Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto, included in “Item 15. Exhibits and Financial Statement Schedules” of this Report. Our accounting policies have the potential to significantly impact our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events that are continuous in nature.
Business Overview, Recent Developments and Outlook
Please see “Item 1. Business” of this Report for an overview of our business and recent developments. Please see “Item 1A. Risk Factors” of this Report for a discussion of the risk factors that may impact our current and future operations, and financial condition.
Liquidity and Capital Resources
Liquidity
At December 31, 2023, we had working capital of $11.6 million, as compared to working capital of $7.7 million at December 31, 2022, an increase of $3.9 million.
Our current assets increased to $26.3 million at December 31, 2023 compared to $23.9 million at December 31, 2022. The change in our current assets was primarily due to an increase in the current portion of notes receivable of $2.1 million, accounts receivable of $0.9 million, and inventory of $0.5 million, offset by decreases in cash and cash equivalents of $0.4 million and other current assets of $0.7 million.
Our current liabilities decreased to $14.7 million at December 31, 2023 as compared to $16.2 million at December 31, 2022. The decrease of $1.5 million is primarily due to a decrease in accounts payable and accrued liabilities of $1.7 million and the current portion of third party debt of $1.7 million, offset by an increase in payables to sellers of $1.8 million.
We believe we can fund our operations and our debt service obligations during 2024 and beyond through a combination of cash flows from our on-going operations and accessing financing from our existing line of credit.
Our indebtedness consists of a promissory note dated August 23, 2021 (the “ALT Note”) issued in the amount of $2.0 million as part of the aggregate purchase price paid to acquire certain assets and liabilities of American Laboratory Trading, any amounts borrowed under the promissory note, business loan agreement, commercial security agreement and pledge agreement (the “2021 Credit Facility”) with C3bank, National Association, for a $10.0 million revolving line of credit, and the Term Loan (as defined below). The terms of the ALT Note require us to pay off the Note in 48 equal installments of approximately $44,000 with an interest rate of 3% per annum and a maturity date of August 23, 2025. As of December 31, 2023, we had an outstanding balance of $0.9 million on the ALT Note.
On May 26, 2023, the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “Modification Agreement”), by and between the Company and C3 Bank. The Modification Agreement modifies and reaffirms the 2021 Credit Facility to, among other things, extend the maturity date, modify the applicable interest rate, and further modify the loan covenants. The maturity date was modified to October 27, 2024. We are permitted to use the proceeds of the loan solely for our business operations. As of December 31, 2023, we had no outstanding balance on the 2021 Credit Facility.
On May 26, 2023, the Company entered into a promissory note, a business loan agreement and commercial security agreement (collectively, the “2023 Credit Facility”) with C3 Bank. The 2023 Credit Facility provides for a new $7.0 million term loan (the "Term Loan"). The Company is permitted to use the proceeds of the Term Loan solely for its business operations. The maturity date of the Term Loan is April 27, 2028. The Term Loan sets the interest rate spread and interest rate floor to accrue at a variable interest rate, which is based on the rate of interest last quoted by The Wall Street Journal as the “prime rate,” plus a margin of 0.25% and a floor of no less than 6.5%. The Term Loan requires we pay monthly installments over a 5-year term with adjustments for changes in the variable interest rate. As of December 31, 2023, we had an outstanding balance of $6.3 million on the Term Loan.
During 2023, our primary source of cash was the cash on hand, proceeds from the Term Loan and cash provided by our operating activities. Cash disbursements during 2023 consisted primarily of investments in notes receivable net of cash received on transfer of notes to partners of $21.0 million, equity method investments of $17.2 million, repayment on our 2021 Credit Facility of $8.9 million, repayment on our ALT Note of $0.5 million, repayment on our Term Loan of $0.7 million, payment of operating expenses, and settlement of auction liabilities.
We expect that future net cash flows from our operating activities will continue to be the primary source of cash required to fund our ongoing operations for the foreseeable future.
