the Company from Elutions, and related commitments, timing and pricing procedures, when the Company is the prime contracting party under certain client statements of work. With respect to the required initial inventory order, the Company was required to purchase $3.0 million of inventory from Elutions upon receiving a booked order for Smart Building Services of a certain size from a customer. As a result of a customer agreement entered into by the Company, during the third quarter of fiscal 2014, the Company acquired $3.0 million in inventory from Elutions to fulfill its initial inventory commitment. As of September 30, 2017, the Company has not sold or licensed any of the initial inventory acquired from Elutions and has not acquired any additional inventory from Elutions.
 
Under the Market Development Agreement, if the Company had not sold 75% of such inventory acquired from Elutions within one year after acquisition, Elutions is required upon request of the Company to source its requirements for future projects in the U.S. or U.K. from such inventory subject to a 10% discount against the Company’s purchase price until the Company has exhausted such inventory. In fiscal 2015, the Company requested that Elutions source its requirements for future projects from the inventory that was acquired by the Company from Elutions in July 2014. Management continues to work with Elutions to utilize the inventory and changes in management’s expectations in future periods could impact the net realizable value of the inventory. See Note 1, Basis of Reporting for a discussion of the inventory recorded with respect to our agreements with Elutions.
 
Also under the Market Development Agreement, Elutions agreed to dedicate three full-time equivalent employees for the purpose of various functions related to the furtherance of the strategic alliance, and the Company agreed to fund the cost of the three full-time equivalent employees at a rate of $36,750 per month. Pursuant to the Market Development Agreement, the Company terminated the provision of the three full-time equivalent employees effective in March 2016. For the thirty-nine weeks ended October 1, 2016, expense related to these dedicated employees was approximately $98,500.

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In connection with the customer agreement entered into by the Company in 2014, the Company entered into a subcontract with Elutions. Under the subcontract, Elutions agreed to provide all services in accordance with the customer agreement except for project management services, to be provided by the Company. In January 2017, the Company entered into an amendment of the customer agreement and an amendment to the subcontract with Elutions. The amendments increase the number of customer sites deployed and extend the term of the original agreement. As of September 30, 2017, the Company estimates total additional license payments to Elutions under the amendment to the subcontract are approximately $0.3 million and that the total remaining license payments to Elutions under the original subcontract, as amended, are approximately $0.7 million over the term of the subcontract, with additional amounts potentially payable to Elutions based upon energy savings achieved by the customer. Annual license payments under the subcontract are recorded as managed services implementation costs which are included in Other current assets on the Condensed Consolidated Balance Sheets. See Note 1, Basis of Reporting. Elutions also agreed in the subcontract to provide all equipment required under the customer agreement, and the Company agreed to advance to Elutions $400,000 of the equipment deployment cost. The advance amount was paid to Elutions during fiscal 2014. Elutions is required to repay the advanced amount plus interest at the rate of 5.5% per annum. The funds are netted directly from the customer’s annual payments. Annual payments to Elutions are paid during the third fiscal quarter of each fiscal year. As of September 30, 2017 and December 31, 2016, the balance remaining for the advance to Elutions was $100,000 and $200,000, respectively, of which $100,000 was included in Other current assets as of both September 30, 2017 and December 31, 2016, and $100,000 was included in Other noncurrent assets as of December 31, 2016, on the Condensed Consolidated Balance Sheets, respectively.
 
Accounting Treatment
 
The Holder Redemption Option was determined to be an embedded derivative liability that was required to be bifurcated and recorded as a liability.
 
In addition, the Company determined that the provision of the Note that permits Cartesian Limited to prepay the Note after 18 months if the trading price of the Company’s common stock exceeds $5.50 per share for a specified period of time is an embedded derivative asset that requires bifurcation (the “Issuer Call Option”). As of September 30, 2017 and December 31, 2016, the fair value of the Issuer Call Option was determined to be immaterial. The carrying value of the Note as of September 30, 2017 and December 31, 2016 was $3,269,000 and as of September 30, 2017 and December 31, 2016, the fair value of the Note was $2,541,000 and $2,703,000, respectively. The Incentive Warrant and Tracking Warrant are accounted for as equity instruments. See Note 9, Fair Value Measurements for discussion of the determination of fair values.
 
The vesting of the Incentive Warrant is contingent on services to be provided by Elutions and the achievement of performance conditions by Elutions. During the thirteen weeks ended September 30, 2017 and October 1, 2016, Elutions earned 2,450 and 4,086 vested shares, respectively, under the Incentive Warrant and the Company recognized $7,000 and $9,000 of expense related to these vested shares, respectively.  During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, Elutions earned 17,844 and 23,020 vested shares, respectively, under the Incentive Warrant and the Company recognized $48,000 and $43,000 of expense related to these vested shares, respectively.
 

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4. Goodwill and Intangible Assets

The following table summarizes the changes in the major classes of intangible assets as of September 30, 2017 and December 31, 2016 (in thousands):
 
 
Tradename
 
Non-Compete
Agreements
 
Customer
Relationships
 
Total
Gross Carrying Amount:
 
 

 
 

 
 

 
 

Balance as of December 31, 2016
 
$
71

 
$
48

 
$
881

 
$
1,000

Changes in foreign currency exchange rates
 
6

 
4

 
73

 
83

 
 
 
 
 
 
 
 
 
Balance as of September 30, 2017
 
$
77

 
$
52

 
$
954

 
$
1,083

 
 
 
 
 
 
 
 
 
Accumulated Amortization:
 
 

 
 

 
 

 
 

Balance as of December 31, 2016
 
$
(71
)
 
$
(15
)
 
$
(357
)
 
$
(443
)
Changes in foreign currency exchange rates
 
(6
)
 
(2
)
 
(38
)
 
(46
)
Amortization expense
 

 
(8
)
 
(196
)
 
(204
)
 
 
 
 
 
 
 
 
 
Balance as of September 30, 2017
 
$
(77
)
 
$
(25
)
 
$
(591
)
 
$
(693
)
 
 
 
 
 
 
 
 
 
Intangible assets, net as of September 30, 2017
 
$

 
$
27

 
$
363

 
$
390

 
The identifiable intangible assets in the table above resulted from the July 2015 acquisition of the Farncombe Entities and include the effects of foreign currency translation. Tradename, non-compete agreements and customer relationships carry amortization periods of six months, four and one-half years and three and one-half years, respectively. The amortization periods are based on the period of expected cash flows used to measure the fair value of the intangible assets.
 
Aggregate amortization expense related to intangible assets was $70,000 and $70,000 for the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively, and was $204,000 and $235,000 for the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively. The following table outlines the estimated future amortization expense related to amortizing intangible assets as of September 30, 2017 (in thousands):
 
2017 (October 1, 2017 – December 30, 2017)
$
71

2018
284

2019
34

2020
1

 
$
390

 
5. Share-Based Compensation
 
The Company issues stock option awards and non-vested share awards under its share-based compensation plans. The key provisions of the Company’s share-based compensation plans are described in Note 5, Share-Based Compensation, in the Notes to the Consolidated Financial Statements included in Item 8, Consolidated Financial Statements of the 2016 Form 10-K.
 
The Company recognized income tax expense of $3,000 and income tax benefits of $12,000 related to share-based compensation arrangements during the thirteen weeks and thirty-nine weeks ended October 1, 2016. No income tax benefit was recognized in the year-to-date period of fiscal 2017 due to the full valuation allowance on the Company's deferred tax assets.
 
Equity Incentive Plan
 
In April 2015, our Board of Directors approved an amendment and restatement of the Company’s Equity Incentive Plan (the “Equity Plan”), which was approved by our stockholders at the 2015 annual meeting of stockholders which was held on June 16, 2015. There are 2,805,659 shares of common stock that are available for issuance (inclusive of shares previously issued) under the Equity Plan. The Equity Plan expires on June 16, 2025.

17



 
Stock Options

Service-Based Stock Option Awards – A summary of the service-based stock option activity under the Equity Plan, as of September 30, 2017 and changes during the thirty-nine weeks then ended is presented below: 
 
 
Shares
 
Weighted
Average
Exercise
Price
Outstanding at December 31, 2016
 
212,762

 
$
6.91

Granted
 

 
$

Forfeited/cancelled
 
(89,496
)
 
$
10.73

 
 
 
 
 
Outstanding at September 30, 2017
 
123,266

 
$
4.13

 
 
 
 
 
Options vested and expected to vest at September 30, 2017
 
116,391

 
$
4.27

 
 
 
 
 
Options exercisable at September 30, 2017
 
85,765

 
$
5.05

 
The Company did not grant any service-based stock option awards during the thirty-nine weeks ended September 30, 2017. The Company granted a service-based stock option award for 37,500 shares of the Company's common stock having an
exercise price of $1.10 per share during the thirteen weeks ended October 1, 2016. The stock option vests solely based on
employee service over a three year period. The Company recorded share-based compensation expense in connection with service-based stock option awards of $5,000 and $2,000 during the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively and recorded $15,000 and $10,000 during the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively. As of September 30, 2017, there was approximately $10,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to service-based stock option awards, and this unrecognized expense is expected to be recognized over a weighted average period of 13 months. As of December 31, 2016, there was $26,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to service-based stock option awards.
 
