Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements (including the notes thereto) contained elsewhere in this report. Certain information contained in this discussion and analysis includes forward-looking statements that involve risk and uncertainties. You are therefore encouraged to read the section in this annual report on Form 10-K titled, “CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS” and “RISK FACTORS.”
Overview and recent developments
We are a Delaware-incorporated entity. As of December 31, 2022, we had operating locations in North Carolina, Canada and Mexico.
On April 7, 2020, AVCT (formerly known as Pensare Acquisition Corp.), consummated the Computex Business Combination in which it acquired Computex, a private operating company that does business as Computex Technology Solutions. In connection with the Computex Business Combination, the Company changed its name to American Virtual Cloud Technologies, Inc.
On December 1, 2020, we acquired Kandy from Ribbon, by acquiring certain assets, assuming certain liabilities and acquiring all of the outstanding interests of Kandy Communications LLC.
Kandy, a provider of cloud-based enterprise services, globally deploys a white-label, carrier-grade cloud-based platform for UCaaS, CPaaS and CCaaS for mid-market and enterprise customers across a proprietary multi-tenant, highly scalable cloud platform. The Kandy platform provides white-labeled services to a variety of customers including communications service providers and systems integrators. With Kandy, companies can quickly embed real-time communications capabilities into their existing applications and business processes.
Computex, classified within discontinued operations, is a leading multi-brand technology solutions provider to large global customers, providing a comprehensive and integrated set of technology solutions, through its extensive hardware, software and value-added service offerings.
On September 16, 2021, the Company announced that as a result of a decision by the Company’s Board of Directors to explore strategic alternatives previously announced on April 7, 2021, the Board had authorized the Company to focus its strategy on acquisitions and organic growth in its cloud technologies business as well as to explore strategic opportunities for its IT solutions business, including the divestiture of Computex. The Company believed that such changes would allow it to optimize resource allocation, focus on core competencies, and improve its ability to invest in areas of maximal growth potential.
On January 27, 2022, the Company announced that it had executed a definitive agreement to sell Computex, and on March 15, 2022, the sale of Computex was consummated, which completed the Company’s transition to a cloud communications company, centered on its Kandy platform. In connection with the then pending sale of Computex, Computex was classified as held for sale as of December 31, 2021, and its operations for current and prior periods were separated and classified as discontinued operations. Accordingly, this management’s discussion and analysis of financial condition and results of operations primarily focuses on the Kandy segment and the Company’s corporate activities. Therefore, unless otherwise indicated, amounts discussed herein, exclude Computex. Net proceeds from the sale of Computex, after payment of closing and certain other obligations were used for working capital and general business purposes.
On August 25, 2022, the Company announced that it had retained Northland Capital Markets to advise the Company in connection with a comprehensive strategic review process that could lead to the sale of the Company or selected assets.
During 2022, the Company continued to explore strategic opportunities, including the rationalization of resource allocation and core competencies. Further, the Company took actions that it believed resulted in significant cost savings. Such savings were generated from selective reductions in workforce and negotiated conversions of certain material vendor support costs from fixed to variable, thereby eliminating certain cost burdens related to unused capacity. In addition, the Company obtained strategic and operating restructuring support services of certain capital advisors.
Additionally, during 2022, the Company projected and announced that it would need additional capital to fund its operations including research & development and capital investment requirements until the Company scaled to a revenue level that would permit cash self-sufficiency. Such factors raised substantial doubt about the ability of the Company to continue as a going concern. The projection was based on the Company’s forecasts regarding product sales and service, cost structure, cash burn rate and other operating assumptions. During 2022, the Company was forced to scale back operations and, as more fully discussed elsewhere in this Form 10-K, including in the Notes to the Consolidated Financial Statements, on January 11, 2023, the Company filed for Chapter 11 and, on March 10, 2023, the Sellers and the Purchaser executed the Purchase Agreement, pursuant to which the Sellers agreed to sell substantially all of the assets of the Company for a cash purchase price of $6.8 million (See Note 1 of the consolidated financial statements). On March 15, 2023, the Court entered an order authorizing the Asset Sale pursuant to the terms of the Purchase Agreement. On March 24, 2023, the Asset Sale closed, thereby completing the disposition of substantially all of the Company’s assets. As identified in the Plan filed with the Court on March 21, 2023, and subject to Court approval, the Company anticipates that there will be no proceeds available for distribution to the Company’s stockholders and that the Company’s outstanding securities shall be upon confirmation of the Plan.
