CLEARONE INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and related notes included in this report, as well as our other filings with the SEC. This discussion contains forward-looking statements based on current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions, as set forth under “Disclosure Regarding Forward-Looking Statements.” Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the following discussion and under the caption “Risk Factors” in Item 1A and elsewhere in this report. OVERVIEW ClearOne is a global Company that designs, develops and sells conferencing, collaboration, and AV networking solutions for voice and visual communications. The performance and simplicity of our advanced, comprehensive solutions offer a high level of functionality, reliability and scalability. We derive a major portion of our revenue from audio conferencing products and microphones by promoting our products in the professional audio-visual channel. We have extended our total addressable market from the installed audio conferencing market to adjacent complementary markets – microphones, video collaboration and AV networking. We have achieved this through strategic technological acquisitions as well as by internal product development. In early January 2022, we introduced DIALOG ® 10 USB, the industry's only pro-quality, single-channel wireless USB microphone system offering professional-quality audio with USB connectivity for webcasting and cloud-based collaboration. In March 2022, this new USB wireless mic system won the 2022 NSCA Excellence in Product Innovation Award. One of only seven winners in this prestigious award program, the DIALOG 10 USB is the industry’s only pro-quality single-channel wireless microphone system with USB connectivity for webcasting and cloud-based collaboration such as Microsoft Teams, Zoom, WebEx, and GotoMeeting. DIALOG 10 USB won its second award in May 2022 by winning the 2022 Top New Technology (TNT) Award in the Microphone category. In June 2022, at Infocomm 2022 in Las Vegas, Nevada, DIALOG 10 USB won two additional awards - Commercial Integrator 2022 BEST Award in the Microphones category and 2022 Sound & Video Contractor Magazine Infocomm Best in Market Award. In January 2022, at the Las Vegas Customer Electronics Show, CES 2022, the world’s most influential annual tech event, our home office Aura™ Xceed™ BMA was singled out for exceptional innovation with a CES Picks Award, presented by Residential Systems magazine. In early February 2022, our Versa Lite CT, a USB audio-enabled Beamforming Ceiling Tile Microphone that brings cost-effective and superb professional conferencing audio to small- and mid-sized spaces received Google Meet certification. Google Meet ranks among the top 5 for growth in the cloud meetings and team collaboration market according to Frost & Sullivan. In early February 2022, we were awarded a new patent for a beamforming microphone array system with distributed processing. This patent claims a ceiling tile microphone array that can be physically separated from the processors running the beamforming algorithm. It enables a single computing engine to run multiple beamforming algorithms for multiple microphone arrays, which can lower the overall system cost compared to an integrated design that is limited to a single computing engine with a single microphone array. Later in the same month another ClearOne patent was granted which is related to beamforming microphone arrays with acoustic echo cancellation. The patent, titled “Band-Limited Beamforming Microphone Array with Acoustic Echo Cancellation," describes, among other things, a microphone array with one set of microphones used for beamforming, and one or more additional microphones that are not used for beamforming, but instead are used to enhance the audio performance of the microphone array. In March 2022, we were awarded a new patent titled “Conferencing Apparatus”, that describes, among other things, a beamforming microphone array with acoustic echo cancellation and a set of configurable fixed beams. The patent goes on to describe performing a direction of arrival determination, and in response to that determination, selecting one or more of those fixed beams for audio transmission. 30 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In April 2022, a ClearOne patent issued titled “Ceiling Tile Microphone,” that claims, among other things, a ceiling tile beamforming microphone that is powered through Power over Ethernet (PoE). Later in the same month another ClearOne patent was granted, also titled “Ceiling Tile Microphone,” that claims, among other things, a ceiling tile microphone that includes beamforming, acoustic echo cancellation, and auto voice tracking. In May 2022, for the sixth time since its groundbreaking debut in 2020, the ClearOne BMA 360 microphone has been recognized by the world’s most discerning AV buyers with the prestigious Best in Market Award at ISE 2022. The microphone was one of only three winners in this year’s award program. The Best in Market Award program is presented by leading industry publication Sound & Video Contractor