Crexendo, Inc. (CXDO) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SAFE HARBOR

In addition to historical information, this Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in Item 1A. above and the risk factors set forth in this Annual Report. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. The forward-looking statements made in this Annual Report are made as of the filing date of this Annual Report with the SEC, and future events or circumstances could cause results that differ significantly from the forward-looking statements included here. Accordingly, we caution readers not to place undue reliance on these statements. We expressly disclaim any obligation to update or alter our forward-looking statements, whether, as a result of new information, future events or otherwise after the date of this document.

OVERVIEW

Crexendo, Inc. is an award-winning premier provider of cloud communication platform and services, video collaboration and managed IT services designed to provide enterprise-class cloud solutions to any size business. By providing a variety of comprehensive and scalable solutions, we are able to cater to businesses of all sizes on a monthly subscription basis without the need for expensive capital investments, regardless of where their business is in its lifecycle. Our products and services can be categorized in the following offerings:

Cloud Telecommunications Services – Our cloud telecommunications services transmit calls using IP or cloud technology, which converts voice signals into digital data packets for transmission over the Internet or cloud. Each of our calling plans provides a number of basic features typically offered by traditional telephone service providers, plus a wide range of enhanced features that we believe offer an attractive value proposition to our customers. This platform enables a user, via a single “identity” or telephone number, to access and utilize services and features regardless of how the user is connected to the Internet or cloud, whether it’s from a desktop device or an application on a mobile device.

We generate recurring revenue from our cloud telecommunications services, broadband Internet services, managed IT services, software license sales, and infrastructure as a service. Our cloud telecommunications contracts typically have a thirty-six to sixty month term. We may also charge activation and flash fees and the Company generally allocates a portion of the activation fees to the desktop devices, which is recognized at the time of the installation or customer acceptance, and a portion to the service, which is recognized over the contract term using the straight-line method. We also charge other various contracted and non-contracted fees.

We generate product revenue, equipment financing revenue, and device as a service revenue from the sale and lease of our cloud telecommunications equipment. Revenues from the sale of equipment, including those from sales-type leases, are recognized at the time of sale or at the inception of the lease, as appropriate.

Our Cloud Telecommunications service revenue increased 52% or $10,153 to $29,668 for the year ended December 31, 2023 as compared to $19,515 for the year ended December 31, 2022. Our Cloud Telecommunications product revenue increased 90% or $2,593 to $5,484 for the year ended December 31, 2023 as compared to $2,891 for the year ended December 31, 2022. The year ended December 31, 2022 includes only two months of revenue from the Allegiant Networks acquisition date of November 1, 2022.

Software Solutions – Our software solutions segment derives revenues from three primary sources: software licenses, software maintenance support and professional services. Software and services may be sold separately or in bundled packages. Generally, contracts with customers contain multiple performance obligations, consisting of software and services. For bundled packages, the Company accounts for individual products and services separately if they are distinct – i.e. if a product or service is separately identifiable from other items in the bundled package and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The consideration is allocated between separate products and services in a bundle based on their relative stand-alone selling prices. The stand-alone selling prices are determined based on the prices at which the Company separately sells the software licenses and professional services. For items that are not sold separately (e.g. additional features) the Company estimates stand-alone selling prices using the adjusted market assessment approach. When we provide a free trial period, we do not begin to recognize recurring revenue until the trial period has ended and the customer has been billed for the services.

We generate software license revenue from the sale of perpetual software licenses, term-based software licenses that expire, and Software-as-a-Service ("SaaS") based software which are referred to as subscription arrangements. The Company does not recognize software revenue related to the renewal of subscription software licenses earlier than the beginning of the subscription period.

We generate subscription and maintenance support revenue from customer support and other supportive services. The Company offers warranties on its products. The warranty period for our licensed software is generally 90 days. Certain of the Company's warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations. The Company also sells separately-priced maintenance service contracts, which qualify as service-type warranties and represent separate performance obligations. The Company does not typically allow and has no history of accepting material product returns. Customer support includes software updates on a when-and-if-available basis, telephone support, integrated web-based support and bug fixes or patches. Subscription and maintenance support revenue is recognized ratably over the term of the customer support agreement, which is typically one year.

We generate professional services and other revenue from consulting, technical support, resident engineer services, design services and installation services. Revenue for professional services and other is recognized when the performance obligation is complete and the customer has accepted the performance obligation.