The description of the Company’s business and result of operations contained herein reflects the Company’s operation of its business prior to the completion of the Asset Sale on March 24, 2023. As a result of the Asset Sale, the Company no longer has any operations, other than those relating to the wind down of its business and completion of the Chapter 11 process.
Nature of revenue categories discussed below:
C loud subscription and software revenue include subscriptions to the Company’s cloud-based technology platform, and revenue from the Company’s on-premise software.
Professional and managed services revenue include services for deployment, configuration, system integration, optimization, customer training and education.
Financial statement presentation and results of operations
The consolidated financial statements of the Company include the accounts of AVCT and its wholly-owned subsidiaries. In the discussion below, the year ended December 31, 2022 and the year ended December 2021 will be referred to as FY 2022 and FY 2021, respectively.
FY 2022 versus FY 2021 (in thousands)
Revenues:
(in thousands)
Cloud subscription and software
Managed and professional services
Other
Total revenues
Cost of revenue
Gross (loss) profit
Goodwill impairment
Research and development
Selling, general and administrative
Loss from continuing operations
Other income (expense)
Change in fair value of warrant liabilities
Change in fair value of derivative liability
Interest expense (1)
Other income
Total other income (expenses)
Net loss from continuing operations before income taxes
Provision for income taxes
Net loss from continuing operations, net of tax
Net income (loss) on discontinued operations, net of tax
Net loss
Interest expense in FY 2022 and 2021 include related party interest of $764 and $14,958, respectively
Net loss from continuing operations, net of tax
Net loss from continuing operations, net of tax, for FY 2022 was $40.5 million compared with $130.9 million in FY 2021. Discussed in the paragraphs below are the revenue and expense factors that primarily contributed to the net loss change. However, the net loss from continuing operations, net of tax, for FY 2021 was impacted by the following noncash items, relative to FY 2022:
Fiscal 2022
Fiscal 2021
Expense (income)
Change
Impairment of goodwill and other intangible assets
Depreciation
Amortization of intangible assets
Amortization of Convertible Debenture discount
Interest on convertible debt paid-in-kind
Share-based compensation
Change in fair value of warrant liabilities
Amortization and write-off of deferred financing costs
Noncash financing fees
Cloud subscription and software revenue
Cloud subscription and software revenue, which represents revenue from subscriptions to the Company’s cloud-based technology platform as well as revenue from the Company’s on-premise software, was $15.6 million in FY 2022 compared with $16.9 million in FY 2021. The decrease was primarily due to the termination of a reseller agreement, in August 2022, in connection with a settlement agreement entered into with Ribbon (See Note 11 of the consolidated financial statements). Such decrease was partially offset by increased UCaaS business from 4 of our customers.
Managed and professional services revenue
Managed and professional services revenue, which was also negatively impacted by the termination of the reseller agreement discussed above, was $1.2 million in FY 2022 compared with $3.1 million in FY 2021.
Total revenue, cost of revenue and gross margin
Aggregate revenue for all product lines together was $16.8 million in FY 2022 compared with $20.0 million in FY 2021.
Cost of revenue increased $2.2 million or 13.5% from $16.2 million in FY 2021 to $18.4 million in FY 2022, due primarily to a $2.7 million increase in platform software support and a $1.9 million increase in employee-related costs, partially offset by a $1.4 million decrease in amortization of intangibles and a $1.1 million decrease in certain consultant and outside services.
The gross margin in FY 2022 was negative due to a combination of decreased revenues and higher costs of revenue. Costs of revenue are primarily fixed.
Impairment of goodwill and other intangible assets
Goodwill impairment of $10.5 million was assessed early in FY 2022, primarily as a result of Kandy’s performance being significantly below forecasts.
The noncash impairment charges recorded in FY 2021 are discussed in Note 3 of the Notes to the Consolidated Financial Statements and were related to goodwill of the Kandy reporting unit and Kandy’s other intangible assets. The impairment of Kandy’s goodwill and other intangible assets resulted from a quantitative impairment analysis during the Company’s December 2021 impairment assessment, after an evaluation based on certain factors considered to be triggering events, such as changes in Kandy’s forecasts. As a result of the quantitative assessment, the Company recorded an impairment charge to goodwill and intangible assets of $13.7 million and $15.3 million, respectively.