Market Condition Stock Option Awards – A summary of the market condition stock option activity under the Equity Plan, as of September 30, 2017 and changes during the thirty-nine weeks then ended is presented below: 
 
 
Shares
 
Weighted
Average
Exercise
Price
Outstanding at December 31, 2016
 
325,000

 
$
2.54

Granted
 

 
$

 
 
 
 
 
Outstanding at September 30, 2017
 
325,000

 
$
2.54

 
 
 
 
 
Options vested and expected to vest at September 30, 2017
 
325,000

 
$
2.54

 
 
 
 
 
Options exercisable at September 30, 2017
 

 
$

 
On September 28, 2016, the Company granted non-qualified stock options awards for 125,000 shares of the Company's common stock having an exercise price of $1.25 per share. On June 16, 2015 the Company granted a non-qualified stock option award for 200,000 shares of the Company’s common stock having an exercise price of $3.34 per share. Except with respect to the non-qualified stock option awards for 125,000 shares which also vest upon a change of control of the Company, these stock options will vest only if the price of the Company’s common stock reaches certain price targets, as follows:

the stock options will vest with respect to 116,666 shares if at any time the closing market price of the Company’s common stock on each day during a 30 consecutive trading day period equals or exceeds $4.00 per share;


18



the stock options will vest with respect to an additional 116,667 shares if at any time the closing market price of the Company’s common stock on each day during a 30 consecutive trading day period equals or exceeds $5.00 per share; and

the stock options will vest with respect to an additional 91,667 shares if at any time the closing market price of the Company’s common stock on each day during a 30 consecutive trading day period equals or exceeds $6.00 per share.
 
For stock options which contain market conditions, the market conditions are required to be considered when calculating the grant date fair value. FASB ASC 718 – “Compensation – Stock Compensation”, requires us to select a valuation technique that best fits the circumstances of an award. In order to reflect the substantive characteristics of the market condition option award, a Monte Carlo simulation valuation model was used to calculate the grant date fair value of such stock options. Monte Carlo approaches are a class of computational algorithms that rely on repeated random sampling to compute their results. This approach allows the calculation of the value of such stock options based on a large number of possible stock price path scenarios. Expense for the market condition stock options is recognized over the derived service period as determined through the Monte Carlo simulation model. The fair value and derived service periods calculated by vesting tranche for the market condition stock option award granted in June 2015 were as follows: 
 
 
Grant Date Fair
Value Per Share
 
Derived Service
Period
(in Trading Days)
$4.00 market condition tranche
 
$
1.95

 
151
$5.00 market condition tranche
 
$
1.95

 
262
$6.00 market condition tranche
 
$
1.99

 
362
 
The fair value and derived service periods calculated by vesting tranche for the market condition stock option awards granted in September 2016 were as follows:
 
 
Grant Date Fair
Value Per Share
 
Derived Service
Period
(in Years)
$4.00 market condition tranche
 
$
0.32

 
5.1
$5.00 market condition tranche
 
$
0.31

 
5.5
$6.00 market condition tranche
 
$
0.30

 
5.9

During the thirteen weeks ended September 30, 2017 and October 1, 2016 the Company recorded $1,000 and $17,000, respectively, of share-based compensation expense in connection with market condition stock option awards and during the thirty-nine weeks ended September 30, 2017 and October 1, 2016, recorded $5,000 and $133,000, respectively. As of September 30, 2017, there was $32,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to the market condition stock option awards, and this unrecognized expense is expected to be recognized over a weighted average period of 20 months. As of December 31, 2016, there was $37,000 of unrecognized expense related to the market condition stock option awards.
 
Non-vested Shares
 
Service-Based Non-vested Share Awards – A summary of the status of service-based non-vested share awards issued under the Equity Plan, as of September 30, 2017 is presented below:
 
 
Shares
 
Weighted
Average
Grant Date
Fair Value per
share
Outstanding at December 31, 2016
 
172,422

 
$
0.71

Granted
 
140,000

 
$
0.95

Vested
 
(172,422
)
 
$
0.71

 
 
 
 
 
Outstanding at September 30, 2017
 
140,000

 
$
0.95


19




On July 25, 2017, the Company granted 50,000 shares of service-based non-vested stock that vest one year from the date of grant. Also on July 25, 2017, the Company granted 30,000 shares of service-based non-vested stock that vest two years from the date of grant. On March 13, 2017, the Company granted 60,000 shares of service-based non-vested stock that vest two years from the date of grant. On July 22, 2016, the Company granted 40,000 shares of service-based non-vested stock that vested one year from the date of grant. These service-based non-vested share awards are valued at the date of grant based on the closing market price of the Company’s common stock, and are expensed using the straight-line method over the requisite service period (which is the vesting period of the award). During the thirteen weeks and thirty-nine weeks ended September 30, 2017, the Company recorded $21,000 and $46,000, respectively, of stock-based compensation expense in connection with these service-based non-vested share awards. During the thirteen weeks and thirty-nine weeks ended October 1, 2016, the Company recorded $6,000 of stock-based compensation expense in connection with these service-based non-vested share awards. As of September 30, 2017 and December 31, 2016, there was an estimated $102,000 and $16,000, respectively, of unrecognized stock-based compensation expense, net of estimated forfeitures, related to these service-based non-vested share awards, and this unrecognized expense is expected to be recognized over a period of 17 months.

On July 22, 2016 and October 3, 2016, the Company also granted 59,922 and 72,500 shares, respectively, of service-based non-vested stock to non-employees for services provided under consulting agreements which had three-year terms. In accordance with ASC 718, the fair value measurement date for these non-vested stock awards is the performance completion date. The fair value of the awards granted to the non-employee consultants was remeasured each reporting period based on their fair value at that time up to the performance completion date. The changes in fair value each reporting period were recognized in the Condensed Consolidated Statements of Operations. Effective March 31, 2017, the consulting agreements were terminated and in accordance with the consulting agreements, all unvested shares of non-vested stock granted under those agreements vested as of March 31, 2017. During the thirty-nine weeks ended September 30, 2017, the Company recorded $85,000 of stock-based compensation expense in connection with these service-based non-vested share awards.

Performance-Based Non-vested Share Awards – A summary of the status of performance-based non-vested share awards issued under the Equity Plan, as of September 30, 2017 is presented below:
 
 
Shares
 
Weighted
Average
Grant Date
Fair Value per
share
Outstanding at December 31, 2016
 
172,657

 
$
3.14

Vested
 
(31,435
)
 
$
3.17

Forfeited/cancelled
 
(141,222
)
 
$
3.14

 
 
 
 
 
Outstanding at September 30, 2017
 

 
$

 
On July 22, 2015, the Company granted 58,940 shares of non-vested stock to two employees that vested in full on July 1, 2017 in proportion to the Earn-Out consideration paid pursuant to the Purchase Agreement for the acquisition of the Farncombe Entities described in Note 2, Acquisition.
 
On April 8, 2013, the Company granted performance-based non-vested share awards for a total of 800,000 shares of Common Stock to various executive officers and employees of the Company that vested in proportion to the ratio that the Company’s “Cumulative Net Non-GAAP EBITDA” achieved over a four-year performance period compared to the Cumulative Net Non-GAAP EBITDA goal of $14 million. All 800,000 non-vested shares had a grant date fair value of $3.14 per share. The first potential vesting date was the Company’s earnings release date for its 2014 first fiscal quarter and each subsequent potential vesting date is each of the Company’s quarterly earnings release dates thereafter through the release date for the first quarter of fiscal 2017. Shares not vested as of the release date for the first quarter of fiscal 2017 were forfeited.
 
Share-based compensation cost for performance-based non-vested share awards is measured at the grant date based on the fair value of shares expected to be earned at the end of the performance period, based on the closing market price of the Company’s common stock on the date of grant, and is recognized as expense using the straight-line method over the performance period based upon the probable number of shares expected to vest. The Company estimates and excludes compensation cost related to awards not expected to vest based upon estimated forfeitures. During the thirteen weeks ended September 30, 2017, the Company recorded share-based compensation expense of $2,000 in connection with performance-based non-vested share awards. Share-based compensation expense recorded in connection with performance-based non-vested share awards during

20



the thirteen weeks ended October 1, 2016 was immaterial. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, the Company recorded share-based compensation income of $144,000 and share-based compensation expense in the amount of $53,000, respectively, in connection with performance-based non-vested share awards. As of September 30, 2017, there was no remaining unrecognized share-based compensation expense related to performance-based non-vested share awards. As of December 31, 2016, there was an estimated $46,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to performance-based non-vested share awards.
 
2000 Supplemental Stock Plan
A summary of the option activity under the Company’s 2000 Supplemental Stock Plan (the “Supplemental Stock Plan”) as of September 30, 2017 and changes during the thirty-nine weeks then ended is presented below: 
 
 
Shares
 
Weighted
Average
Exercise
Price
Outstanding at December 31, 2016
 
30,100

 
$
11.06

Forfeited/cancelled
 
(22,400
)
 
$
11.61

 
 
 
 
 
Outstanding at September 30, 2017
 
7,700

 
$
9.45

 
 
 
 
 
Options vested and exercisable at September 30, 2017
 
7,700

 
$
9.45

 
 
 
 
 
No awards have been granted under the Supplemental Stock Plan since it expired on May 23, 2010. There is no remaining unrecognized compensation cost related to stock options issued under the Supplemental Stock Plan. 