Our Software Solutions revenue increased 19%, or $2,899 to $18,047 for the year ended December 31, 2023 as compared to $15,148 for the year ended December 31, 2022.

Results of Consolidated Operations

The following discussion of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included herein this Annual Report.

Results of Consolidated Operations (in thousands, except for per share amounts)

———————

Year Ended December 31, 2023 Compared to Year Ended December 31, 2023

Total Revenue

Total revenue consists of service revenue, software solutions revenue and product revenue. The following table reflects our total revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in total revenue is due to an increase in service revenue of $10,153, an increase in software solutions revenue of $2,899, and an increase in product revenue of $2,593. Our November 1, 2022 acquisition of Allegiant Networks contributed $8,886 of the increase in service revenue and $2,131 of the increase in product revenue compared to 2022.

Loss Before Income Taxes

The following table reflects our income/(loss) before income taxes for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The decrease in loss before income taxes is primarily related to an increase in revenue of $15,645, a decrease in operating expenses of $20,058, and an increase in other income of $208. The increase in revenue is primarily related to organic growth and twelve months of Allegiant Networks revenue compared to two months in the prior year, which contributed $11,017 of the increase in revenue. The decrease in operating expenses is primarily related to a $32,678 decrease in goodwill and long-lived asset impairment, offset by twelve months of Allegiant Networks operating expenses compared to two months in the prior year, which contributed $11,006, increases in salaries, benefits, and commission expense of $1,539, and other operating expenses of $75. The increase in other income is primarily related to the gain on the sale of our corporate headquarters located in Tempe, Arizona of $1,459 and decreases in foreign currency loss, offset by a decrease in the 2022 release of a sales tax accrual of $1,435.

Income Tax Benefit

The following table reflects our income tax benefit/(provision) for the year ended December 31, 2023, compared to the year ended December 31, 2022:

We had an income tax provision of $(98) for the year ended December 31, 2023 compared to an income tax benefit of $762 for the year ended December 31, 2022. For the year ended December 31, 2023, we recorded additional valuation allowance of $1,603 and for the year ended December 31, 2022, we recorded a valuation allowance release of $1,681.

Use of Non-GAAP Financial Measures

To evaluate our business, we consider and use non-generally accepted accounting principles (“Non-GAAP”) net income and Adjusted EBITDA as a supplemental measure of operating performance. These measures include the same adjustments that management takes into account when it reviews and assesses operating performance on a period-to-period basis. We consider Non-GAAP net income to be an important indicator of overall business performance because it allows us to evaluate results without the effects of share-based compensation, acquisition related expenses, changes in fair value of contingent consideration, amortization of intangibles, and goodwill and long-lived asset impairment. We define EBITDA as U.S. GAAP net income/(loss) before interest expense, interest income and other expense/(income), the gain/(loss) on the sale of property and equipment, goodwill and long-lived asset impairments, provision/(benefit) for income taxes, and depreciation and amortization. We believe EBITDA provides a useful metric to investors to compare us with other companies within our industry and across industries. We define Adjusted EBITDA as EBITDA adjusted for acquisition related expenses, changes in fair value of contingent consideration and share-based compensation. We use Adjusted EBITDA as a supplemental measure to review and assess operating performance. We also believe use of Adjusted EBITDA facilitates investors’ use of operating performance comparisons from period to period, as well as across companies.

In our March 5, 2024 earnings press release, as furnished on Form 8-K, we included Non-GAAP net income, EBITDA and Adjusted EBITDA. The terms Non-GAAP net income, EBITDA, and Adjusted EBITDA are not defined under U.S. GAAP, and are not measures of operating income, operating performance or liquidity presented in analytical tools, and when assessing our operating performance, Non-GAAP net income, EBITDA, and Adjusted EBITDA should not be considered in isolation, or as a substitute for net income/(loss) or other consolidated income statement data prepared in accordance with U.S. GAAP. Some of these limitations include, but are not limited to:

We compensate for these limitations by relying primarily on our U.S. GAAP results and using Non-GAAP net income, EBITDA, and Adjusted EBITDA only as supplemental support for management’s analysis of business performance. Non-GAAP net income, EBITDA and Adjusted EBITDA are calculated as follows for the periods presented.