Research and development
For FY 2022 and FY 2021, research and development expenses were $15.6 million and $17.9 million, respectively. The decrease of $2.3 million, or 12.9%, was primarily due to reductions in salaries and related costs, which reflect the impact of recent cost saving efforts.
Selling, general and administrative expenses
Selling, general and administrative expenses for FY 2022 and FY 2021 consisted of the components in the following table (in thousands):
Increase
(decrease)
Salaries, benefits, subcontracting & personnel administration costs
Building occupancy costs, utilities, office supplies & repairs and maintenance
Sales and marketing
Professional fees
Insurance
ERP/CRM implementation costs
Other
Refers to the enterprise resource planning/customer relationship management system
Selling, general and administrative expenses was $29.5 million and $36.4 million in FY 2022 and FY 2021, respectively, a decrease of $6.9 million or 18.9%.
The salaries and related costs component of selling, general and administrative expenses decreased due to a reduction in corporate headcount including at the executive level along with a related reduction in stock compensation expenses. Excluding stock compensation expense, corporate salaries and related costs decreased $5.9 million in FY 2022, compared with FY 2021, while such costs at the Kandy business unit increased $0.3 million. As previously indicated, the decrease in salaries was impacted by the inclusion, in FY 2021, of $3.1 million of termination expenses in connection with a reduction in headcount. The stock compensation expense component of selling, general and administrative expenses decreased $6.0 million in Fiscal 2022, compared with Fiscal 2021 due to the reduction in corporate executive headcount and lower stock prices that impacted the fair value of new awards.
The professional fees component of selling, general and administrative expenses increased $2.8 million, from $5.6 million in FY 2021 to $8.4 million in Fiscal 2022, due to a combination of i) increased financing activities that required the services of legal and other professionals as well as ii) an increase in financial advisory professional fees. As discussed previously, the Company undertook a number of financing transactions during FY 2022. Also, as previously discussed, the Company has obtained strategic and operating restructuring support services of capital advisors in support of its strategic, operating and capital restructuring initiatives, which has resulted in increased non-recurring legal and financial advisory professional expenses.
ERP/CRM implementation costs began being expensed in May 2022 as a new ERP/CRM system went live effective May 1, 2022. Prior to May 2022, such costs were deferred as the ERP/CRM system was in the development phase.
Change in fair value of warrant liabilities
The change in the fair value of warrant liabilities represent mark-to-market fair value adjustments related to certain warrants, and primarily fluctuate due to changes in and the volatility of the Company’s stock price. The fair value changes of each warrant were as follows in FY 2022 and FY 2021 (in thousands):
Income (expense)
Series A Warrants
Series B Warrants
Series C Warrants
Series D Warrants
Monroe Warrants
February 2022 Warrants
2017 Private Placement and EBC Warrants
Interest expense
Interest expense for FY 2022 and FY 2021 consisted of the following (in thousands):
Interest expense and financing fees - Credit Agreement
Amortization of deferred financing costs and issue discount - February 2022 Warrants
Interest and extension fee on related party promissory note
Amortization of deferred financing costs and discount - Series B Preferred Stock
Amortization of deferred financing costs and discount - Convertible Notes
Amortization of debenture discount and debenture deferred fees
Debenture interest paid-in-kind
Financing charges due to a triggering event related to a floor price, as defined - Series B Preferred Stock
Hudson Bay waiver fee
Other
Interest expense was $20.4 million in FY 2022 compared with $31.7 million in FY 2021, a decrease of $11.3 million. Substantially all of such charges are not expected to recur due to the following:
In aggregate, $11.2 million of the $20.3 million incurred during FY 2022 relate to financing charges and amortization of deferred charges relating to the Series B Preferred Stock and the Convertible Notes. All amounts outstanding and all obligations under the Series B Preferred Stock and the Convertible Notes have since been repaid
An aggregate $6.9 million of the $20.3 million incurred during FY 2022 related to the Credit Agreement which was fully repaid on March 1, 2022
iii)
An aggregate $1.4 million of the $20.3 million incurred during FY 2022 was attributable to the February Warrants which have been converted to common stock
Debenture-related charges incurred in FY 2021 of $18.1 million, relate to Debentures which were fully converted to common stock FY 2021
The related party promissory note was repaid in FY 2022.