6. Supplemental Balance Sheet Information

Accrued payroll, bonuses and related expenses and Other accrued liabilities consist of the following (amounts in thousands): 

 
 
September 30, 2017
 
December 31, 2016
Accrued payroll, bonuses and related expenses
 
 

 
 

Accrued payroll
 
$
505

 
$
313

Accrued bonuses
 
583

 
2,060

Accrued payroll taxes
 
620

 
515

Accrued vacation
 
814

 
494

Accrued severance
 
20

 
117

Other
 
248

 
253

 
 
$
2,790

 
$
3,752

Other accrued liabilities
 
 

 
 

Sales and value-added taxes payable
 
$
787

 
$
911

Lease termination liability
 
130

 
103

Accrued income taxes
 
54

 
152

Accrued acquisition consideration
 

 
32

Other
 
524

 
919

 
 
$
1,495

 
$
2,117

 
 
 
 
 

7. Business Segments and Major Customers
 
The Company identifies its segments based on the way management organizes the Company to assess performance and make operating decisions regarding the allocation of resources. In accordance with the criteria in FASB ASC 280, “Segment Reporting”, the Company has concluded it has three reportable segments: the North America segment, the EMEA segment and the Strategic Alliances segment. The North America and EMEA segments are both single reportable, operating segments that encompass the Company’s operational, technology and software consulting services inside of North America and outside of

21



North America, respectively. Both reportable segments offer management consulting, custom developed software, and technical services. The Strategic Alliances reportable segment is a single, reportable segment that includes the Company’s world-wide commercial activities undertaken with third party service or solutions providers.
 
Management evaluates segment performance based upon income (loss) from operations, excluding share-based compensation (benefits) and depreciation. There were no inter-segment revenues during the thirty-nine weeks ended September 30, 2017 or October 1, 2016. In addition, in its administrative division, entitled “Not Allocated to Segments,” the Company accounts for non-operating activity and the costs of providing corporate and other administrative services to all the segments, including, but not limited to, share-based compensation expense, depreciation expense, goodwill impairment and certain research and development costs. Summarized financial information concerning the Company’s reportable segments is shown in the following table (amounts in thousands):
 
 
 
North America
 
EMEA
 
Strategic
Alliances
 
Not
Allocated
to
Segments
 
Total
As of and for the thirty-nine weeks ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
13,522

 
$
26,067

 
$
460

 
$

 
$
40,049

Income (loss) from operations
 
1,638

 
2,842

 
(50
)
 
(8,671
)
 
(4,241
)
Total assets
 
$
3,354

 
$
10,472

 
$
326

 
$
6,308

 
$
20,460

 
 
 
 
 
 
 
 
 
 
 
As of and for the thirteen weeks ended September 30, 2017:
 
 

 
 

 
 

 
 

 
 

Revenues
 
$
4,178

 
$
8,444

 
$
163

 
$

 
$
12,785

Income (loss) from operations
 
409

 
1,020

 
(15
)
 
(2,710
)
 
(1,296
)
 
 
 
 
 
 
 
 
 
 
 
As of the fiscal year ended December 31, 2016:
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
3,378

 
$
10,113

 
$
550

 
$
8,660

 
$
22,701

 
 
 
 
 
 
 
 
 
 
 
As of and for the thirty-nine weeks ended October 1, 2016:
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
22,601

 
$
33,429

 
$
521

 
$

 
$
56,551

Income (loss) from operations
 
4,810

 
5,268

 
(129
)
 
(23,388
)
 
(13,439
)
Total assets
 
$
4,968

 
$
10,517

 
$
628

 
$
9,640

 
$
25,753

 
 
 
 
 
 
 
 
 
 
 
As of and for the thirteen weeks ended October 1, 2016:
 
 

 
 

 
 

 
 

 
 

Revenues
 
$
6,563

 
$
10,507

 
$
265

 
$

 
$
17,335

Income (loss) from operations
 
1,453

 
2,206

 
5

 
(3,584
)
 
80

 
Segment assets, regularly reviewed by management as part of its overall assessment of the segments’ performance, include both billed and unbilled trade accounts receivable, net of allowances, inventory, and certain other assets, if applicable. Assets not assigned to segments include cash and cash equivalents, current and non-current investments, property and equipment, goodwill, intangible assets and deferred tax assets, excluding deferred tax assets recognized on accounts receivable reserves, which are assigned to their segments. 
 
In accordance with the provisions of FASB ASC 280-10, revenues earned in the United States and internationally based on the location where the services are performed are shown in the following table (amounts in thousands):
 

22



 
 
For the Thirteen Weeks
Ended
 
For the Thirty-nine Weeks
Ended
 
 
September 30,
2017
 
October 1,
2016
 
September 30,
2017
 
October 1,
2016
United States
 
$
4,535

 
$
6,940

 
$
14,587

 
$
23,590

International:
 
 

 
 

 
 
 
 
United Kingdom
 
7,166

 
9,124

 
22,513

 
30,202

Other
 
1,084

 
1,271

 
2,949

 
2,759

Total
 
$
12,785

 
$
17,335

 
$
40,049

 
$
56,551

 
In accordance with the provisions of FASB ASC 280-10, long-lived assets, excluding intangible assets, by geographic area are shown in the following table (amounts in thousands):
 
 
 
Long-Lived Assets
 
 
September 30,
2017
 
December 31,
2016
United States
 
$
2,388

 
$
2,154

United Kingdom
 
181

 
217

France
 
12

 
10

Total
 
$
2,581

 
$
2,381

 
Major customers in terms of significance to Cartesian’s revenues (i.e. in excess of 10% of revenues) and accounts receivable were as follows (amounts in thousands):

 
 
Revenues
 
 
For the Thirty-nine weeks
ended September 30, 2017
 
For the Thirty-nine weeks
ended October 1, 2016
 
 
North
America
 
EMEA
 
North
America
 
EMEA
Customer A
 

 
$
11,240

 

 
$
12,394

Customer B
 
$
3,467

 

 
$
2,983

 

Customer C
 
$
5,718

 

 
$
9,556

 

Customer D
 

 
3,449

 

 
$
7,032

 
 
 
Revenues
 
 
For the Thirteen weeks
ended September 30, 2017
 
For the Thirteen weeks
ended October 1, 2016
 
 
North
America
 
EMEA
 
North
America
 
EMEA
Customer A
 

 
$
3,590

 

 
$
3,897

Customer B
 
$
1,449

 

 
$
920

 

Customer C
 
$
1,298

 

 
$
3,082

 

Customer D
 

 
$
794

 

 
$
1,635

 

23



 
 
Accounts Receivable
 
 
As of
September 30, 2017
 
As of
October 1, 2016
Customer A
 
$
3,475

 
$
3,300

Customer B
 
$
1,502

 
$
611

Customer C
 
$
638

 
$
1,314

Customer D
 
$
484

 
$
1,351

 
Revenues from the Company’s ten most significant customers accounted for approximately 82.1% and 74.1% of revenues during the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively and 83.2% and 77.7% of revenues for the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively.
  
8. Income Taxes
 
During the thirteen weeks ended September 30, 2017 the Company recorded an income tax provision of $50,000 and during the thirteen weeks ended October 1, 2016, the Company recorded an income tax provision of $89,000. During the thirty-nine weeks ended September 30, 2017, the Company recorded an income tax benefit of $22,000 and during the thirty-nine weeks ended October 1, 2016, the Company recorded an income tax provision of $221,000. The income tax provisions for the thirteen weeks ended September 30, 2017 and October 1, 2016 primarily relate to the generation of pre-tax book income within the Company’s U.K. operations and the income tax benefit for the thirty-nine weeks ended September 30, 2017 is primarily related to refinements of the projected 2016 U.K. tax liabilities. The income tax benefit for the thirty-nine weeks ended October 1, 2016 was primarily related to the generation of pre-tax book income within the Company’s U.K. operations in addition to deferred taxes recognized on goodwill amortized for income tax purposes but not for financial reporting purposes in fiscal 2016.
 
The Company has reserved all of its domestic and international net deferred tax assets as of September 30, 2017 and December 31, 2016 with a valuation allowance in accordance with the provisions of FASB ASC 740, “Income Taxes”, which requires an estimation of the recoverability of the recorded income tax asset balances. As of September 30, 2017 and December 31, 2016, the Company has recorded $37.8 million and $36.6 million, respectively, of valuation allowances attributable to its net deferred tax assets. The determination of recording and releasing valuation allowances against deferred tax assets is made, in part, pursuant to the Company’s assessment as to whether it is more likely than not that the Company will generate sufficient future taxable income against which benefits of the deferred tax assets may or may not be realized. Significant judgment is required in making estimates regarding the Company’s ability to generate income in future periods.
Realization of deferred tax assets is dependent on generating sufficient income in future periods. In evaluating the ability to use its deferred tax assets, the Company considers all positive and negative evidence including the Company's past operating results, the existence of cumulative losses in the most recent three fiscal years and the Company's forecast of future income. In determining future income, the Company is responsible for assumptions utilized including the amount of state, federal and international operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future income and are consistent with the plans and estimates the Company is using to manage the underlying business.
The Company analyzes its uncertain tax positions pursuant to the provisions of FASB ASC 740 “Income Taxes”. There was no material activity related to the liability for uncertain tax positions during the thirty-nine weeks ended September 30, 2017 and October 1, 2016, and the Company has determined it does not have any material uncertain tax positions requiring reserves at September 30, 2017 or December 31, 2016.
 