Reconciliation of Non-GAAP Financial Measures

In accordance with the requirements of Regulation G issued by the SEC, we are presenting the most directly comparable U.S. GAAP financial measures and reconciling the unaudited Non-GAAP financial metrics to the comparable U.S. GAAP measures.

Reconciliation of U.S. GAAP Net Income to Non-GAAP Net Income

(Unaudited)

Reconciliation of U.S. GAAP Net Income to EBITDA to Adjusted EBITDA

(Unaudited)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The following accounting policies are the most critical in understanding our consolidated financial position, results of operations or cash flows, and that may require management to make subjective or complex judgments about matters that are inherently uncertain.

Revenue Recognition

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services and excludes any amounts collected on behalf of third parties. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. We recognize revenue for delivered elements only when we determine there are no uncertainties regarding customer acceptance. Changes in the allocation of the sales price between delivered and undelivered elements can impact the timing of revenue recognized but does not change the total revenue recognized on any agreement.

The consideration (including any discounts) is allocated between separate products and services in a bundle based on their relative stand-alone selling prices. The stand-alone selling prices are determined based on the prices at which the Company separately sells the products and services. For items that are not sold separately (e.g. additional features) the Company estimates stand-alone selling prices using the adjusted market assessment approach. Professional services revenue includes activation fees and any professional installation services. Installation services are recognized as revenue when the services are completed. The Company generally allocates a portion of the activation fees to the desktop devices, which is recognized at the time of the installation or customer acceptance, and a portion to the service, which is recognized over the contract term using the straight-line method. Our telecommunications services contracts typically have a term of thirty-six to sixty months. When we provide a free trial period, we do not begin to recognize recurring revenue until the trial period has ended and the customer has been billed for the services.

Goodwill

We have recorded goodwill related to various business acquisitions. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. In each of our acquisitions, the objective of the acquisition was to expand our product offerings and customer base and to achieve synergies related to cross selling opportunities, all of which contributed to the recognition of goodwill. We test goodwill for impairment on an annual basis or more frequently if events or changes in circumstances indicate that goodwill might be impaired. The estimated fair value of the reporting unit is determined using our market capitalization as of our annual impairment assessment date or more frequently if circumstances indicate the goodwill might be impaired. Items that could reasonably be expected to negatively affect key assumptions used in estimating fair value include but are not limited to: sustained decline in our stock price due to a decline in our financial performance due to the loss of key customers, loss of key personnel, emergence of new technologies or new competitors; and decline in overall market or economic conditions leading to a decline in our stock price.

The process of estimating the fair value of goodwill is subjective and required the Company to make estimates that may significantly impact the outcome of the analysis. A qualitative assessment considers events and circumstances such as macroeconomic conditions, industry and market conditions, cost factors and overall financial performance, as well as company specifications. If after performing this assessment, the Company concluded it is more likely than not that the fair value of the reporting unit is less than its carrying amount, then the Company performed the quantitative test.

Under the quantitative test, a goodwill impairment is identified by comparing the fair value of the reporting unit to the carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds the fair value of the reporting unit, goodwill is considered impaired and an impairment charge is recognized in an amount equal to the excess, not to exceed the carrying amount of goodwill.

The Company estimated the fair value of the reporting unit with an income approach using the discounted cash flow (“DCF”) analysis and the Company also considered a market-based valuation methodology using comparable public company trading values and the Company’s market capitalization. Determining fair value requires the exercise of significant judgments, including the amount and timing of expected future cash flows, long-term growth rates, the discount rate and relevant comparable public company earnings multiples. The cash flows employed in the DCF analysis are based on the Company’s best estimate of future sales, earnings and cash flows after considering factors such as general market conditions and recent operating performance. The discount rate utilized in the DCF analysis is based on the reporting unit’s weighted-average cost of capital, which takes into account the relative weights of each component of capital structure (equity and debt) and represents the expected cost of new capital, adjusted as appropriate to consider the risk inherent in future cash flows of the Company’s reporting unit.

Impairment assessment inherently involves management judgments regarding a number of assumptions described above. The reporting unit fair value also depends on the future strength of the U.S. economy. New and developing competition as well as technological change could also adversely affect future fair value estimates. Due to the many variables inherent in the estimation of a reporting unit’s fair value and the relative size of the Company’s recorded goodwill, differences in assumptions could have a material effect on the estimated fair values. For further information, see Note 8 (Intangible Assets and Goodwill).