Other income (expense)
Other income of $0.9 million in FY 2022 consists of the gain of $1.7 million recorded in connection with the Ribbon Settlement Agreement (See Note 11 of Notes to the Consolidated Financial Statements), partially offset by other expenses of $0.8 million. Other income for FY 2021 was nominal.
Net income (loss) on discontinued operations, net of tax
Discontinued operations relate to Computex, which was sold in March 2022. Net income on discontinued operations, net of tax, for FY 2022 was $0.7 million compared with a net loss on discontinued operations, net of tax, in FY 2021 of $30.5 million. The loss in FY 2021 was primarily a result of a $32.1 million impairment charge recorded in Fiscal 2021 within the Computex business unit, in connection with the pending sale of Computex at that time.
Provision for income taxes
The Company assesses available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit the use of existing deferred tax assets. A significant component of objective negative evidence identified during management’s evaluation was the three-year cumulative loss for FY 2022 and FY 2021. Such objective negative evidence outweighed the positive evidence identified by the Company. On the basis of this evaluation, the Company maintained a full valuation allowance as of December 31, 2022 and December 31, 2021. In 2022, the Company identified uncertain tax positions relating to its domestic and foreign operations and recorded liabilities for the uncertain tax benefits
Liquidity and Capital Resources
Overview
Historically, the Company’s primary sources of liquidity have been cash and cash equivalents, cash flows from operations (when available) and cash flows from financing activities, including funding under credit agreements and the sale of equity securities. As of December 31, 2022, the Company had an aggregate cash balance of $12.6 million in its operating bank accounts and net working capital of $15.3 million. As of March 31, 2023, aggregate cash in the Company’s operating bank accounts was $13.3 million.
During 2022, the Company projected and announced that it would need additional capital to fund its operations including research & development and capital investment requirements. The Company also announced that it was pursuing strategic initiatives that could result in a sale of all or a portion of the assets of the Company. In addition, the Company continued to explore strategic opportunities, including the rationalization of resource allocation and core competencies. Further, the Company took actions that it believed resulted in significant cost savings. Such savings were generated from selective reductions in workforce and negotiated conversions of certain material vendor support costs from fixed to variable, thereby eliminating certain cost burdens related to unused capacity. Additionally, the Company obtained strategic and operating restructuring support services of certain capital advisors. On January 11, 2023, the Company filed for Chapter 11 and, in March 2023, entered into an agreement to sell substantially all of the assets of the Company. On March 15, 2023, the Court entered an order authorizing the Asset Sale pursuant to the terms of the Purchase Agreement. On March 24, 2023, the Asset Sale closed, thereby completing the disposition of substantially all of the Company’s assets.
After the consummation of the sale, the Company plans to pursue steps to facilitate an orderly winding up of its remaining operations and believes it has sufficient liquidity to achieve such. However, no assurance can be provided that such projections will be realized.
Cash balances and working capital noted above were impacted by the following recent transactions.
The entry into and subsequent repayment of the Credit Agreement with Monroe, which was entered into on December 2, 2021, for a $27 million term loan facility, to fund working capital, general business activities and to pay off amounts owing under a prior credit agreement ($12.8 million) that the Company previously assumed when it acquired Computex. Interest on the Credit Agreement was payable monthly at the rate of 12% per annum. However, the lenders under the Credit Agreement were guaranteed a minimum return of $7.3 million. On March 1, 2022, all amounts owing under the Credit Agreement were repaid, including the unpaid amounts of the minimum return.
The issuance and repayment of a $5.0 million subordinated promissory note (the “2021 Note”), which was entered into on September 16, 2021, which was secured by an affiliate of a shareholder that owned more than five percent of the Company’s common stock and which was repaid on March 15, 2022. The 2021 Note, which had a minimum return of 25%, became due on March 1, 2022, due to the Company’s sale of registered equity securities and the early pay-off of the Credit Agreement. However, for a waiver fee of $250,000, the lender extended the maturity date to May 1, 2022, and on March 15, 2022, the 2021 Note was paid in full using proceeds received from the sale of Computex.