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and in various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2000. As of September 30, 2017, the Company has no income tax examinations in process.
 

9. Fair Value Measurements
 
The Company utilizes the methods of fair value measurement as described in FASB ASC 820, “Fair Value Measurements” to value its financial assets and liabilities, including the financial instruments issued in the transaction described in Note 3, Strategic Alliance and Investment by Elutions, Inc. and the contingent consideration liability described in Note 2, Acquisition.

24



As defined in FASB ASC 820, fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, FASB ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:
 
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
 
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
 
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
 
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.
 
Recurring Fair Value Measurements
 
The fair value of the Company’s Note and the Holder Redemption Option were determined using a binomial lattice model. (See Note 3, Strategic Alliance and Investment by Elutions, Inc., for further discussion of the Note and Holder Redemption Option.) The Holder Redemption Option was determined to be an embedded derivative liability that was required to be bifurcated and recorded as a liability.
 
The Company has classified the Holder Redemption Option and Note as Level 3 liabilities. Changes in the fair value of the Holder Redemption Option are recognized in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The Company reassesses the fair value of this liability on a quarterly basis. Based on that assessment, the Company recognized a decrease of $100,000 in the fair value of this liability during the thirteen weeks ended September 30, 2017 and recognized an decrease of $114,000 in the fair value of this liability during the thirteen weeks ended October 1, 2016. The Company recognized a decrease of $242,000 in the fair value of this liability during the thirty-nine weeks ended September 30, 2017 and recognized a decrease of $65,000 during the thirty-nine weeks ended October 1, 2016. To determine the fair value of the Holder Redemption Option, management evaluates assumptions that require significant judgment. Changes in certain inputs to the valuation model, including the Company’s period end stock price and stock volatility, can have a significant impact on the estimated fair value. The fair value recorded for the Holder Redemption Option may vary significantly from period to period. This variability may result in the actual liability for a period either above or below the estimates recorded in the Company’s consolidated financial statements, resulting in significant fluctuations in other income (expense) as a result of the corresponding non-cash gain or loss recorded. The model requires the following inputs: (i) price of the Company’s common stock; (ii) the expected life of the instrument or derivative; (iii) risk-free interest rate; (iv) estimated dividend yield, and (v) estimated stock volatility. Assumptions used in the calculation require significant management judgment.

The following table sets forth the Level 3 inputs to the binomial lattice model that were used to determine the fair value of the Note and the Holder Redemption Option:
 
 
 
September 30, 2017
 
December 31, 2016
Common stock price
 
$
0.70

 
$
0.91

Dividend yield
 
%
 
%
Credit spread
 
24.9
%
 
16.0
%
Risk-free interest rate
 
1.4
%
 
1.3
%
Estimated stock volatility
 
109.0
%
 
77.3
%
 
In addition, the Company determined that the provision of the Note that permits Cartesian Limited to prepay the Note after 18 months if the trading price of the Company’s common stock exceeds $5.50 per share for a specified period of time is an embedded derivative asset that requires bifurcation (the “Issuer Call Option”). As of September 30, 2017 and December 31, 2016, the fair value of the Issuer Call Option was determined to be immaterial.
 

25



Because the Company measures the Holder Redemption Option at fair value on a recurring basis, transfers, if any, between the levels of the fair value hierarchy are recognized at the end of the fiscal quarter in which the change in circumstances that caused the transfer occurred.
 
In connection with the acquisition of the Farncombe Entities, the Company recorded a liability related to the Earn-Out portion of the purchase consideration. As of December 31, 2016, the Company had classified the Earn-Out liability as a Level 3 liability and the fair value of the Earn-Out liability is evaluated each reporting period and changes in its fair value are included in the Company’s results of operations. As of December 31, 2016, the fair value of the Earn-Out liability was calculated using a Monte Carlo simulation using a risk-adjusted discount rate applied to management’s estimate of forecasted revenues that are eligible under the Earn-Out as described in the Purchase Agreement. To determine the fair value of the Earn-Out liability, management evaluated assumptions that required significant judgment.

On April 17, 2017, the Company entered into a Letter Agreement with the former shareholders of the Farncombe Entities whereby the parties agreed to a final determination of the Earn-Out, that the Earn-Out target was expected to be achieved, and that the Company would pay 100% of the Earn-Out consideration described above to the Sellers. The Earn-Out was paid in full during the third quarter of fiscal 2017. See Note 2, Acquisition, for further discussion of the Earn-Out liability.
 
Because the Company measured the Earn-Out liability at fair value on a recurring basis, transfers, if any, between the levels of the fair value hierarchy are recognized at the end of the fiscal quarter in which the change in circumstances that caused the transfer occurred. There were no transfers between Level 1, 2 or 3 liabilities during the thirty-nine weeks ended September 30, 2017 or during the fiscal year ended December 31, 2016.
 
As of September 30, 2017 and December 31, 2016, liabilities recorded at fair value on a recurring basis consist of the following (in thousands):
 
 
 
Total
 
Quoted prices
in
active markets
Level 1
 
Significant
other
observable
inputs
Level 2
 
Significant
other
unobservable
inputs
Level 3
September 30, 2017:
 
 

 
 

 
 

 
 

Holder Redemption Option
 
$
728

 
$

 
$

 
$
728

December 31, 2016:
 
 

 
 

 
 

 
 

Holder Redemption Option
 
$
970

 
$

 
$

 
$
970

Earn-Out Liability
 
$
1,903

 
$

 
$

 
$
1,903

 
The following table summarizes the year-to-date changes to the fair value of the Holder Redemption Option which is a Level 3 liability (in thousands):
 
 
 
Holder
Redemption
Option
 
Fair value at December 31, 2016
 
$
970

 
Decrease in fair value
 
(242
)
 
Fair value at September 30, 2017
 
$
728

 
 
Other Fair Value Disclosures
 
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair values because of the relatively short-term maturities of these financial instruments.
 


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10. Commitments and Contingencies
 
The Company is not subject to any material litigation as of September 30, 2017. However, the Company may become involved in various legal and administrative actions arising in the normal course of business. These could include actions brought by taxing authorities challenging the employment status of consultants utilized by the Company. In addition, future customer bankruptcies could result in additional claims on collected balances for professional services near the bankruptcy filing date. When management has determined that it is probable that an asset has been impaired or a liability had been incurred related to an action, claim or assessment and the amount of loss can be reasonably estimated, the Company will record a liability for such estimated loss in the appropriate accounting period. The resolution of any of such actions, claims, or the matters described above may have an impact on the financial results for the period in which they occur. 
  
During the first quarter of fiscal 2015, the Company renewed an agreement under which it had a commitment to purchase a minimum of $412,000 in computer software over a three-year period. During the first quarter of fiscal 2016, the Company amended the agreement to include an additional commitment of $95,000 over a two-year period. As of December 31, 2016, the Company had an obligation of $181,000 remaining under this commitment. These amounts were paid during the first quarter of fiscal 2017.
 
11. Common Stock Repurchase Program
 
On June 7, 2016, the Board of Directors of the Company (the “Board”) authorized an amendment to the Company’s previously-announced stock repurchase program to extend the program through June 30, 2017. The program was initially authorized in February 2014 and was extended in June 2015. The program authorized the Company to repurchase up to $2 million of Company common stock. Under the program, repurchases may be made by the Company from time to time in the open market or through privately negotiated transactions depending on market conditions, share price and other factors. The program expired on June 30, 2017. The Company did not repurchase any shares under the stock repurchase program during the thirty-nine weeks ended September 30, 2017 or October 1, 2016.
 
12. Exit and Disposal Activities
 
In fiscal 2015, the Company took steps to discontinue use of its leased facilities in McLean, Virginia. The space is leased under an operating lease with a term expiring in July 2019. It is comprised of 4,823 square feet. Although the Company has clients in this geographic market, projects are performed from either client sites or other Company locations, and thus the space is not required or used by Company employees, and specifically not used for revenue-generating activities. In March 2017, the Company entered into a sublease for this facility. The sublease does not relieve the Company of its primary obligations under the original lease. We accounted for the discontinuation of use of this property in accordance with FASB ASC 420, “Exit or Disposal Cost Obligations” and as such recorded a liability during fiscal year 2015. As of September 30, 2017, a liability of $180,000 is recorded of which $130,000 is recorded in Other accrued liabilities and $50,000 is recorded in Other noncurrent liabilities in the Condensed Consolidated Balance Sheets. As of December 31, 2016, a liability of $185,000 was recorded of which $103,000 was included in Other accrued liabilities and $82,000 was included in Other noncurrent liabilities in the Condensed Consolidated Balance Sheets. The amount recorded as of December 31, 2016, was calculated using probability-weighted cash flow analysis and represents the present value, calculated using a credit-adjusted risk free rate, of our remaining costs under the remaining term of the lease, net of sublease payments.
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Cartesian Inc. and its subsidiaries are referred to herein as “Cartesian”, “we,” “us,” “our” or the “Company”.
 