at Integrated Systems Europe (ISE), the world’s largest AV and systems integration show. The program recognizes the most innovative technology within the AV industry, and the judges include respected AV and IT managers, directors, engineers, industry consultants and integrators. In July 2022, we introduced the CONVERGENCE® InSite server network hardware that enables remote device management by facilitating bi-directional communications between its Cloud or Enterprise AV Manager and on-site ClearOne Pro Audio products. At the end of October 2022, we announced the introduction of UNITE 60, a new wide angle 4K USB camera featuring AI-powered smart face and voice tracking, along with electronic PTZ (pan/tilt/zoom) capabilities. With a 120-degree field of view, and a plug-and-play USB 3.0 connection for video, control, and power, the new UNITE® 60 camera is ideally suited for rooms such as executive offices, huddle rooms, or smaller conference rooms. The UNITE 60 camera leverages a wide dynamic range and super-high SNR with advanced 2D and 3D noise reduction to deliver excellent visuals across varied lighting conditions. In addition to the AI auto-tracking feature, the camera can also be controlled via IR remote or UVC protocol. The camera can be paired with a wide variety of microphones and speakers. In November 2022, we announced the introduction of UNITE 160, a new camera that offers cutting-edge 4K UHD performance with 12x optical zoom capabilities, remote-controlled mechanical pan and tilt as well as AI-powered smart face tracking and auto framing. This camera is designed to capture all participants in large rooms while enabling automated focus on a moving presenter, making it ideal for larger spaces including board rooms, training centers, conference rooms and classrooms. This new camera offers an integrated AI-based camera tracking solution for rooms that are a fit for ClearOne's single Versa Lite CT and a single camera. This new lower-cost camera tracking configuration eliminates the need for a DSP mixer and a control system. T hroughout 2022, we continued our efforts to protect our intellectual property rights, including through litigation. On December 9, 2022 we entered into a confidential settlement and license agreement under which we received a one-time settlement payment of $55 million in January 2023. Under the terms of this agreement, both parties dismissed with prejudice all the litigations between the parties and released all claims against each other in connection with the litigations. The parties also agreed to cross-license certain patents to each other and certain covenants not to sue. See also Part II, Item 1. Legal Proceedings. We also continued our programs to cut costs and to speed up product development that we believe will enable us to get back to a growth path. During 2022 , our overall revenue of $ 25.2 million decreased by 13 % when compared to revenue during 2021 . The decrease in revenues from video products and microphones were partially offset by an increase in revenues from audio conferencing. The revenue decline was primarily due to the decline in demand for video products and due to our inability in the second half of 2022 to source adequate inventory to meet the demand for professional audio products and BMA due to the ongoing transition of manufacturing of our products from China to Singapore by our EMS provider and the increased costs associated with the electronic raw material supply shortages that have affected the global manufacturing of high tech products. We expect these supply shortages and associated increased costs to continue through at least the first half of 2023. 31 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Our gross profit margin decreased to 38 % during 2022 from 41% in 2021 . Net loss of $7 .7 million in 2021 changed to net income of $21.6 million in 2022 . The change from net loss to net income was primarily due to the recognition of a gain of $33.6 million and included under other income related to the one-time legal settlement receivable of $55 million net of unamortized capitalized legal expenses of $21.4 million. This gain was partially offset by operating loss of $7.2 million and a tax provision of $6.9 million. Industry conditions We operate in a very dynamic and highly competitive industry which is dominated on the one hand by a few players with respect to certain products like traditional video conferencing appliances while on the other hand influenced heavily by a fragmented reseller market consisting of numerous regional and local players. The industry is also characterized by venture capitalist funded start-ups and private companies willing to fund cumulative cash losses in order to gain market share and achieve certain non-financial goals. It has become increasingly important to have higher interoperability with other products in the audio visual market as well as with leading video conferencing service providers like Microsoft and Zoom. Economic conditions, challenges and risks The audio-visual products market is characterized by intense competition and rapidly evolving technology. Our