Intangible Assets

Our intangible assets consist of customer relationships, developed technologies, trademark and trade names. The intangible assets are amortized following the patterns in which the economic benefits are consumed or straight-line over the estimated useful life. We periodically review the estimated useful lives of our intangible assets and review these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The determination of impairment is based on estimates of future undiscounted cash flows. If an intangible asset is considered to be impaired, the amount of the impairment will be equal to the excess of the carrying value over the fair value of the asset.

Amortizable intangible assets are amortized over the estimated useful lives as follows:

Valuation of Long-Lived Assets.

The Company reviews the carrying amount of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Once an indicator of potential impairment has occurred, the impairment test is based on whether the intent is to hold the asset for continued use or to hold the asset for sale. If the intent is to hold the asset for continued use, the impairment test first requires a comparison of projected undiscounted future cash flows against the carrying amount of the asset group. If the carrying value of the asset group exceeds the estimated undiscounted future cash flows, the asset group would be deemed to be potentially impaired. The impairment, if any, would be measured based on the amount by which the carrying amount exceeds the fair value. Fair value is determined primarily using the projected future undiscounted cash flows. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost to dispose. We recognized impairment losses of $0 and $69 in the Consolidated Statements of Operations for the years ended December 31, 2023 and 2022, respectively.

Deferred Taxes

Our provision for income taxes is comprised of a current and a deferred portion. The current income tax provision is calculated as the estimated taxes payable or refundable on tax returns for the current year. The deferred income tax provision is calculated for the estimated future tax effects attributable to temporary differences and carryforwards using expected tax rates in effect during the years in which the differences are expected to reverse or the carryforwards are expected to be realized.

We currently have net deferred tax assets consisting of net operating loss carryforwards, tax credit carryforwards and deductible temporary differences. Management periodically weighs the positive and negative evidence to determine if it is more likely than not that some or all of the deferred tax assets will be realized. As of December 31, 2023, excluding the gain on the sale of property and equipment, we have three years of cumulative pretax losses and the weight of all other positive and negative evidence, such as forecasts and projections of future pretax income are inherently subjective and require management to make assumption or complex judgments about matters that are inherently uncertain and therefore are not sufficient to overcome the significant negative evidence of a three year lookback cumulative loss position. Therefore, management determined that it is not more likely than not that we will be able to realize our deferred tax assets, and we have recorded a valuation allowance of $4,782 at December 31, 2023.

Product Warranty

We provide for the estimated cost of product warranties at the time we recognize revenue. We evaluate our warranty obligations on a product group basis. Our standard product warranty terms generally include post-sales support and repairs or replacement of a product at no additional charge for a specified period of time. We base our estimated warranty obligation upon warranty terms, ongoing product failure rates, and current period product shipments. If actual product failure rates, repair rates or any other post-sales support costs were to differ from our estimates, we would be required to make revisions to the estimated warranty liability. Warranty terms generally last for the duration that the customer has service. Some third-party equipment vendors offer extended warranties. These extended warranties are sold separately and provide services in addition to assurance that the product will function as expected, including updates and patches. The Company is arranging for these services to be provided by the third-party and is acting as an agent in the transaction and records revenue on a net basis at the time of sale.

Allowance for Credit Losses

We record an allowance for credit losses in accordance with the Current Expected Credit Loss (“CECL”) model. We utilize the forward looking “expected loss” model to establish an allowance for credit losses for our trade receivables, contract asset, and equipment financing receivables.

The trade receivables allowance for credit losses is determined based on an assessment of historical collection experience using the aging schedule method as well as consideration of current and future economic conditions. Trade receivables are written off against the allowance after all collection efforts have been exhausted and management deems the account to be uncollectible. We believe that our trade receivable credit risk is low because of the geographic and industry diversification of our clients and small account balances for most of our clients. We continually evaluate the adequacy of the allowance for credit losses and adjust as necessary.

The contract assets allowance for credit losses is determined based on an assessment of historical collection experience using the loss-rate method as well as consideration of current and future economic conditions and changes in our loss-rate trends. We utilize a five-year lookback period to establish our estimate of expected credit losses, as our contractual terms range from three to five years. Contract assets are written off against the allowance after all collection efforts have been exhausted and management deems the account to be uncollectible. We believe that our contract assets credit risk is low because of the geographic and industry diversification of our clients and small account balances for most of our clients. We continually evaluate the adequacy of the allowance for credit losses and adjust as necessary.