The receipt of gross proceeds of $5.0 million (before deduction of offering costs), in November 2021, from the sale to an institutional investor in a registered direct offering, of 166,666 shares of common stock at a purchase price of $2.00 per share. In addition to the 166,666 shares of the Company’s common stock, the buyer received certain warrants. In December, the Company received an additional $5.0 million in gross proceeds from the subsequent exercise of one group of the warrants.
The repayment of a subordinated note of $0.5 million along with related accrued interest in November 2021.
The receipt of gross proceeds of $25.0 million (before deduction of offering costs), in December 2021, from the sale of securities consisting of 522,666 shares of common stock, 12,456 units of convertible preferred stock and certain warrants.
The receipt of gross proceeds of $15.0 million on March 1, 2022, representing the first tranche of a sale of securities in connection with a February 28, 2022 securities purchase agreement (the “February 2022 Purchase Agreement”) entered into with a buyer.
The sale in April 2022 of additional securities, which resulted in net cash proceeds of $9.9 million.
Cash financing charges of $2.8 million paid to the previous holders of the Series B Preferred Stock as a result of the Company’s stock price falling below a stipulated floor price, as defined in the Series B Preferred Stock agreement
the sale of 4,515,000 shares of the Company’s common stock, in September 2022, for net proceeds of $14.3 million, after deducting commission and other offering costs
Increased payments for legal, professional and advisory fees in 2022 and early 2023
The consummation, on October 20, 2022, of a securities purchase agreement entered into with two institutional accredited investors, which netted cash proceeds of $9.3 million, and which related to the sale of (i) an aggregate of 5,000,000 shares of the Company’s common stock, in a registered direct offering and (ii) warrants to purchase up to an aggregate of 10,000,000 shares of the Company’s common stock, at an exercise price of $1.80 per share, in a concurrent private placement, for a combined purchase price of $2.00 per share
Cash of $2.5 million received in connection with the Ribbon Settlement Agreement.
The Company believes that current cash balances, accounts receivable collections, funds held in escrow and proceeds from the sale of substantially all its assets will provide sufficient liquidity to fund the Company’s remaining activities through the anticipated liquidation date. However, there is no assurance that such projections will be achieved. This projection is based on the Company’s current expectations.
Cash flows
Net cash used in continuing operating activities was $64.1 million and $47.4 million in Fiscal 2022 and Fiscal 2021, respectively, and primarily consisted of cash used in Kandy’s operating activities (including its research and development activities), interest and certain financing costs, professional fees, insurance premiums and corporate support costs. Interest and financing costs included cash interest and other financing costs of $10.9 million primarily related to the Credit Agreement that was repaid in the 1 st quarter of 2022 as well as $2.8 million in financing charges that were paid to the previous holders of the Series B Preferred Stock.
Investing activities
Cash provided by continuing investing activities was $1.3 million in Fiscal 2022. Cash used in investing activities was $3.9 million in Fiscal 2021. Cash provided by continuing investing activities for Fiscal 2022 consisted of proceeds from the sale of certain software rights of $2.5 million, partially offset by $0.9 million of deferred development costs on the enterprise resource planning and customer relationship management system (commonly referred to as ERP and CRM systems) and other capital spending of $0.3 million. For FY 2021, cash used in continuing investing activities consisted of $0.9 million of deferred development costs on the ERP and CRM system and $3.0 million on other capital spending.
Financing activities
Cash provided by continuing financing activities was $13.5 million in Fiscal 2022 and primarily consisted of proceeds from the issuance of securities of $48.7 million, partially offset by debt repayments of $33.9 million and payment of deferred financing fees of $1.2 million.
Cash provided by continuing financing activities was $71.9 million in Fiscal 2021 and consisted primarily of proceeds of $27.8 million from the issuance of securities, $27.0 million from issuance of debt, $24.0 million from the issuance of Debentures, $5.0 million from the issuance of a promissory note, and $5.0 million from the exercise of warrants, partially offset by $1.1 million of tax payment for withheld shares associated with vested restricted stock units issued under the Company’s equity incentive plan, payment of deferred financing fees of $1.9 million and debt repayments of $13.9 million.