competitors vary within each product category. Our installed professional audio conferencing products, which is our flagship product category, continue to be ahead of the competition despite the reduction in revenues. Our strength in this space is largely due to our fully integrated suite of products consisting of DSP mixers, wide range of professional microphone products and video collaboration products. Despite our strong leadership position in the installed professional audio conferencing market, we face challenges to revenue growth due to the limited size of the market, pricing pressures from new competitors attracted to the commercial market due to higher margins, our limited ability to be interoperable with other audio visual products in the market, and the lack of certifications from Microsoft. Our video products and beamforming microphone arrays, especially highly advanced BMA 360 and BMA-CT are critical to our long term growth. We face intense competition in this market from well-established market leaders as well as emerging players rich with marketing funds. We expect our strategy of making our products more interoperable with other audio-visual products, continuing to improve the quality of our high-end audio conferencing products and microphones, and offering a wide range of innovative professional cameras will generate high growth in the near future. We derive a significant portion of our revenue (approximately 52% in 2022 ) from international operations and expect this trend to continue in the future. Most of our revenue from ou tside the U.S. is billed in U.S. dollars and is not exposed to any significant currency risk. However, we are exposed to foreign exchange risk if the U.S. dollar is strong against other currencies as it will make U.S. Dollar denominated prices of our products less competitive. In December 2019, a novel strain of coronavirus (“COVID- 19 ”) started spreading from China and was declared a pandemic. The COVID- 19 pandemic caused severe global disruptions and had varying impact on our business. The installed audio conferencing market was negatively impacted due to lockdowns , postponement of projects and restrictions on installers to visit commercial sites. On the other hand, COVID- 19 generated higher than normal demand in 2020 for our video products and personal conferencing products due to the significant expansion of work-from-home market. The extent of COVID- 19 ’s effect on our operational and financial performance keeps evolving and depends on multiple factors including the severity and infectiousness of current and future virus strains, effectiveness of vaccines especially on novel strains of COVID- 19 , government regulations, etc ., all of which are uncertain and difficult to predict considering the rapidly evolving landscape. Supply chain disruptions resulting from COVID-19 have caused significant fluctuations in our costs of goods resulting in a reduction of our gross margins in 2021 and 2022. We expect these fluctuations to continue in 2023. If the pandemic continues to be a severe worldwide health crisis, the disease could have a material adverse effect on our business, results of operations, financial condition and cash flows and adversely impact the trading price of our common stock. Deferred Revenue De ferred revenue increased from $54 thousand in 2021 to $63 thousand in 2022 due to a small increase in new subscriptions to the video conferencing software. 32 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DISCUSSION OF RESULTS OF OPERATIONS The following table sets forth certain items from our consolidated statements of operations and comprehensive income (loss) for t he years ended December 31, 2022 and 2021 , together with the percentage change each item represents. Throughout this discussion, we compare results of operations for the year ended December 31, 2022 (“2022 ”) to the year ended December 31, 2021 (“2021 ” or “the comparable period”). (In thousands, except percentages) 2022 2021 Change Favorable (Adverse) in % Revenue $ 25,205 $ 28,967 (13 ) Cost of goods sold 15,748 17,051 8 Gross profit 9,457 11,916 (21 ) Sales and marketing 5,517 6,736 18 Research and product development 4,390 5,794 24 General and administrative 6,772 6,881 2 Total operating expenses 16,679 19,411 14 Operating loss (7,222 ) (7,495 ) 4 Income (loss) before income taxes 27,460 (7,977 ) 444 Provision for (benefit from) income taxes 6,904 (283 ) (2,540 ) Net income (loss) $ 20,556 $ (7,694 ) 367 Revenue Our revenue decreased by 13% to $25.2 million in 2022 compared to $29.0 million of revenue in 2021 . The highest decline in revenue was seen in video products with a 45 % decrease, followed by a decrease in microphones of 10%. These decreases were partially offset by a 2% increase in revenues from audio conferencing. Video products suffered a decline in revenues in 2022 compared to 2021 due to a lack of demand for video products due to bottoming of demand for the work from home and learn from home markets and due to extreme pricing pressures. Except for professional audio conferencing category under audio conferencing products