The equipment financing receivables allowance for credit losses is determined based on historical loss experience, adverse situations that may affect a client's ability to pay, current economic conditions and outlook based on reasonable and supportable forecasts. We continually evaluate the adequacy of the allowance for credit losses and adjust as necessary. Equipment financing receivables are written off against the allowance after all collection efforts have been exhausted and management deems the account to be uncollectible. We believe that our equipment financing receivable credit risk is low because of the geographic and industry diversification of our clients and small account balances for most of our clients.

Contingent Liabilities

Contingent liabilities require significant judgment in estimating potential payouts. Contingent considerations arising from business combinations and asset acquisitions require management to estimate future payouts based on forecasted results, which are highly sensitive to the estimates of discount rates and future revenues. These estimates can change significantly from period to period and are reviewed each reporting period to establish the fair value of the contingent liability.

Share-Based Compensation

We account for our share-based compensation awards using the fair-value method. The grant date fair value was determined using the Black-Scholes-Merton pricing model. The Black-Scholes-Merton valuation calculation requires us to make key assumptions such as future stock price volatility, expected terms, risk-free rates, and dividend yield. Our expected volatility is derived from our volatility rate as a publicly traded company. The expected term is based on our historical experience. The risk-free interest factor is based on the United States Treasury yield curve in effect at the time of the grant for zero coupon United States Treasury notes with maturities of approximately equal to each grant’s expected term. For the year ended December 31, 2023, one quarterly dividend of $0.005 was declared and paid, however we have assumed a 0% dividend yield for the year ended December 31, 2023. For the year ended December 31, 2022, quarterly dividends of $0.005 were declared and paid, however we have assumed a 0% dividend yield.

We develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. We will continue to use judgment in evaluating the expected term, volatility, and forfeiture rate related to our own share-based awards on a prospective basis, and in incorporating these factors into the model. If our actual experience differs significantly from the assumptions used to compute our share-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little share-based compensation cost.

For additional information on use of estimates, see summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements.

Segment Operating Results

The Company has two operating segments, which consist of Cloud Telecommunications Services and Software Solutions. The information below is organized in accordance with our two reportable segments. Segment operating income is equal to segment net revenue less segment cost of service revenue, cost of software solution revenue, cost of product revenue, sales and marketing, research and development, and general and administrative expenses.

Operating Results of our Cloud Telecommunications Services Segment (in thousands):

Quarterly Financial Information

Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

Service Revenue

Cloud telecommunications service revenue consists primarily of fees collected for cloud telecommunications services, professional services, interest from sales-type leases, reselling broadband Internet services, managed IT service, and administrative fees. The following table reflects our service revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in service revenue is due to an increase in telecommunications services fees of $8,604, an increase in one-time fees, commissions and other of $1,192, an increase in fees, commissions, and other, recognized over time of $191, and an increase in sales-type lease interest of $166. Our November 1, 2022 acquisition of Allegiant Networks, contributed $8,886 of the total increase in service revenue. A substantial portion of Cloud Telecommunications service revenue is generated through thirty-six to sixty month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop phone devices, third-party equipment, and device as a service. The following table reflects our product revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

Product revenue fluctuates from one period to the next based on timing of installations. Our typical customer installation is complete within 30-60 days. However, larger enterprise customers can take multiple months, depending on size and the number of locations. Product revenue is recognized when products have been installed and services commence. Additionally, product revenue can fluctuate due to the allocation of discounts or sales promotions across the performance obligations. The increase in product revenue is primarily related to additional product revenue of $2,131 contributed by our November 1, 2022 acquisition of Allegiant Networks during the year ended December 31, 2023 and an increase in organic product revenue of $462.