Cautionary Statement Regarding Forward-Looking Statements. In addition to historical information, this quarterly report contains forward-looking statements. Forward-looking statements include, but are not limited to, statements of plans and objectives, statements of future economic performance or financial projections, statements of assumptions underlying such statements, and statements of the Company’s or management’s intentions, hopes, beliefs, expectations or predictions of the future. Forward-looking statements can often be identified by the use of forward-looking terminology, such as “believes”, “expects”, “may”, “should”, “could”, “intends”, “plans”, “estimates” or “anticipates”, variations thereof or similar expressions. Certain risks and uncertainties could cause actual results to differ materially from those reflected in such forward-looking statements. Factors that might cause a difference include, but are not limited to, our ability to generate sufficient cash flow from operations and obtain sufficient financing to pay our Note issued to Elutions if called for redemption by Elutions, our ability to successfully implement the strategic relationship with Elutions, conditions in the industry sectors that we serve, including the

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slowing of client decisions on proposals and project opportunities along with scope reduction of existing projects, overall economic and business conditions, our ability to retain the limited number of large clients that constitute a major portion of our revenues, our ability to protect client or Cartesian data or information systems from security breaches and cyber-attacks, technological advances and competitive factors in the markets in which we compete, foreign currency exchange rate fluctuations and the factors discussed in Item 1A. Risk Factors and the section entitled “Cautionary Statement Regarding Forward-Looking Information” in Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (“2016 Form 10-K”). Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date of this report. Except as may be required by applicable law, we undertake no obligation to revise, or publicly release the results of any revision to, these forward-looking statements. Readers should carefully review the cautionary statements contained in our 2016 Form 10-K and in other documents that we file from time to time with the Securities and Exchange Commission.
 
The following should be read in connection with Management’s Discussion and Analysis of Financial Condition and Results of Operations as presented in our 2016 Form 10-K.
 
OVERVIEW
 
Cartesian is among the leading providers of consulting services and managed solutions to the global leaders in the communications, digital media, and technology sectors. We offer a portfolio of strategy, management, marketing, operational, and technology consulting services. We have consulting experience with almost all major aspects of managing a global communications company. Our portfolio of solutions includes proprietary methodologies and toolsets, deep industry experience, and hands-on operational expertise.
  
Our global investments in targeting the cable industry have positioned our business to better serve consolidating telecommunications carriers and the converging global media and entertainment companies. The convergence of communications with media and entertainment, the pace of technological change in the sector, and the consolidation of large telecommunications carriers have required us to focus our strategy on serving our clients in both North America and European markets, continuing to expand our offerings with software and strengthening our position within the large carriers and media and entertainment companies. Subject to the effects of cyclical economic conditions, our efforts are helping us build what we believe is a more sustainable revenue model over the long-term, which will enable us to expand our global presence. We continue to focus our efforts on identifying, adapting to and capitalizing on the changing dynamics prevalent in the converging communications, media and entertainment industries, as well as providing our wireless and IP services within the communications sector.
 
On July 22, 2015, we entered into a Share Purchase Agreement (the “Purchase Agreement”) and completed the acquisition of all of the outstanding shares of capital stock of Farncombe France SARL and Farncombe Technology Limited (collectively, the “Farncombe Entities”). The Farncombe Entities operate primarily in the U.K. and Europe and are in the business of providing strategic consultancy, content security, testing and implementation services for broadcast and broadband internet digital television. The leaders and consultants of the Farncombe Entities are known experts in video, digital rights, content and security across multiple platforms, including broadcast, mobile and broadband networks. In addition to serving a complementary client base, the Farncombe Entities position Cartesian to support the growing digital TV needs of communications service providers. We currently expect the acquisition to provide cross-selling and upselling opportunities across our combined customer base, particularly in strategy and analytics. The global payTV market exceeds more than $250 billion annually and continues to grow steadily. Convergence of content across digital media platforms is increasingly important in markets across the globe. Ensuring a high quality, seamless viewing experience along with the security of content is a requirement to compete effectively. Farncombe’s experience in these areas along with Cartesian’s strategic, operational and technical capabilities in serving global service providers strengthens the Company’s ability to support convergence and quad play offerings in this growing market.
 
Strategic alliance partnerships are an element of our strategy. In 2014, we entered into a strategic alliance and Investment Agreement with Elutions, Inc. (“Elutions”), a provider of operational business intelligence solutions. With regard to the commercial relationship, Elutions is a provider of smart building and smart asset management solutions for energy management. Elutions uniquely combines technology and expertise to enable a machine-to-machine automated control and optimization of commercial and technical sites in a manner that can deliver significant energy savings with existing building infrastructure by optimizing use. Elutions’ end-to-end solution includes web-enabled application software, wireless and wireline networking hardware, energy management bureau services and engineering and integration services. In the communications sector that we primarily serve, energy consumption is a large and often sub-optimized component of operating costs and an area that continues to escalate as service providers invest in areas like datacenters. In the partnership with Elutions,

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Cartesian may provide: lead generation to Elutions; sales and marketing support, program management and potentially prime certain transactions with our clients.
 
Our financial results are affected by macroeconomic conditions, industry conditions, credit market conditions, and the overall level of business confidence. Economic volatility has continued to impact our customer base and has resulted in continued higher levels of unemployment in certain markets, which may have impacted financial results of our customers.

The rate of change in the communications industry, driving convergence of media and telecommunications, consolidation of providers and expanded deployment of wireless capabilities have added both opportunity and uncertainty for our clients. Consolidation within the sector tends to result in increased consolidation of competitors. The supply chain divisions within larger clients, given sector consolidation, also tend to reduce the number of vendors utilized and to negotiate volume programs with select preferred vendors. This activity could result in further price reductions, fewer client projects, under-utilization of consultants, reduced operating margins and loss of market share. Declines in our revenues can have a significant impact on our financial results. Although we have a flexible cost base comprised primarily of employee and related costs, there is a lag in time required to scale the business appropriately if revenues are reduced. In addition, our future revenues and operating results may fluctuate from quarter to quarter based on the number, size and scope of projects in which we are engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, consultant utilization rates, general economic conditions and other factors.
 
Our sales strategy focuses on building long-term relationships with both new and existing clients. Strategic alliances with other companies are also used to sell services. The volume of work performed for specific clients may vary from period to period and a major client from one period may not use our services or the same volume of services in another period. In addition, clients generally may end their engagements with little or no penalty or notice. If a client consulting engagement ends earlier than expected, we must re-deploy professional service personnel as any resulting non-billable time could harm margins.
 
Cost of services consists primarily of compensation for consultants who are employees as well as fees paid to independent contractor organizations and related expense reimbursements. Employee compensation includes certain non-billable time, training, vacation time, benefits and payroll taxes. Gross margins are primarily impacted by the type of consulting services provided; the size of service contracts and negotiated discounts; changes in our pricing policies and those of competitors; utilization rates of consultants and independent subject matter experts; and employee and independent contractor costs, which tend to be higher in a competitive labor market.
  
Sales and marketing expenses consist primarily of personnel salaries, bonuses, and related costs for direct client sales efforts and marketing staff. We primarily use a relationship sales model in which partners, principals and senior consultants generate revenues. In addition, sales and marketing expenses include costs associated with marketing collateral, product development, trade shows and advertising. General and administrative expenses consist mainly of costs for personnel, information technology, insurance, rent and outside professional services incurred in the normal course of business.

We are subject to a number of significant risks in the operation of our business, including operational, strategic, financial and regulatory risks. These include risks related to legal compliance, financial performance and condition, liquidity, concentration of credit, protection of our information technology networks and systems and intellectual property, counterparty credit and performance risk and other risks. Our Board of Directors has delegated to the Audit Committee, consisting solely of independent directors, the responsibility to oversee the assessment and management of the Company’s risks, including reviewing management’s risk assessment and risk management policies and procedures and steps management has taken to control material risk exposures. The Audit Committee is authorized to identify and discuss with management, the Board of Directors and the independent auditors the material risks faced by our business or which could impact our financial condition or performance, evaluate how those risks are managed and the quality and adequacy of our reporting with regard to them. Although we have processes and procedures to attempt to mitigate many of the risks that we face, there can be no assurance that such processes or procedures will be successful. For a discussion of certain risks relating to the Company, see Item 1A, "Risk Factors" and Part I, "Cautionary Statement Regarding Forward-Looking Information" in the 2016 Form 10-K. 
 
CRITICAL ACCOUNTING POLICIES
 
While the selection and application of any accounting policy may involve some level of subjective judgments and estimates, we believe the following accounting policies are the most critical to our condensed consolidated financial statements, potentially involve the most subjective judgments in their selection and application, and are the most susceptible to uncertainties and changing conditions:
  
Impairment of Long-lived Assets;

29




Revenue Recognition;

Fair Value Measurement;

Accounting for Income Taxes;

Research and Development and Software Development Costs;

Inventory; and

Share-based Compensation Expense.

Impairment of Long-lived Assets – Identifiable intangible assets, resulting from the acquisition of the Farncombe Entities, consist of customer relationships, agreements not to compete, and a trade name. We amortize the identifiable intangible assets over their estimated economic benefit period, from six months to four and one-half years. In accordance with FASB ASC 360, "Property, Plant and Equipment," we use our best estimates based upon reasonable and supportable assumptions and projections to review for impairment of long-lived assets to be held and used whenever events or changes in circumstances indicate that the carrying amount of our assets might not be recoverable. If we were to determine that events and circumstances warrant a change to the estimate of an identifiable intangible asset's remaining useful life, then the remaining carrying amount of the identifiable intangible asset would be amortized prospectively over that revised remaining useful life. Additionally, information resulting from other events and circumstances may indicate that the carrying value of one or more identifiable intangible assets is not recoverable which would result in recognition of an impairment charge.
 