every other category suffered revenue decreases during 2022. Cameras as a category declined the most followed by video conferencing equipment and personal audio conferencing categories. Revenue from these categories declined due to reduced demand for these products. Revenue from beamforming microphone arrays reduced mainly due to our inability to procure adequate supply of inventory due to the ongoing transition of manufacturing from China to Singapore. We expect our revenues for professional audio conferencing and beamforming microphone arrays to be adversely impacted at least through the first half of 2023 due to the delay in the completion of transition of outsourced manufacturing from China to Singapore. We believe our revenues in the second half of 2023 will be positively impacted by new product introductions, which would leverage our advanced beamforming microphone array technology and our recent initiative to improve the interoperability of our products with audiovisual products made by other manufacturers. Despite the introduction of new cameras in 2022, we expect the challenging market conditions for our video products to continue through 2023. The share of audio conferencing products in our product mix increased significantly from 40% in 2021 to 47 % in 2022 . The share of microphones in the revenue mix increased slightly from 38% in 2021 to 39 % in 2022 . Share of video products in the revenue mix declined significantly from 22% in 2021 to 14% in 2022 . During 2022 , revenue decreased significantly in all regions of the world. Asia Pacific inclu ding the Middle East decreased by 5 %, Europe and Africa decreased by 24 % a nd the Americas decreased by approximately 12 %. We believe, although there can be no assurance, that we can return to revenue growth and generating operating profits through our strategic initiatives namely product innovation, focus on core products and cost reduction. 33 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cost of Goods Sold and Gross Profit Cost of goods sold (“COGS”) includes expenses associated with finished goods purchased from outsourced manufacturers, the manufacture of our products (including material and direct labor), our manufacturing and operations organization, property and equipment depreciation, warranty expense, freight expense, and the allocation of overhead expenses. Our gross profit during 2022 was approximately $9.5 million or 38% compared to approximately $11.9 mill ion or 41 % in 2021 . The gross profit margin was negatively impacted due to increase in material costs due to supply chain constraints and increased administration costs as a percentage of revenue partially offset by reduction in inventory obsolescence and freight and tariff costs. Our profitability in the near-term continues to depend significantly on our revenues from audio conferencing products. We hold long-term inventory and if we are unable to sell our long-term inventory, our profitability might be affected by inventory write-offs and price mark-downs. Our long-term inventory includes approximately $0.5 million of wireless microphone-related finished goods and assemblies, $ 1 million of video products and about $1 million of raw materials that will be used primarily for manufacturing installed professional audio conferencing products. Operating Expenses and Profits (Losses) Operating income (loss), or income ( loss) from operations, is the surplus or deficit after operating expenses are deducted from gross profits. Operating expenses include sales and marketing (“S&M”) expenses, research and product development (“R&D”) expenses and general and administrative (“G&A”) expenses. Total operating expenses were $16.7 million in 2022, compared to $19.4 million in 2021 . The following contains a more detailed discussion of expenses related to sales and marketing, research and product development, general and administrative, and other items. Sales and Marketing S&M expenses include sales, customer service, and marketing expenses such as employee-related costs, allocations of overhead expenses, trade shows, and other advertising and selling expenses. S&M expenses in 2022 decreased to $5.5 million, compared to $6.7 million in 2021. The decrease was primarily due to (a) decreases in employment expenses and consultant expenses, (b) a decrease in commissions paid to employees and full-time consultants (c) a decrease in employee benefits costs, and (d) a decrease in costs of inventory used for sales demonstrations. This overall decrease was partially offset by (a) an increase in trade-show-related costs, (b) an increase in travel expenses, and (c) an increase in commissions paid to independent manufacturer representatives. Research and Product Development R&D expenses include research and development, product line management, engineering services, and test and application expenses, including employee-related costs, outside services, expensed materials, depreciation, and an allocation of overhead expenses. R& D expenses decreased from $5.8 million in 2021 to $4.4 million in 2022 . The decrease was primarily due to (a) a decrease in project-related