Backlog

Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of December 31, 2023 and 2022. Backlog increased 40%, or $12,794 to $44,810 as of December 31, 2023 as compared to $32,016 as of December 31, 2022. Below is a table which displays the Cloud Telecommunications segment revenue backlog as of December 31, 2023 and 2022, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):

Cost of Service Revenue

Cost of service revenue consists primarily of fees we pay to third-party telecommunications carriers, broadband Internet providers, software providers, costs related to installations, customer support salaries, benefits, bonuses, and share-based compensation. The following table reflects our cost of service revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in cost of service revenue was primarily related to additional cost of service revenue of $5,439 contributed by our November 1, 2022 acquisition of Allegiant Networks during the year ended December 31, 2023. Additionally, we had a $242 increase in salaries, benefits, bonuses, and share-based compensation related to increases in headcount to assist with the migration of our customers to our new VIP platform and expenses for the accrual of annual employee bonuses, an increase in third-party telecommunications carrier costs of $158, and an increase in other cost of service revenue of $56.

Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. The following table reflects our cost of product revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase is primarily related to an increase of $269 from our organic product revenue growth and an increase in additional cost of product revenue of $1,425 contributed by our November 1, 2022 acquisition of Allegiant Networks during the year ended December 31, 2023.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales representative salaries, benefits, bonuses, and share-based compensation, partner channel commissions, amortization of costs to acquire contracts, travel expenses, lead generation services, trade shows, internal and third-party marketing costs, the production of marketing materials, and sales support software. The following table reflects our selling and marketing expenses for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in selling and marketing expense is primarily related to an increase in additional selling and marketing expense of $2,178 contributed by our November 1, 2022 acquisition of Allegiant Networks during the year ended December 31, 2023 and an increase in commission expense of $742 directly related to the increase in revenue, an increase in salaries, benefits, bonuses, and share-based compensation of $60, and an increase in other selling and marketing expenses of $37.

General and Administrative

General and administrative expenses consist of salaries, benefits, bonuses and share-based compensation for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, depreciation, amortization of intangibles, and other administrative corporate expenses. The following table reflects our general and administrative expenses for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The decrease in general and administrative expenses is primarily related to a decrease in administrative salaries, benefits, bonuses, and share-based compensation of $1,882 related to a decrease in share-based compensation and the reclassification of salary, wages, and benefits to the Software Solutions segment, offset by an increase in expenses for the accrual of annual employee bonuses, a decrease in telecommunication fees of $134, and a decrease in other general and administrative expenses of $40, offset by an increase in additional general and administrative expense of $1,965 contributed by our November 1, 2022 acquisition of Allegiant Networks during the year ended December 31, 2023.

Research and Development

Research and development expenses primarily consist of salaries, benefits, bonuses, and share-based compensation, outsourced engineering services related to the development of new cloud telecommunications features and products. The following table reflects our research and development expenses for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The decrease in research and development expenses is primarily related to a decrease in salaries, benefits, bonuses, and share-based compensation of $55 and a decrease in costs for maintenance on our mobile applications and other development costs of $39 due to a reduction in development on our legacy platform as we migrate customers to our new VIP platform.

Other Income/(Expense)

Other income/(expense) primarily relates to interest expense and net foreign exchange gains or losses, offset by credit card cash back rewards. The following table reflects our other income/(expense) for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The change in other income/(expense) is primarily related to the gain on the sale of our corporate headquarters located in Tempe, Arizona of $1,459 offset by a decrease in other income/(expense) of $29.

Operating Results of our Software Solutions Segment (in thousands):

Quarterly Financial Information

Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

Software Solutions Revenue

Software solutions revenue consists primarily of software license fees, subscription maintenance and support, professional services, and annual user group meeting fees. Software licenses are billed by the number of concurrent sessions a Partner has purchased or subscribes to. Subscription maintenance and support is ongoing and provides for software updates and improvements, support for add-on modules, bug fixes, and other general maintenance items. Professional services and other revenues consist of professional services such as the installation of software and integration of other modules, training and implementation as well as custom mobile branding. The following table reflects our service revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase is primarily related to a $2,352 increase in recurring software license and maintenance and support subscriptions an increase in professional services of $307, and an increase in perpetual software license revenue of $240.

Cost of Software Solutions Revenue

Cost of software solutions revenue consists primarily of salaries, benefits, bonuses, and amortization expense related to the technology, cost of data center hosting, third-party software modules, annual user group meeting costs, and outsourced services required to install and support software solutions. The following table reflects our cost of service revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in cost of service revenue is primarily related an increase in software costs of $294, an increase in annual user group meeting expenses of $223, an increase in outside consulting services of $179, an increase in salaries, benefits, bonuses, and share-based compensation of $117, offset by the reclassification of $452 of research and development expenses out of cost of service revenue after carefully reviewing operating expenses, that qualify as research and development operating expenses, and a decrease in other cost of software solutions revenue of $71.