16
Ownership Structure and Capital Resources
At December 31, 2023 and 2022, we had stockholders’ equity of $61.1 million and $48.3 million, respectively.
We determine our future capital and operating requirements based upon our current and projected operating performance and contractual commitments. We expect to be able to finance our future operations through a combination of working capital, future net cash flows from operating activities, our 2021 Credit Facility and Term Loan. Our contractual requirements are limited to the outstanding debt and lease commitments with related and unrelated parties. Capital requirements are generally limited to our purchases of surplus and distressed assets and our investment activity under our Specialty Lending segment. We believe that our current capital resources, including available borrowing capacity from our 2021 Credit Facility and Term Loan, are sufficient for these requirements. In the event additional capital is needed, we believe we can obtain additional debt financing through capital partners.
Cash Position and Cash Flows
Cash and cash equivalents at December 31, 2023 were $12.3 million compared to $12.7 million at December 31, 2022.
Cash provided by operating activities. Cash provided by operating activities was $13.0 million during 2023 as compared to $6.5 million during 2022. The approximate $6.5 million change was primarily attributable to a change of $8.6 million in net income adjusted for noncash items during 2023 as compared to 2022, which includes significant changes of a $5.9 million change in earnings from equity method investments and a $5.4 million change in deferred taxes, offset by a $3.0 million decrease in net income. The amount was offset by changes in operating assets and liabilities of $2.0 million during 2023 as compared to 2022.
The significant changes in operating assets and liabilities during 2023 as compared to 2022 are primarily due to the nature of our operations. We earn revenue from discrete auction and liquidation deals that vary considerably with respect to their magnitude and timing, and that can consist of fees, commissions, asset sale proceeds, or a combination of all. The operating assets and liabilities associated with such transactions are therefore subject to the same variability and can be different at the end of any given period.
Cash used in investing activities. Cash used in investing activities during 2023 was $15.9 million, as compared to cash used in investing activities of $7.5 million during 2022.
Cash used in investing activities during 2023 consisted primarily in investment in notes receivable of $29.8 million and equity method investments of $17.2 million. Cash used in investing activities during 2023 was offset by cash provided by investing activities primarily of cash received on transfer of notes receivable to partners of $8.9 million, payments received on notes receivable of $11.9 million as well as return of investment and cash distributions received from equity method investments of $10.7 million.
Cash used in investing activities in 2022 of $7.5 million was attributable to our investment in equity method investments of $14.6 million, which $12.2 million related to activity within our Specialty Lending segment, $1.4 million directly related to the acquisition of two pharmaceutical plants, by KNFH LLC, a joint venture, and $1.0 million investment in DHC8 LLC. In addition, we used $8.4 million in funding our investment in notes receivable.
Cash used in investing activities during 2022 was offset by cash provided by investing activities of $15.8 million, which consisted primarily of payments received on notes receivable of $3.4 million, return of investment of $5.3 million and cash distributions received from equity method investments of $7.0 million, of which included $0.7 million related to specialty lending activity within our Financial Assets division, $3.8 million from the sale of the remaining real estate assets of CPFH LLC, the joint venture, located in Huntsville, Alabama, and $2.5 million from the sales of real estate and machinery and equipment assets of KNFH LLC.
Cash provided by financing activities. Cash provided by financing activities was $2.5 million during 2023, as compared to cash provided by financing activities of $0.1 million during 2022.
Cash provided by financing activities in 2023 of $2.5 million was primarily attributable to $13.0 million in proceeds from draws on our 2021 Credit Facility and Term Loan, offset by $8.9 million in repayments to our 2021 Credit Facility, $0.7 million in repayments to our Term Loan, $0.5 million in repayments to our ALT Note, as well as repurchase of our common stock under our 2022 Repurchase Program of approximately $0.4 million.