expenses and (b) a decrease in employment expenses including salaries and benefits. General and Administrative G&A expenses include employee-related costs, professional service fees, allocations of overhead expenses, litigation costs, and corporate administrative costs, including costs related to finance and human resources. G&A expenses decreased marginally to $6.8 million in 2022, compared to $6.9 million in 2021. The decrease was primarily due to (a) a decrease in legal expenses (b) a decrease in consulting expenses, and (c) a decrease in regular employment expenses including salaries and benefits. This decrease was mostly offset by (a) increases in bonuses paid to employees and executives, and (b) an increase in amortization of capitalized legal costs related to patents litigation. 34 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other income (expense), net Other income (expense), net includes interest income and foreign currency changes. Other income during 2022 includes (a) $1.5 million recognized on the gain arising from the CARES Act Paycheck Protection Program loan forgiveness, and (b) a gain recognized of $33.6 million related to the one-time legal settlement receivable of $55 million, net of unamortized capitalized legal expenses of $21.4 million. Other items remained immaterial in 2022 and 2021. I nterest expense decreased to $0.4 million in 2022 compared to $0.5 million in 2021. Provision for income taxes The effective tax provision rate was 25 % in 2022, comp ared to 4% effective tax benefit rate during 2021 . Income tax provision for 2022 was $6.9 million as compared to an income tax benefit of $0.3 million in 2021. The significant change in income taxes was primarily due to an increase in net income due to the recognition of a one-time settlement payment. We have been recording a valuation allowance against net deferred tax assets since 2018 and have not been claiming tax benefit for our losses as we have concluded that it is more likely than not that our deferred tax assets were not realizable, primarily due to our recent pre-tax losses. LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION As of December 31, 2022 , our cash and cash equivalents were approximately $1.0 million compared to $1.1 million as of December 31, 2021 . Our working capital was $ 69.3 million and $18.0 million as of December 31, 2022 and 2021 , respectively. Net cash flows used in operating activities were approximately $4.2 million during 2022 , a decrease of ap proximately $0.2 million from $4.4 million used in opera ting activities in 2021 . The decrease in cash used was due to (a) a change in net income by $28.3 million from a net loss of $7.7 million in 2021 to a net income of $20.6 million in 2022 , (b) a decrease of $35.7 million in non-cash charges primarily due to the recognition of a gain from the one-time settlement payment which was not received before the end of the year, and (c) a decrease in cash outflows due to change in operating assets and liabilities of $7.6 million which included among other things cash inflows due to (i) a $6.8 million change in income tax receivable and (ii) a $5.5 million change in accounts payable, partially offset by (iii) a $3.2 million change in prepaid expenses. Net cash provided by investing activities was $2.1 million in 2022 compared to $8.5 million used in investing activities in 2022 , a decrease in cash used of $10.6 million. The decrease in cash used in investing activities in 2022 was primarily due to (a) a decrease of $7.1 million in capitalized legal spending, and (b) an increase in net cash inflows from sale of marketable securities of approximately $3.2 million. Net cash provided by financing activities was $2.1 million during 2022 compared to net cash provided by financing activities of $10.2 million during 2021, a decrease in cash provided of $8.2 million. The decrease was primarily due to a decrease in cash raised through equity and debt issuances of $11.3 million in 2021 to $2.0 million in 2022. This decrease was partially offset by $0.8 million refund of CARES Act Paycheck Protection Program Loan. Capitalization of patent defense costs . We capitalized external legal costs incurred in the defense of our patents when we believe that a significant, discernible increase in value will result from the defense and a successful outcome of the legal action is probable. When we capitalize patent defense costs we amortize the costs over the remaining estimated useful life of the patent, which is 15 to 17 y ears. During 2022 we spent $ 0.7 million of legal costs related to the defense of our patents and capitalized the entire amount. As of December 31, 2022, the unamortized balance of capitalized legal expenses of $21.4 million was fully netted against the one-time settlement amount of $55 million and a gain of $33.6 million was recognized. 