Backlog

Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of December 31, 2023 and 2022. Backlog increased 29%, or $4,292 to $19,122 as of December 31, 2023 as compared to $14,830 as of December 31, 2022. Below is a table which displays the Software Solutions segment revenue backlog as of December 31, 2023 and 2022, which we expect to recognize as revenue within the next thirty-six months (in thousands):

Selling and Marketing

Selling and marketing expenses consist primarily of sales and marketing salaries, benefits, bonuses, commissions, share-based compensation, travel expenses, lead generation services, trade shows, third-party marketing services, the production of marketing materials, UGM costs, and sales support software. The following table reflects our selling and marketing expenses for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The decrease in selling and marketing expense is primarily related to decrease in marketing consultants costs of $137 and a decrease in annual user group meeting costs of $119, offset by an increase in salaries, benefits, bonuses, and share-based compensation of $160 related to an increase in headcount and expenses for the accrual of annual employee bonuses, and an increase in other selling and marketing costs of $25.

General and Administrative

General and administrative expenses consist of salaries and benefits for executives, administrative personnel, amortization of intangible asset related to customer lists, legal, rent, equipment, accounting and other professional services, and other administrative corporate expenses. The following table reflects our general and administrative expenses for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The increase in general and administrative expenses is primarily related to the reclassification of salaries and benefits from the Cloud Telecommunication Services segment of $682 after carefully reviewing expenses that related to the Software Solutions segment, an increase in salaries, benefits, bonuses, and share-based compensation of $300 related to salary increases and expense for accrual of annual employee bonuses, an increase in depreciation expense of $29, and an increase in other general and administrative expenses of $62, offset by a decrease in general and administrative expenses relating to the reclassification of research and development expenses out of general and administrative expenses after carefully reviewing expenses that qualify of $93.

Research and Development

Research and development expenses primarily consists of salaries, benefits, bonuses, share-based compensation, and outsourcing engineering services related to the development of our software solutions. The following table reflects our research and development expense for the year end December 31, 2023, compared to the year ended December 31, 2022:

The increase in research and development expenses is primarily related to the reclassification of research and development expenses out of cost of service revenue of $452 and out of general and administrative expense of $93, after carefully reviewing expenses that qualify as research and development operating expenses, an increase in salaries, benefits, bonuses, and share-based compensation of $273 related to an increase in headcount, salary increases, and expenses for accrual of annual employee bonuses, an increase in outside consulting services of $132, and an increase in other research and development expenses of $49.

Other Income/(Expense)

Other income/(expense) primarily relates to interest expense, net foreign exchange gains or losses, and other income and expenses. The following table reflects our other expense for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The decrease in other income/(expense) is primarily related to the prior year release of a sales tax accrual of $1,435, offset by a decrease in foreign exchange losses of $133, and an increase in other income of $80.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. We finance our operations primarily through services, software solutions, and product sales to our customers. As of December 31, 2023 and 2022, we had cash and cash equivalents of $10,347 and $5,475, respectively. Changes in cash and cash equivalents are dependent upon changes in, among other things, working capital items such as contract liabilities, contract costs, accounts payable, accounts receivable, prepaid expenses, and various accrued expenses, as well as purchases of property and equipment, asset acquisitions, business combinations, and changes in our capital and financial structure due to debt repayments and issuances, stock option exercises, sales of equity investments and similar events. We believe that our operations along with existing liquidity sources will satisfy our cash requirements for at least the next 12 months.

On November 1, 2022, the Company acquired 100% of the issued and outstanding shares of Allegiant Networks, a provider of telecommunications products, services, and solutions in Kansas and Missouri. The aggregate purchase price of $9.4 million consisted of $2.0 million of cash paid at closing, 2,461,538 shares of our common stock with an estimated fair value of $6.3 million issued at closing, and a three-year promissory note for $1.1 million.