A change in the estimate of the remaining life of one or more identifiable intangible assets or the impairment of one or more identifiable intangible assets could have a material impact on our results of operations and financial condition. Our identifiable intangible assets' carrying value, net of amortization, was approximately $0.4 million as of September 30, 2017
 
Revenue Recognition – We recognize revenues from time and materials consulting contracts in the period in which our services are performed. We recognized $5.9 million and $6.2 million in revenues from time and materials contracts during the thirteen weeks ended September 30, 2017 and October 1, 2016, respectively. We recognized $17.3 million and $20.9 million in revenues from time and materials contracts during the thirty-nine weeks ended September 30, 2017 and October 1, 2016, respectively. In addition to time and materials contracts, we also enter into fixed fee contracts. We recognize revenues on milestone or deliverables-based fixed fee contracts and time and materials contracts not to exceed contract price using the percentage of completion-like method described by FASB ASC 605-35, “Revenue Recognition – Construction-Type and Production-Type Contracts”. For fixed fee contracts where services are not based on providing deliverables or achieving milestones, we recognize revenues on a straight-line basis over the period during which such services are expected to be performed. During the thirteen weeks ended September 30, 2017 and October 1, 2016, we recognized $6.8 million and $11.2 million in revenues on fixed fee contracts, respectively. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, we recognized $22.7 million and $35.7 million in revenues on fixed fee contracts, respectively. In connection with some fixed fee contracts, we receive payments from customers that exceed recognized revenues. We record the excess of receipts from customers over recognized revenue as deferred revenue. Deferred revenue is classified as a current liability to the extent it is expected to be earned within twelve months from the date of the balance sheet.
  
The FASB ASC 605-35 percentage-of-completion-like methodology involves recognizing revenue using the percentage of services completed, on a current cumulative cost to total cost basis, using a reasonably consistent profit margin over the period. Due to the longer term nature of these projects, developing the estimates of costs often requires significant judgment. Factors that must be considered in estimating the progress of work completed and ultimate cost of the projects include, but are not limited to, the availability of labor and labor productivity, the nature and complexity of the work to be performed, and the impact of delayed performance. If changes occur in delivery, productivity or other factors used in developing the estimates of costs or revenues, we revise our cost and revenue estimates, which may result in increases or decreases in revenues and costs, and such revisions are reflected in income in the period in which the facts that give rise to that revision become known.
  
Fair Value Measurement – We utilize the methods of fair value measurement as described in FASB ASC 820, “Fair Value Measurements” to value our financial assets and liabilities, including the financial instruments issued in the transaction described in Note 3, Strategic Alliance and Investment by Elutions, Inc. and the contingent consideration liability described in Note 2, Acquisition in the Notes to the Condensed Consolidated Financial Statements (Unaudited) included in Item 1, Condensed Consolidated Financial Statements (Unaudited), of this report. As defined in FASB ASC 820, fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market

30



participants at the measurement date. In order to increase consistency and comparability in fair value measurements, FASB ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:
 
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
 
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
 
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
 
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.
 
Accounting for Income Taxes – Accounting for income taxes requires significant estimates and judgments on the part of management. Such estimates and judgments include, but are not limited to, the effective tax rate anticipated to apply to tax differences that are expected to reverse in the future, the sufficiency of taxable income in future periods to realize the benefits of net deferred tax assets and net operating losses currently recorded and the likelihood that tax positions taken in tax returns will be sustained on audit. We account for income taxes in accordance with FASB ASC 740 “Income Taxes”. As required by FASB ASC 740, we record deferred tax assets or liabilities based on differences between financial reporting and tax basis of assets and liabilities using currently enacted rates that will be in effect when the differences are expected to reverse. FASB ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. As of September 30, 2017, cumulative valuation allowances in the amount of $37.8 million were recorded in connection with domestic and international net deferred income tax assets.
  
As required by FASB ASC 740, we have performed a comprehensive review of our portfolio of uncertain tax positions in accordance with recognition standards established by the guidance. Pursuant to FASB ASC 740, an uncertain tax position represents our expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As of September 30, 2017, we have no recorded liability for unrecognized tax benefits.
 
We have generated substantial deferred income tax assets related to our domestic operations, and to a lesser extent our international operations, primarily from the accelerated financial statement write-off of goodwill, the charge to compensation expense taken for stock options and net operating losses. Within our foreign operations, mostly domiciled within the United Kingdom, we have generated deferred tax assets primarily from the charge to compensation expense for stock options and operating losses. For us to realize the income tax benefit of these assets in the applicable jurisdiction, we must generate sufficient taxable income in future periods when such deductions are allowed for income tax purposes. In some cases where deferred taxes were the result of compensation expense recognized on stock options, our ability to realize the income tax benefit of these assets is also dependent on our share price increasing to a point where these options have intrinsic value at least equal to the grant date fair value and are exercised. In assessing whether a valuation allowance is needed in connection with our deferred income tax assets, we have evaluated our ability to generate sufficient taxable income in future periods to utilize the benefit of the deferred income tax assets. We continue to evaluate our ability to use recorded deferred income tax asset balances. If we continue to report operating losses for financial reporting in future years, no additional tax benefit would be recognized for those losses, since we will not have accumulated enough positive evidence to support our ability to utilize net operating loss carry-forwards in the future. 
  
International operations have become a significant part of our business. As part of the process of preparing our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We utilize a “cost plus fixed margin” transfer pricing methodology as it relates to inter-company charges for headquarters support services performed by our domestic entities on behalf of various foreign affiliates. The judgments and estimates used are subject to challenge by domestic and foreign taxing authorities. It is possible that such authorities could challenge those judgments and estimates and draw conclusions that would cause us to incur liabilities in excess of those currently recorded. We use an estimate of our annual effective tax rate at each interim period based upon the facts and circumstances available at that time, while the actual annual effective tax rate is calculated at year-end. Changes in the geographical mix or estimated amount of annual pre-tax income could impact our overall effective tax rate.
  
Research and Development and Software Development Costs – Software development costs are accounted for in accordance with FASB ASC 985-20, “Software – Costs of Software to Be Sold, Leased, or Marketed” and FASB ASC 350-40, “Intangibles

31



– Goodwill and Other – Internal-Use Software”. Capitalization of software development costs for products to be sold to third parties begins upon the establishment of technological feasibility and ceases when the product is available for general release. We capitalize development costs incurred during the period between the establishment of technological feasibility and the release of the final product to customers if such costs are material. In addition, we capitalize software development costs for internal use software that we do not intend to market to third parties but use to deliver services. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management concerning certain external factors including, but not limited to, the date technological feasibility is reached, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies. During the thirteen weeks ended September 30, 2017 and October 1, 2016, internal use software development costs of $102,000 and $89,000, respectively, were expensed as incurred. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, internal use software development costs of $279,000 and $364,000, respectively, were expensed as incurred. During the thirteen weeks ended September 30, 2017 and October 1, 2016, $48,000 and $32,000 of internal use software development costs were capitalized, respectively. During the thirty-nine weeks ended September 30, 2017 and October 1, 2016, $231,000 and $389,000, respectively, of internal use software development costs were capitalized.
 
Inventory – In accordance with the provisions of FASB ASC 330, “Inventory”, the Company’s inventory is stated at the lower of cost, using the first-in, first-out (FIFO) method, or fair value. As of September 30, 2017, the Company had $0.2 million in inventory, all of which was finished goods. All of the inventory was purchased in July 2014 from Elutions, which owns more than five percent of the outstanding shares of common stock of the Company. As provided for in the general framework agreement between the Company and Elutions (see Note 3, Strategic Alliance and Investment by Elutions, Inc. in the Notes to the Condensed Consolidated Financial Statements (Unaudited) included in Item 1, Condensed Consolidated Financial Statements (Unaudited), of this report), if the Company has not sold 75% of the inventory acquired from Elutions within one year after acquisition, Elutions is required upon request to source its requirements for future projects in the U.S. or U.K. from such inventory subject to a 10% discount against the Company’s purchase price until the Company has exhausted such inventory. In fiscal 2015, the Company requested that Elutions source its requirements for future projects from the inventory that was acquired by the Company from Elutions in July 2014. Management expects to continue to work with Elutions to utilize the inventory and changes in management’s expectations in future periods as the matter is resolved could impact the net realizable value of the inventory.
 
Share-based Compensation Expense We grant stock options and non-vested stock to our employees under stock incentive plans and also provide employees the right to purchase our stock at a discount pursuant to an employee stock purchase plan. The benefits provided under these plans are share-based payment awards subject to the provisions of FASB ASC 718, “Compensation-Stock Compensation.” Under FASB ASC 718, we are required to make significant estimates related to determining the value of our share-based compensation. If factors change and we develop different assumptions in the application of FASB ASC 718 in future periods, the compensation expense that we record under FASB ASC 718 may differ significantly from what we have recorded in the current period. There is a high degree of subjectivity involved when using option pricing models to estimate share-based compensation under FASB ASC 718. Changes in the subjective input assumptions can materially affect our estimates of fair values of our share-based compensation. Certain share-based payment awards, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, values may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of employee share-based awards is determined in accordance with FASB ASC 718 and SEC’s Staff Accounting Bulletin (“SAB”) SAB No. 110 using an option pricing model, such value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
 
For stock options with only a service-based vesting requirement, we calculate grant date fair value using the Black-Scholes valuation model. Our expected stock-price volatility assumption is based on historical volatilities of the underlying stock which are obtained from public data sources. The expected term of options granted is based on the simplified method in accordance with the SAB No. 110 as our historical share option exercise experience does not provide a reasonable basis for estimation. Expense for the awards ultimately expected to vest is recognized on a graded vesting schedule over the vesting period.
 