35 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In order to maintain liquidity, the Company has been actively engaged in preserving cash by implementing company-wide cost reduction measures and raising additional capital. The company raised additional capital in 2019 by issuing senior convertible notes, in 2020 by borrowing through the CARES Act Paycheck Protection Program and issuing common stock and warrants and in 2021 by issuing short-term notes and issuing common stock and warrants. In January 2022, the Company issued $2,000 in common stock as consideration for the cancellation and termination of the short-term notes. In October 2022, the Company issued short term notes to raise $2,000. In addition, the Company has been generating additional cash as our inventory levels are brought down to historical levels. The Company also believes that the Company's core strategies of product innovation and prudent cost management will bring the company back to profitability in the future. The Company believes, although there can be no assurance, that all of these measures and effective management of working capital, along with the current cash balance after the receipt of proceeds from legal settlement, will provide the liquidity needed to meet our operating needs through at least March 31, 2024. As of December 31, 2022 , we had open purchase orders of approximately $2.0 million mostly for purchase of inventory. As of December 31, 2022 , we had inventory totaling $11.7 million, of which non-current inventory accounted for $2.7 million. This compares to total inventories of $ 13.6 million and non-current inventory of $3.6 million as of December 31, 2021 . Contractual Obligations and Commitments The following table summarizes our contractual obligations as of December 31, 2022 (in millions): Payment Due by Period Total Less Than 1 Year 1-3 Years 3-5 Years More than 5 years Senior Convertible Notes and short-term notes $ 3.9 $ 3.9 $ — $ — $ — Operating lease obligations 1.2 0.6 0.5 0.1 — Purchase obligations 2.0 2.0 — — — Total $ 7.1 $ 6.5 $ 0.5 $ 0.1 $ — Off-Balance Sheet Arrangements We have no off-balance-sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial conditions, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, results of operations or liquidity. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our results of operations and financial position are based upon our consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles ("GAAP"). We review the accounting policies used in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We evaluate our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. We believe that the estimates we use are reasonable; however, actual results could differ from those estimates. Our significant accounting policies are described in Note 1 - Business Description, Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part IV of this report. We believe the following critical accounting policies identify our most critical accounting policies, which are the policies that are both important to the representation of our financial condition and results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. 36 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue and Associated Allowances for Revenue Adjustments and Doubtful Accounts The Company recognizes revenue when it satisfies a performance obligation. The Company recognizes revenue from sales agreements upon transferring control of a product to the customer. This typically occurs when products are shipped or delivered, depending on the delivery terms, or when products that are consigned at customer locations are sold to dealers or end users. Revenue recognized during the twelv e months ended December 31, 2022 for audio and video conferencing equipment sales was $25.1 million, and for software, licenses, etc. was $ 0.1 million . Sales returns and allowances are estimated based on historical experience. Provisions for discounts and rebates to customers, estimated returns and allowances, ship and credit claims and other adjustments are provided for in the same period the related revenues are recognized, and are netted against revenues. For returns, the Company recognizes a related asset for the right to recover returned products with a corresponding reduction to cost of goods sold. The Company reviews warranty and related claims activity and records provisions, as necessary. Frequently, the Company receives orders with multiple delivery dates that may extend across reporting periods. Since each delivery constitutes a performance obligation, the Company allocates the transaction price of the contract to each performance obligation based on the stand-alone selling price of the products. The Company invoices the customer for each delivery upon shipment and recognizes revenues in accordance with delivery terms. Although payment terms vary, distributors typically pay within 45 days of invoicing and dealers pay within 30 days of invoicing. As scheduled delivery dates are within one year, revenue allocated to future shipments of partially completed contracts are not disclosed. The Company has elected to record freight and handling costs associated with outbound freight after control over a product has transferred to a customer as a fulfillment cost and include it in cost of revenues. Taxes assessed by government authorities on revenue-producing