Cash provided by financing activities in 2022 of $0.1 million was primarily attributable $2.9 million in proceeds from draws on our 2021 Credit Facility, offset by aggregate repayment of debt payable to third parties of $2.4 million and repurchase of our common stock under our 2022 Repurchase Program of approximately $0.4 million.
Management’s Discussion of Results of Operations
The following table summarizes our consolidated results of operations (in thousands):
17
Year Ended December 31,
2023
2022
Revenues:
Services revenue
$
39,480
$
23,419
Asset sales
21,065
23,495
Total revenues
60,545
46,914
Operating costs and expenses:
Cost of services revenue
8,007
4,654
Cost of asset sales
12,724
16,256
Selling, general and administrative
26,040
21,326
Depreciation and amortization
514
536
Total operating costs and expenses
47,285
42,772
Earnings of equity method investments
1,059
6,978
Operating income
14,319
11,120
Interest expense, net
(324
)
(113
)
Income before income tax expense (benefit)
13,995
11,007
Income tax expense (benefit)
1,520
(4,486
)
Net income
$
12,475
$
15,493
Our revenue has several components: (1) traditional fee based asset disposition services, such as commissions from on-line and webcast auctions, liquidations and negotiated sales, and commissions from the NLEX charged-off receivables business, (2) the acquisition and subsequent disposition of distressed and surplus assets, including industrial machinery and equipment and real estate, and (3) fees and interest earned for appraisal, management advisory services and specialty lending services.
We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments. We manage our business primarily on differentiated revenue streams for services offered. Our reportable segments consist of the Auction and Liquidation segment, Refurbishment & Resale segment, Brokerage segment, and Specialty Lending segment. Our Auction and Liquidation segment, through HGP, operates as a global full-service auction, appraisal and asset advisory firm, including the acquisition of turnkey manufacturing facilities and used industrial machinery and equipment. Our Refurbishment & Resale segment, through ALT, acquires, refurbishes and supplies specialized laboratory equipment. Our Brokerage segment, through NLEX, brokers charged-off receivables in the U.S. and Canada on behalf of financial institutions. Our Specialty Lending segment, through HGC, provides specialty financing solutions to investors in charged-off and nonperforming asset portfolios.
We evaluate the performance of our reportable segments based primarily on operating income. Notwithstanding the foregoing, the reported segment operating income for ALT and HGC represents incremental costs for managing these segments as part of their sister segments (HGP for ALT and NLEX for HGC). As such, the reported operating income for ALT and HGC does not represent their true standalone contribution, as we do not attempt to allocate existing fixed divisional overhead costs of the sister divisions to the newer segments. Similarly, corporate overhead cost is not allocated to the operating divisions for management reporting purposes. Further, we do not utilize segmented asset information to evaluate the performance of our reportable segments and do not include intercompany transfers between segments for management reporting purposes.
18
The following table sets forth operating income information for the Company's reportable segments (in thousands):
Year Ended December 31,
2023
2022
Industrial Assets Division:
Auction and Liquidation
$
4,918
$
7,979
Refurbishment & Resale
2,847
1,187
Total divisional operating income
7,765
9,166
Financial Assets Division:
Brokerage
8,946
4,709
Specialty Lending
1,862
1,213
Total divisional operating income
10,808
5,922
Corporate & other operating loss
(4,254
)
(3,968
)
Consolidated operating income
$
14,319
$
11,120
2023 Compared to 2022
Revenues and cost of revenues – Revenues were $60.5 million in 2023 as compared to $46.9 million in 2022 and costs of services revenue and asset sales were $20.7 million in 2023 compared to $20.9 million in 2022. This resulted in gross profit of $39.8 million in 2023 compared to $26.0 million in 2022, an increase of approximately $13.8 million or approximately 53%. The increased gross profit in the current year reflects the significant improvement in performance of our core business segments and increased volume in the financial assets division from both the brokerage and specialty lending segments.