Operating Activities

Cash provided by or used in operating activities is driven by our net loss, adjustments to reconcile to net cash provided by or used in operating activities, the timing of customer collections, as well as the amount and timing of disbursements to our vendors, the amount of cash we invest in personnel, marketing, and infrastructure costs to support the anticipated growth of our business. The following table reflects our net cash provided by/(used in) operating activities for the year ended December 31, 2023, compared to the year ended December 31, 2022:

The net cash provided by operations was primarily driven by non-cash expenses for depreciation and amortization of $3,573 and share-based compensation of $3,849, a decrease in inventories of $297, a decrease in other assets of $651, and an increase in accounts payable and accrued expenses of $623, offset by our net loss for the year ended December 31, 2023 of $362, the gain on disposal of property and equipment of $1,459, an increase in trade receivables of $164, an increase in contract assets of $109, an increase in equipment financing receivables of $905, an increase in contract costs of $1,473, and a decrease in contract liabilities of $997.

The net cash used in operations for the year ended December 31, 2022, was primarily driven by our net loss of $35,413, the non-cash release of sales tax accrual of $1,435, an increase in trade receivables receivable of $361, an increase in equipment financing receivables of $616, an increase in contract costs of $788, an increase in other assets of $544, and a decrease in contract liabilities of $360, offset by non-cash expenses for depreciation and amortization of $2,747, share-based compensation $4,374, and goodwill and long-lived asset impairment of $32,678, and an increase in accounts payable and accrued expenses of $246.

Investing Activities

Cash provided by or used in investing activities is driven by the purchase of property and equipment, business combinations, and asset acquisitions. The following table reflects our net cash provided by/(used in) investing activities for the year ended December 31, 2023, compared to the year ended December 31, 2022:

Net cash provided by investing activities for the year ended December 31, 2023 primarily relates to the sale of the corporate headquarters located in Tempe, Arizona, which generated $3,792 in proceeds from the sale, offset by the purchases of property and equipment of $92.

Net cash used in investing activities for the year ended December 31, 2022 primarily relates to the purchases of property and equipment of $289 and the acquisition of a business, net of cash acquired of $1,414.

Financing Activities

Cash provided by or used in financing activities is driven by the proceeds from the exercise of options, taxes paid on the net settlement of stock options and RSUs, payments of contingent consideration, proceeds from finance leases and notes payable, repayments made on finance leases and notes payable, proceeds and repayments on line of credit, and proceeds from the issuance of common stock in connection with an offering. The following table reflects our net cash provided by financing activities for the year ended December 31, 2023, compared to the year ended December 31, 2022:

Net cash used in financing activities for the year ended December 31, 2023 primarily relates to repayments made on finance leases and notes payable of $2,349, payments of employee tax withholdings related to the net settlement of stock options and RSUs of $264, dividend payments of $130, and repayments on the line of credit of $82, offset by proceeds from notes payable of $278 and cash proceeds from the exercise of stock options of $241.

Net cash used in financing activities in the year ended December 31, 2022, primarily relates to dividend payments of $462, payments of employee tax withholdings related to the net settlement of stock options and RSUs of $290, and repayments made on finance leases and notes payable of $200, offset by cash proceeds from the exercise of stock options of $816 and proceeds from the line of credit of $82.

OFF BALANCE SHEET ARRANGEMENTS

As of December 31, 2023, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

RELATED PARTY TRANSACTIONS

On November 1, 2022, the Company completed the acquisition of Allegiant Networks, LLC, a Kansas limited liability company (the “Allegiant Networks”) to acquire from Seller one hundred percent (100%) of the issued and outstanding shares of Allegiant Networks in exchange for (i) a cash payment at closing in the amount of $2.0 million, (ii) a three-year promissory note by the Company in favor of Seller in the amount of $1.1 million, and (iii) 2,461,538 shares of the Company’s common stock, par value $0.001 per share. In connection with this transaction, the seller Bryan Dancer, became a greater than five percent shareholder of the Company. Therefore, the three-year promissory note in the amount of $1.1 million, is considered a related party transaction. The loan agreement has a term of three (3) years with quarterly payments of Ninety-Eight Thousand Three Hundred Eighty-one Dollars ($98,381), including interest at 4.00%, beginning on April 1, 2023. As of December 31, 2023 and 2022, the outstanding balance of the related party note payable was $843 and $1,100, respectively. During the year ended December 31, 2023, the Company paid principal and interest of $257 and $38, respectively.

RECENT ACCOUNTING PRONOUNCEMENTS

For a summary of recent accounting pronouncements and the anticipated effects on our consolidated financial statements, see Note 1 to the consolidated financial statements, which is incorporated by reference herein.