transactions, including value-added and excise taxes, are presented on a net basis (excluded from revenues) in the Consolidated Statements of Operations and Comprehensive Income (Loss). The details of deferred revenue and associated cost of goods sold and gross profit are as follows (in thousands): As of December 31, 2022 2021 Deferred revenue $ 63 $ 54 Deferred cost of goods sold — — Deferred gross profit $ 63 $ 54 The Company offers rebates and market development funds to certain of its distributors, dealers/resellers, and end-users based upon the volume of product purchased by them. The Company records rebates as a reduction of revenue in accordance with GAAP. The Company provides, at its discretion, advance replacement units to end-users on defective units of certain products under warranty. Since the purpose of these units is not revenue generating, the Company tracks the units due from the end-user, until the defective unit has been returned. Any amount due from the customer upon failure to return the products is accounted as receivable only after establishing customer's failure to return the products. The inventory due from the customer is accounted at cost or market value whichever is lower. Impairment of Long-Lived Assets We assess the impairment of long-lived assets, such as property and equipment and definite-lived intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset or asset group to estimated future undiscounted net cash flows of the related asset or group of assets over their remaining lives. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized for the amount by which the carrying amount exceeds the estimated fair value of the asset. Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent of other groups of assets. The impairment of long-lived assets requires judgments and estimates. If circumstances change, such estimates could also change. Assets held for sale are reported at the lower of the carrying amount or fair value, less the estimated costs to sell. 37 Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Accounting for Income Taxes We are subject to income taxes in both the United States and in certain non-U.S. jurisdictions. We account for income taxes following ASC 740, Accounting for Income Taxes, recognizing deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between book and tax basis of recorded assets and liabilities. We estimate our current tax position together with our future tax consequences attributable to temporary differences resulting from differing treatment of items, such as deferred revenue, depreciation, and other reserves for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities. We assess the likelihood that our deferred tax assets will be recovered from future taxable income, prior year carryback, or future reversals of existing taxable temporary differences. To the extent we believe that recovery is not more likely than not, we establish a valuation allowance against these deferred tax assets. Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets. To the extent we establish a valuation allowance in a period, we must include and expense the allowance within the tax provision in the consolidated statement of operations. In accordance with ASC Topic 740, “Accounting for Income Taxes”, we analyzed our valuation allowance at December 31, 2022 and determined that based upon available evidence it is more likely than not that certain of our net deferred tax assets will not be realized and, accordingly, we have recorded a full valuation allowance against these deferred tax assets in the amount of $13.5 million. Please refer to Note 13 - Income Taxes in the Notes to Consolidated Financial Statements for additional information. Share-Based Payments We estimate the fair value of stock options using the Black-Scholes option pricing model, which requires certain estimates, including an expected forfeiture rate and expected term of options granted. We also make decisions regarding the method of calculating expected volatilities and the risk-free interest rate used in the option-pricing model. The resulting calculated fair value of stock options is recognized as compensation expense over the requisite service period, which is generally the vesting period. When there are changes to the assumptions used in the option-pricing model, including fluctuations in the market price of our common stock, there will be variations in the calculated fair value of our future stock option awards, which results in variation in the compensation cost recognized. IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS For descriptions of recently issued accounting standards, see Note 1. Business Description, Basis of Presentation and Significant Accounting Policies of our Notes to Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable ITEM 8 . FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial statements and supplementary data required by this are included herein as a separate section of this Form 10-K, beginning on page F-1, and are incorporated in this Item 8 by reference. 38 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.