For stock options containing a market condition, the market conditions are required to be considered when calculating the grant date fair value. FASB ASC 718 requires us to select a valuation technique that best fits the circumstances of an award. In order to reflect the substantive characteristics of the market condition option award, a Monte Carlo simulation valuation model is used to calculate the grant date fair value of such stock options. Monte Carlo approaches are a class of computational algorithms that rely on repeated random sampling to compute their results. This approach allows the calculation of the value of such stock options based on a large number of possible stock price path scenarios. Expense for the market condition stock options is recognized over the derived service period as determined through the Monte Carlo simulation model. See Note 5, Share-Based Compensation in the Notes to the Condensed Consolidated Financial Statements (Unaudited) included in Item 1, Condensed Consolidated Financial Statements (Unaudited), of this report.

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For non-vested, service-based stock awards, compensation is recognized based on achievement of service conditions alone. The fair value of the awards is determined based on the market value of the underlying stock at the grant date. Expense for the awards ultimately expected to vest is recognized on a graded vesting schedule over the vesting period.
For non-vested, performance-based stock awards, compensation expense is recognized based on management’s expectations with regard to achievement of certain performance and service conditions. The fair value of the awards is determined based on the market value of the underlying stock at the grant date. Expense for the awards ultimately expected to vest is recognized on a straight-line basis over the implied service period of the award. There is a high degree of subjectivity involved when determining the number of awards which are expected to vest over the service period based on projections of the underlying performance measure. Changes in assumptions related to the achievement of the performance measure may materially affect the amount of expense recognized by the Company for performance-based non-vested stock.
 
RESULTS OF OPERATIONS
 
THIRTEEN WEEKS ENDED SEPTEMBER 30, 2017 COMPARED TO THIRTEEN WEEKS ENDED OCTOBER 1, 2016

REVENUES
 
Revenues decreased $4.5 million, or 26.2%, to $12.8 million for the third quarter of fiscal 2017 from $17.3 million for the comparable period in the prior fiscal year. The decrease was primarily due to a lower volume of projects in both the North America and EMEA segments. Our international revenues were approximately 64.5% of total revenues for the third quarter of fiscal 2017 as compared to 60.0% for the comparable period in fiscal 2016.
 
North America segment revenues decreased $2.4 million, or 36.3% to $4.2 million for the third quarter of fiscal 2017 from $6.6 million for the third quarter of fiscal 2016. The decrease was primarily due to a lower volume of projects compared to the prior year quarter. During the third quarter of fiscal 2017, the North America segment provided services on 61 customer projects, compared to 59 projects performed in the comparable period in the prior fiscal year. Average revenue per project was $69,000 for the third quarter of fiscal 2017 and $111,000 for the third quarter of fiscal 2016. Revenues recognized in connection with fixed price engagements for the third quarters of fiscal 2017 and fiscal 2016 totaled $2.6 million and $5.4 million, respectively, representing 62% and 82% of the total revenues of the segment, respectively.
 
EMEA segment revenues decreased $2.1 million, or 19.6%, to $8.4 million for the third quarter of fiscal 2017 from $10.5 million for the comparable period in the prior fiscal year. The decrease was related to a lower volume of projects during fiscal 2017. During the third quarters of fiscal 2017 and fiscal 2016, this segment provided services on 186 and 207 customer projects, respectively, and average revenue per project was approximately $44,000 and $50,000, respectively.
 
Strategic Alliances segment revenues were $0.2 million and $0.3 million for the third quarters of fiscal 2017 and fiscal 2016, respectively.
 
COST OF SERVICES
 
Cost of services decreased $2.6 million, or 22.8%, to $8.7 million for the third quarter of fiscal 2017 from $11.2 million for the third quarter of fiscal 2016. Our gross margin was 32.2% for the third quarter of fiscal 2017 compared to 35.3% for the comparable period in the prior fiscal year.
 
Cost of services in the North America segment was $2.8 million for the third quarter of fiscal 2017 compared to $4.0 million for the third quarter of fiscal 2016. This decrease was primarily related to lower revenues in the third quarter of fiscal 2017 as compared to the third quarter of fiscal 2016. Our North America segment gross margin was 34.1% for the third quarter of fiscal 2017 compared to 38.7% for the third quarter of fiscal 2016. The decline in gross margin rate during the third quarter of fiscal 2017 was primarily driven by project mix.
 
Cost of services in the EMEA segment was $5.6 million and $6.8 million during the third quarters of fiscal 2017 and fiscal 2016, respectively. Gross margin in our EMEA segment was 33.3% for the third quarter of fiscal 2017, compared to 34.9% for the comparable period in the prior fiscal year. The decrease in gross margin rate within the EMEA segment was primarily due to project mix.
 
For our Strategic Alliances segment, cost of services was $0.2 million and $0.3 million for the third quarters of fiscal 2017 and fiscal 2016, respectively.

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OPERATING EXPENSES
 
Selling, general and administrative expenses were $5.4 million for the third quarter of fiscal 2017 compared to $6.0 million for the third quarter of fiscal 2016, a decrease of $0.6 million, or 10.2%. During the third quarter of fiscal 2017 as compared to the third quarter of fiscal 2016, severance expense decreased $0.1 million, sublease rental income increased $0.2 million, information technology costs decreased $0.2 million, and foreign currency gains and losses decreased $0.2 million. As a percentage of revenues, our selling, general and administrative expenses were 42.4% for the third quarter of fiscal 2017 compared to 34.8% in the comparable period of the prior fiscal year.

OTHER INCOME AND EXPENSE
 
Other expense for the third quarters of fiscal 2017 and fiscal 2016 was $2,000 and $14,000, respectively. Other expense for both the 2017 and 2016 fiscal periods included interest expense on the promissory note. Each of the third quarters of fiscal 2017 and 2016 included income of $0.1 million, respectively, related to the change in fair value of the derivative liability embedded in the promissory note. See Note 3, Strategic Alliance and Investment by Elutions, Inc., in the Notes to the Condensed Consolidated Financial Statements (Unaudited) included in Item 1, Condensed Consolidated Financial Statements (Unaudited), of this report.
 
INCOME TAXES
 
During the third quarter of fiscal 2017, we recorded an income tax provision of $50,000 and during the third quarter of fiscal 2016, we recorded an income tax provision of $89,000. The income tax provisions for fiscal 2017 and fiscal 2016 were primarily related to the generation of pre-tax book income within our U.K. operations. For the third quarters of fiscal 2017 and fiscal 2016, we recorded no income tax benefit related to our domestic pre-tax losses, in accordance with the provisions of FASB ASC 740, "Income Taxes", which requires an estimation of our ability to use recorded deferred income tax assets. We currently have recorded a valuation allowance against all domestic deferred income tax assets generated due to uncertainty about their ultimate realization as a result of our history of domestic operating losses. If we continue to report net operating losses for financial reporting in our domestic operations, no additional tax benefit would be recognized for those losses, since we will not have accumulated enough positive evidence to support our ability to utilize the net operating loss carry-forwards in the future.

THIRTY-NINE WEEKS ENDED SEPTEMBER 30, 2017 COMPARED TO THIRTY-NINE WEEKS ENDED OCTOBER 1, 2016

REVENUES
 
Revenues decreased $16.5 million, or 29.2%, to $40.0 million for the year-to-date period of fiscal 2017 from $56.6 million for the comparable period in the prior fiscal year. The decrease was primarily due to a large customer engagement in North America in the comparable prior year period along with a lower volume of projects in the year-to-date period of fiscal 2017. The decrease is also related to a $2.4 million unfavorable change in foreign currency translation rates applied to revenues in our EMEA segment. Our international revenues were approximately 63.6% of total revenues for year-to-date period of fiscal 2017 as compared to 58.3% for the comparable period in fiscal 2016.
 
North America segment revenues decreased $9.1 million, or 40.2%, to $13.5 million for the year-to-date period of fiscal 2017 from $22.6 million for the same period in fiscal 2016. The decrease was primarily due to a large customer engagement in North America in the prior year period along with a lower volume of projects in the year-to-date period of fiscal 2017. During the year-to-date period of fiscal 2017, the North America segment provided services on 105 customer projects compared to 94 projects performed in the comparable period in the prior fiscal year. Average revenue per project was $129,000 for the year-to-date period of 2017 and $240,000 for the same period of fiscal 2016. Revenues recognized in connection with fixed price engagements for the year-to-date period of fiscal 2017 and fiscal 2016 totaled $9.7 million and $18.4 million, respectively, representing 72% and 81% of the total revenues of the segment, respectively.
 
EMEA segment revenues decreased $7.4 million, or 22.0%, to $26.1 million for the year-to-date period of fiscal 2017 from $33.4 million for the comparable period in the prior fiscal year. The decrease was primarily due to a $2.4 million impact of unfavorable foreign currency translation of the segment’s functional currency to our reporting currency, the U.S. Dollar, as well as a lower volume of projects. During the year-to-date periods of fiscal 2017 and fiscal 2016, this segment provided services on

34



309 and 386 customer projects, respectively, and average revenue per project was approximately $83,000 and $85,000, respectively.
 