Selling, general and administrative expense – Selling, general and administrative expense was $26.0 million in 2023 as compared to $21.3 million in 2022, an increase of $4.7 million or 22%. As compared to 2022 there was an increase in selling, general and administrative expense during 2023 primarily due to increased compensation expense as a result of improved performance across our segments and increased headcount.
Significant components of selling, general and administrative expense were as shown below (dollars in thousands):
Year Ended December 31,
2023
2022
% change
Compensation:
Auction and Liquidation
$
6,502
$
6,380
2
%
Refurbishment & Resale
2,314
1,601
45
%
Brokerage
6,217
4,911
27
%
Specialty Lending
1,030
659
56
%
Corporate & other
2,357
2,061
14
%
Stock-based compensation
776
540
44
%
Consulting
98
108
-9
%
Board of Directors fees
322
308
5
%
Accounting, tax and legal professional fees
1,696
1,200
41
%
Insurance
540
467
16
%
Occupancy
1,285
1,105
16
%
Travel and entertainment
831
683
22
%
Advertising and promotion
604
448
35
%
Information technology support
436
383
14
%
Provision for credit losses
530
—
100
%
Other
502
472
6
%
Total selling, general and administrative expense
$
26,040
21,326
22
%
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Depreciation and amortization expense – Depreciation and amortization expense in each of the years ended 2023 and 2022 was $0.5 million and consisted almost entirely of amortization expense related to intangible assets. In both years the depreciation of property, plant and equipment was not material.
Off-Balance Sheet Arrangements – We had no off-balance sheet arrangements during the years ended December 31, 2023 and 2022.
Key Performance Indicators
We monitor a number of financial and non-financial measures on a regular basis in order to track our underlying operational performance and trends. Other than operating income (a GAAP financial measure as shown in our consolidated income statements), which we believe is the most important measure of our operational performance and trends, we believe that EBITDA and Adjusted EBITDA (non-GAAP financial measures) are key performance indicators (“KPIs”) for our business. These KPIs may not be defined or calculated in the same way as similar KPIs used by other companies.
We prepared our audited consolidated financial statements in accordance with GAAP. We define EBITDA as net income plus depreciation and amortization, interest expense, and provision for income taxes. Adjusted EBITDA reflects EBITDA adjusted further to eliminate the effects of stock-based compensation. Management uses EBITDA and Adjusted EBITDA in assessing the Company’s results, evaluating the Company’s performance and in reaching operating and strategic decisions. Management believes that the presentation of EBITDA and Adjusted EBITDA, when considered together with our GAAP financial statements and the reconciliation to the most directly comparable GAAP financial measure, is useful in providing investors a more complete understanding of the factors and trends affecting the underlying performance of the Company on a historical and ongoing basis. Our use of EBITDA and Adjusted EBITDA is not meant to be, and should not be, considered in isolation or as a substitute for, or superior to, any GAAP financial measure. You should carefully evaluate the financial information below, which reconciles our GAAP reported net income to EBITDA and Adjusted EBITDA for the periods presented (in thousands).
Year Ended December 31,
2023
2022
Net income
$
12,475
$
15,493
Add back:
Depreciation and amortization
514
536
Interest expense, net
324
113
Income tax expense (benefit)
1,520
(4,486
)
EBITDA
14,833
11,656
Management add back:
Stock based compensation
776
540
Adjusted EBITDA
$
15,609
$
12,196
Recently adopted accounting pronouncements
In 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”), which applies a current expected credit loss model, which is a new impairment model based on expected losses rather than incurred losses. The expected credit losses, and subsequent adjustments to such losses, is recorded through an allowance account that is deducted from, or added to, the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected. ASU 2016-13 eliminates the current accounting model for loans and debt securities acquired with deteriorated credit quality under ASC Topic 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality , which provides authoritative guidance for the accounting of our notes receivable. With respect to smaller reporting companies, the amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The adoption of ASU 2016-13 resulted in an adjustment to retained earnings on January 1, 2023 of $0.3 million, and established an expected credit loss reserve against our receivables related to loans outstanding, including those held within equity method investments. The increase is a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. As of December 31, 2023, the allowance for credit losses was $1.7 million, with $0.1 million classified as accounts receivable, $0.7 million classified as notes receivable and $0.9 million classified as equity method investments.