Cash flows from discontinued operations
Net cash provided by discontinued operations consisted of the following:
Net cash (used in) provided by operating activities
Net cash provided by (used in) investing activities
Net cash provided by discontinued operations
Off-Balance Sheet Arrangements
As of December 31, 2022, we had no off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K and had not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.
Critical Accounting Policies, Judgements and Estimates
This discussion of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included elsewhere in this annual report. The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and income and expenses during the periods reported. Actual results could differ materially from those estimates. Currently, we believe the accounting policies that involve the most significant judgments and estimates used in the preparation of the consolidated financial statements include those relating to revenue recognition, accounting for warrants, accounting for income taxes, the recognition and impairment evaluation relating to tangible and intangible assets, and accounting for share-based compensation. We discuss some of these policies below. The ones not discussed below are discussed in Note 3 of the Notes to the Consolidated Financial Statements.
Revenue recognition
Revenue from contracts with customers are not recorded until the Company has the approval and commitment from the parties, the rights of the parties are identified, payment terms are established, the contract has commercial substance and collectability of the consideration is probable. The Company also evaluates the following indicators, amongst others, when determining whether it is acting as a principal in the transaction (and therefore whether to record revenue on a gross basis): (i) whether the Company is primarily responsible for fulfilling the promise to provide the specified good or service, (ii) whether the Company has the inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer and (iii) whether the Company has the discretion to establish the price for the specified good or service. If the terms of a transaction do not indicate that the Company is acting as a principal in the transaction, then the Company is acting as an agent in the transaction and therefore, the associated revenue is recognized on a net basis (that is revenue net of costs).
Revenue is recognized once control passes to the customer. The following indicators are evaluated in determining when control has passed to the customer: (i) whether the Company has a right to payment for the product or service, (ii) whether the customer has legal title to the product, (iii) whether the Company has transferred physical possession of the product to the customer, (iv) whether the customer has the significant risk and rewards of ownership of the product and (v) whether the customer has accepted the product. The Company’s products can be delivered to customers in a variety of ways, including (i) physical shipment from the Company’s warehouse, (ii) via drop-shipment by the vendor or supplier or (iii) via electronic delivery of keys for software licenses. The Company’s shipping terms typically allow for the Company to recognize revenue when the product is shipped to the customer’s location.
When an arrangement contains more than one performance obligation, the Company will allocate the transaction price to each performance obligation on a relative standalone selling price basis. The Company utilizes the observable price of goods and services when they are sold separately to similar customers in order to estimate standalone selling price.
Cloud subscription and software revenue
Revenue from subscriptions to Kandy’s cloud-based technology platform is recognized on a ratable basis over the contractual subscription term beginning on the date that the platform is made available to the customer until the end of the contractual period. Payments received in advance of subscription services are recorded as deferred revenue; revenue recognized for services rendered in advance of payments received are recorded as contract assets. Usage fees, when bundled, are billed in advance and recognized on a ratable basis over the contractual subscription term, which is usually the monthly contractual billing period. Non-bundled usage fees are recognized as actual usage occurs.
The Company also recognizes revenue for term-based software licenses and has concluded that its software licenses are functional intellectual property that are distinct, as the user can benefit from the software on its own. The software license revenue is typically recognized upon transfer of control or when the software is made available for download, as this is the point at which the user of the software can direct the use of, and obtain substantially all of the remaining benefits from, the functional intellectual property.
Managed and professional services
Professional and managed services revenue include services for deployment, configuration, system integration, optimization, customer training and education. In these arrangements, the Company satisfies the performance obligations and recognizes revenue over time.
Such professional services are provided under both time and materials and fixed price contracts. When services are provided on a time and materials basis, the Company recognizes revenues at agreed-upon billing rates as services are performed. When services are provided on a fixed fee basis, the Company recognizes revenues over time in proportion to the Company’s progress towards satisfaction of the performance obligation.
In arrangements for managed services, the Company’s arrangement is typically a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company typically recognizes revenue from these services on a straight-line basis over the period services are provided, which is consistent with the timing of services rendered.