Strategic Alliances segment revenues were $0.5 million and $0.5 million for the year-to-date period of fiscal 2017 and fiscal 2016, respectively.
 
COST OF SERVICES
 
Cost of services decreased $9.6 million, or 25.9%, to $27.5 million for the year-to-date period of fiscal 2017 from $37.1 million for the comparable period in fiscal 2016. Our gross margin was 31.3% for the year-to-date period of fiscal 2017 compared to 34.3% for the comparable period in the prior fiscal year.
 
Cost of services in the North America segment was $8.9 million for the year-to-date period of fiscal 2017 compared to $13.9 million for the same period in fiscal 2016. This decrease was primarily related to lower revenues in the year-to-date period of fiscal 2017 as compared to the comparable period in fiscal 2016. Our North America segment gross margin was 34.3% for the year-to-date period of fiscal 2017 compared to 38.4% for the same period in fiscal 2016. The decline in gross margin rate was primarily driven by project mix.
 
Cost of services in the EMEA segment was $17.8 million and $22.3 million during the year-to-date periods of fiscal 2017 and fiscal 2016, respectively. The decrease in cost of services was a result of lower revenue as well as the impact of a $1.6 million change in foreign currency exchange rates. Gross margin in our EMEA segment was 31.7% for the year-to-date period of fiscal 2017, compared to 33.2% for the comparable period in the prior fiscal year. The decrease in gross margin rate within the EMEA segment was primarily due to project mix.
 
For our Strategic Alliances segment, cost of services was $0.6 million and $0.6 million for the year-to-date periods of fiscal 2017 and fiscal 2016, respectively.

OPERATING EXPENSES
 
Selling, general and administrative expenses were $16.8 million for the year-to-date period in fiscal 2017 compared to $22.0 million for the comparable period of fiscal 2016, a decrease of $5.3 million, or 24%. The decrease in selling, general and administrative expenses included a reduction of approximately $0.5 million related to the change in foreign currency exchange rates. During the year-to-date period of fiscal 2017 as compared to the same period of fiscal 2016, salaries and related expense decreased $2.7 million, severance expense decreased $0.8 million, professional fees and external consultants expense decreased $0.4 million, information technology costs decreased $0.6 million and travel related expense decreased $0.2 million. These decreases were partially offset by $0.4 million of non-cash expense related to the increase in the fair value of the earn-out liability in the year-to-date period of fiscal 2017 as compared to a $0.2 million reduction in the fair value of the earn-out liability in the prior year period. As a percentage of revenues, our selling, general and administrative expenses were 41.9% for the year-to-date period of fiscal 2017 compared to 39.0% in the comparable period of the prior fiscal year.

GOODWILL IMPAIRMENT
The Company recorded a non-cash goodwill impairment charge of $10.8 million during the second quarter of fiscal 2016. The facts and circumstances that led to the impairment of goodwill were primarily a result of the decreased market value of the Company based upon the market price of the Company's common stock.

OTHER INCOME AND EXPENSE
 
Other expense for the year-to-date periods of fiscal 2017 and fiscal 2016 was $39,000 and $123,000, respectively. Other expense for both the 2017 and 2016 fiscal periods included interest expense on the promissory note. The year-to-date periods of fiscal 2017 and 2016 included income of $242,000 and income of $65,000, respectively, related to the change in fair value of the derivative liability embedded in the promissory note. See Note 3, Strategic Alliance and Investment by Elutions, Inc., in the Notes to the Condensed Consolidated Financial Statements (Unaudited) included in Item 1, Condensed Consolidated Financial Statements (Unaudited), of this report.
 
INCOME TAXES
 

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During the year-to-date period of fiscal 2017, we recorded an income tax benefit of $22,000 and during the year-to-date period of fiscal 2016, we recorded an income tax provision of $221,000, respectively. The income tax benefit for fiscal 2017 was primarily related to refinements of the projected 2016 U.K. tax liabilities. The income tax provision for fiscal 2016 was primarily related to the generation of pre-tax book income within our U.K. operations as well as deferred taxes recognized for fiscal 2016 related to goodwill amortized for income tax purposes but not for financial reporting purposes. For the year-to-date periods of fiscal 2017 and fiscal 2016, we recorded no income tax benefit related to our domestic pre-tax losses, in accordance with the provisions of FASB ASC 740, "Income Taxes", which requires an estimation of our ability to use recorded deferred income tax assets. We currently have recorded a valuation allowance against all domestic deferred income tax assets generated due to uncertainty about their ultimate realization as a result of our history of domestic operating losses. If we continue to report net operating losses for financial reporting in our domestic operations, no additional tax benefit would be recognized for those losses, since we will not have accumulated enough positive evidence to support our ability to utilize the net operating loss carry-forwards in the future.

STATEMENT REGARDING NON-GAAP FINANCIAL MEASUREMENT
 
In addition to income (loss) from operations on a GAAP basis and net income (loss) and net income (loss) per share on a GAAP basis, our management uses the non-GAAP financial measures, "Non-GAAP adjusted (loss) income from operations", "non-GAAP adjusted net (loss) income" and “Constant Currency Revenues” in its evaluation of our performance, particularly when comparing performance to the prior year's period. These non-GAAP measures contain certain non-GAAP adjustments which are described in the following schedule entitled "Reconciliation of GAAP Net (Loss) Income to Non-GAAP Adjusted Net (Loss) Income and GAAP (Loss) Income from Operations to Non-GAAP Adjusted (Loss) Income from Operations" and “Reconciliation of Non-GAAP Constant Currency Revenues to GAAP Revenues”. In making these non-GAAP adjustments, we take into account certain non-cash expenses and benefits, including tax effects as applicable, and the impact of certain items that are generally not expected to be on-going in nature or that are unrelated to our core operations. Management believes the exclusion of these items provides a useful basis for evaluating underlying business performance, but should not be considered in isolation and is not in accordance with, or a substitute for, evaluating our performance utilizing GAAP financial information. In calculating revenues for the third quarter and year-to-date period of fiscal 2017 on a constant currency basis, the Company applied average foreign exchange rates from the comparable periods of the prior fiscal year to the Company's foreign-denominated revenues in the third quarter and year-to-date period of the current fiscal year. We believe that providing such adjusted results allows investors and other users of our financial statements to better understand our comparative operating performance for the periods presented. Our non-GAAP measures may differ from similar measures by other companies, even if similar terms are used to identify such measures. Although management believes the non-GAAP financial measures are useful in evaluating the performance of our business, we acknowledge that items excluded from such measures have a material impact on our loss from operations and net loss and net loss per share calculated in accordance with GAAP. Therefore, management uses non-GAAP measures in conjunction with GAAP results. Investors and other users of our financial information should also consider the above factors when evaluating our results. 

36



CARTESIAN, INC.
RECONCILIATION OF GAAP (LOSS) INCOME FROM OPERATIONS TO NON-GAAP ADJUSTED
(LOSS) INCOME FROM OPERATIONS AND GAAP NET (LOSS) INCOME
TO NON-GAAP ADJUSTED NET (LOSS) INCOME
(unaudited)
(in thousands, except per share data)
 
 
Thirteen Weeks Ended
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
Thirty-nine Weeks Ended
 
 
 
September 30,
2017
 
October 1,
2016
 
September 30,
2017
 
October 1,
2016
 
Reconciliation of GAAP (loss) income from operations to non-GAAP adjusted (loss) income from operations:
 
 

 
 

 
 
 
 
 
GAAP (loss) income from operations
 
$
(1,296
)
 
$
80

 
$
(4,241
)
 
$
(13,439
)
 
Depreciation
 
325

 
251

 
921

 
759

 
Amortization of intangible assets
 
70

 
70

 
204

 
235

 
Non-cash share based compensation expense
 
34

 
33

 
25

 
222

 
Goodwill impairment
 

 

 

 
10,830

 
Fair value adjustment to contingent consideration
 

 
66

 
365

 
(235
)
 
Inventory adjustment
 
44

 
52

 
135

 
156

 
Accrued executive severance and related costs
 
84

 
182

 
138

 
932

 
Lease expense for discontinuation of office space
 

 

 
58

 

 
Foreign currency exchange (gain) loss on note payable
 
(95
)
 
95

 
(263
)
 
428

 
Adjustments to GAAP (loss) income from operations
 
462

 
749

 
1,583

 
13,327

 
Non-GAAP adjusted (loss) income from operations
 
$
(834
)
 
$
829

 
$
(2,658
)
 
$
(112
)
 
 
 
 
 
 
 
 
 
 
 
Reconciliation of GAAP net (loss) income to non-GAAP adjusted net (loss) income:
 
 

 
 

 
 
 
 
 
GAAP net (loss) income
 
$
(1,344
)
 
$
5

 
$
(4,258
)
 
$
(13,783
)
 
Depreciation
 
325

 
251

 
921

 
759

 
Amortization of intangible assets
 
70

 
70

 
204

 
235

 
Non-cash share based compensation expense
 
34

 
33

 
25

 
222

 
Goodwill impairment
 

 

 

 
10,830

 
Fair value adjustment to contingent consideration
 

 
66

 
365

 
(235
)
 
Inventory adjustment
 
44

 
52

 
135

 
156

 
Accrued executive severance and related costs