When services do not meet certain service levels of commitments, customers are entitled to receive service credits, and in certain cases, refunds, each representing a form of variable consideration. Kandy historically has not experienced any significant incidents affecting the defined levels of reliability and performance as required by its subscription contracts. Therefore, the variable consideration has been insignificant and there are no reserves for such service credits as of December 31, 2022.
Contract liabilities
Contract liabilities (or deferred or unearned revenue) are recognized when cash payments are received or due in advance of the Company’s performance obligations.
We consider revenue recognition to be a critical accounting policy and one that involves critical accounting estimates because of the materiality of this item to our financial statements and the level of judgement involved. Judgement is required in some of the factors discussed above including whether we are acting as a principal or an agent, the determination of when risk effectively passes to the customer, the determination of the price expected to be collected from the customer, the determination of whether revenue from certain software sales should be recognized as a single performance obligation or whether certain software support should be recognized as a separate performance obligation, and the assessment of whether the third-party delivered software support is critical or essential to the core functionality of the software itself.
Goodwill and intangibles impairment assessment
The Company reviews its long-lived assets for impairment whenever events or circumstances exist that indicate the carrying amount of an asset or asset group may not be recoverable. The recoverability of long-lived assets is measured by a comparison of the carrying amount of the asset or asset group to the future undiscounted cash flows expected to be generated by that asset group. If the asset or asset group is considered to be impaired, an impairment loss is recorded to adjust the carrying amounts to the estimated fair value. During the year ended December 31, 2021, the Company recorded impairment of intangible assets of $15.3 million relating to the Kandy reporting unit based on a comparison of the reporting unit’s fair value with its carrying value. The excess of the carrying value of the reporting unit over the estimated fair value was first allocated to the intangibles and then to goodwill. Fair value was determined using the income approach.
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill is reviewed for impairment at least annually, in December, or more frequently if a triggering event occurs between impairment testing dates. As of December 31, 2021, the Company had two operating segments and two reporting units for the purpose of evaluating goodwill impairment.
The Company’s impairment assessment begins with a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. Qualitative factors may include, macroeconomic conditions, industry and market considerations, cost factors, and other relevant entity and Company specific events. If, based on the qualitative test, the Company determines that it is “more likely than not” that the fair value of a reporting unit is less than its carrying value, then the Company evaluates goodwill for impairment by comparing the fair value of each reporting unit to its respective carrying value, including its goodwill . If it is determined that it is “not likely” that the fair value of the reporting unit is less than its carrying value, then no further testing is required.
The selection and assessment of qualitative factors used to determine whether it is more likely than not that the fair value of a reporting unit exceeds the carrying value involves significant judgment and estimates. Fair values may be determined using a combination of both income and market-based approaches.
As indicated in Note 1 of the Notes to the Consolidated Financial Statements, in connection with the planned sale of Computex, the Company recorded a noncash goodwill impairment charge of $32.1 million during the year ended December 31, 2021 which represents the excess of the carrying value of the Computex reporting unit over the expected sale proceeds less costs to sell. As indicated above, impairment of Kandy’s goodwill was also recorded during the year ended December 31, 2021. Goodwill impairment of the Kandy reporting unit was $13.7 million.
Warrants
On July 27, 2017, the Company entered into certain Warrant Purchase Agreements with each of Pensare Sponsor Group, LLC, a Delaware limited liability company (the “Sponsor”), and certain other investors (collectively, the “Purchasers”), pursuant to which the Purchasers purchased an aggregate of 700,833 warrants (including the full over-allotment amount) in connection with and simultaneously with the closing of the IPO (the “2017 Private Placement Warrants”) at a purchase price of $15.00 per Private Placement Warrant.
On or about August 1, 2017, in the IPO, the Company sold units of the Company’s equity securities, each such unit consisting of one share of Common Stock, one-half of one Public Warrant and one-tenth of one right to acquire one share of the Company’s common stock upon the closing of the initial business combination (the “Units”) and, in connection therewith, issued and delivered 1,035,000 warrants to public investors in the Offering (the “Public Warrants”). In addition, 45,000 warrants, underlying unit purchase options issued to the underwriters of the IPO and certain of their designees (the “2017 EBC Warrants”), were issuable. The 2017 EBC Warrants together with the 2017 Private Placement Warrants and the Public Warrants are collectively referred to as the “2017 Warrants.” Each whole 2017 Warrant entitles the holder thereof to purchase one share of the Company’s common stock for $172.50 per share, subject to adjustments. In addition to the 45,000 warrants, the unit purchase options, which expired in July 2022, entitled the holders to receive 99,000 shares of common stock for an exercise price of $150 per unit.
As of December 31, 2022, a total of 1,035,000 Public Warrants and 700,833 of the 2017 Private Placement Warrants remained outstanding.
The 2017 Private Placement Warrants are exercisable on a cashless basis, at the holder’s option, and are non-redeemable so long as they are held by the initial Purchasers or their permitted transferees. Public Warrants and any 2017 Private Placement Warrants that are transferred to nonpermitted transferees are redeemable at the option of the Company and are not exercisable on a cashless basis.
The Company evaluated the 2017 Warrants under ASC 815-40, Derivatives and Hedging—Contracts in Entity’s Own Equity , and concluded that the 2017 Private Placement Warrants and the 2017 EBC Warrants did not meet the criteria to be classified in stockholders’ equity. A recent SEC Statement focused in part on provisions in warrant agreements that provide for potential changes to the settlement amounts dependent upon the characteristics of the warrant holder and because the holder of a warrant is not an input into the pricing of a fixed-for-fixed option on equity shares, such provision precluded the 2017 Private Placement Warrants and 2017 EBC Warrants from being classified in equity and therefore the 2017 Private Placement Warrants and 2017 EBC Warrants were classified as liabilities at fair value, with subsequent changes in fair values recognized in earnings at each reporting date. The 2017 Private Placement Warrants were valued using a Black-Scholes pricing model as described in Note 3 of the Notes to the Consolidated Financial Statements. Changes in the fair value of such Warrants requires significant judgment, including the determination of the appropriate valuation model to use and the inputs to the valuation model.
Accounting for income taxes
Under the Financial Accounting Standard Board’s (“FASB”) Accounting Standard Codification (“ASC”) No. 740 (“ASC No. 740”), income tax expense is recorded for the amount of income tax payable or refundable for the current period and for the change in net deferred tax assets or liabilities resulting from events that are recorded for financial reporting purposes in a different reporting period than recorded in the tax return. We make significant assumptions, judgments, and estimates in the determination of our provision for income taxes and also our deferred tax assets and liabilities and any valuation allowances.
Our judgments, assumptions, and estimates relating to the current tax provision take into account current tax laws, our interpretation of current tax laws, allowable deductions, tax credits, and possible outcomes of current and future tax audits. We do not recognize a tax benefit unless we conclude that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is greater than a 50 percent likelihood of realization. Changes in tax laws or our interpretation of tax laws and the resolution of current and future tax audits could materially impact the amounts provided for income taxes. Our assumptions, judgments, and estimates relative to the value of our net deferred tax assets take into account predictions of the amount and category of future taxable income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments, and estimates inaccurate, thus materially impacting our financial position and results of operations.
Share-based compensation
The Company accounts for share-based compensation in accordance with ASC 718, Compensation - Stock Compensation , which requires the measurement and recognition of compensation expense, based on estimated fair values, for share-based awards made to employees and directors. Based on the grant date fair value of the award, the Company recognizes compensation expense over the requisite service period or performance period on a straight-line basis, and accounts for forfeitures as they occur.
Significant judgement is required in the estimation of fair values of stock awards. For the restricted stock awards with a time-based vesting condition, the fair value is determined by reference to the Company’s stock price on the grant date. A portion of the Company’s restricted stock awards are performance-based with a market condition that must be met for the award to vest. For those restricted stock awards, the fair value is estimated using a Monte Carlo simulation model, whereby the fair value of such awards is fixed at the grant date and amortized over the shorter of the remaining performance or service period. The Monte Carlo simulation valuation model utilizes the following assumptions: expected stock price volatility, expected life of the awards and a risk-free interest rate. Significant judgment is required in estimating the expected volatility of our common stock. Due to the limited trading history of the Company’s common stock, estimated volatility was based on a peer group of public companies and took into consideration the increased short-term volatility in historical data due to COVID-19.
Recent Accounting Pronouncements Issued and Adopted
See Note 3 of the Notes to the Consolidated Financial Statements.