Critical Accounting Policies
The preparation of our consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions. Our critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
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Revenue recognition
We recognize revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”) and ASC Topic 310, Receivables (“ASC 310”).
Services revenue generally consists of commissions and fees from providing auction services, appraisals, brokering of sales transactions, and secured lending. Asset sales revenue generally consists of proceeds obtained through sales of purchased assets. With the exception of revenue generated within our Specialty Lending segment, revenue is recognized for both services revenue and asset sales revenue based on the ASC 606 standard recognition model, which consists of the following: (1) an agreement exists between two or more parties that creates enforceable rights and obligations, (2) the performance obligations are clearly identified, (3) the transaction price has been determined, (4) the transaction price has been properly allocated to each performance obligation, and (5) the entity satisfies a performance obligation by transferring a promised good or service to a customer for each of the entities.
All services and asset sales revenue from contracts with customers consists of three of our reportable segments: Auction and Liquidation, Refurbishment & Resale, and Brokerage segments. Generally, revenue is recognized at the point in time in which the performance obligation has been satisfied and full consideration is received. The exception to recognition at this point in time occurs when certain contracts provide for advance payments recognized over a period of time. Services revenue recognized over a period of time is not material in comparison to total revenues (less than 1% of total revenues for the year ended December 31, 2023), and therefore not reported on a disaggregated basis. Further, as certain contracts stipulate that the customer make advance payments, amounts not recognized within the reporting period are considered deferred revenue and our “contract liability”. As of December 31, 2023, the deferred revenue balance was $0.5 million. The deferred revenue balance is primarily related to customer deposits on asset sales within our Refurbishment & Resale segment. We record receivables in certain situations based on timing of payments for Auction and Liquidation transactions held at the end of the reporting period; however, revenue is generally recognized in the period that we satisfy the performance obligation and cash is collected. We do not record a “contract asset” for partially satisfied performance obligations.
For auction services and brokerage sale transactions, funds are typically collected from buyers and are held by us on the seller's behalf. The funds are included in cash and cash equivalents in the Consolidated Balance Sheets. We release the funds to the seller, less our commission and other fees due, after the buyer has accepted the goods. The amount of cash held on behalf of the sellers is recorded as payables to sellers in the accompanying Consolidated Balance Sheets.
We evaluate revenue from Auction and Liquidation and Brokerage segment transactions in accordance with the accounting guidance to determine whether to report such revenue on a gross or net basis. We have determined that we act as an agent for our fee based transactions and therefore we report the revenue from transactions in which we act as an agent on a net basis.
We also earn income through transactions that involve us acting jointly with one or more additional purchasers or lenders, pursuant to a partnership, joint venture or limited liability company agreement (collectively, “Joint Ventures”). For these transactions, in which our ownership share meets the criteria for the equity method investments under ASC Topic 323, Equity Method and Joint Ventures (“ASC 323”), we do not record revenue or expense. Instead, our proportionate share of the net income (loss) is reported as earnings of equity method investments. In general, the Joint Ventures apply the same revenue recognition and other accounting policies as the Company.
Through our Specialty Lending segment, we provide specialty financing solutions to investors in charged-off and nonperforming asset portfolios. We recognize revenue generated by lending activity in accordance with ASC 310. Fees collected in relation to the issuance of loans includes loan origination fees, interest income, portfolio monitoring fees, and a backend profit share percentage related to the underlying asset portfolio.
The loan origination fees are offset with any direct origination costs and are deferred upon issuance of the loan and amortized over the lives of the related loans, as an adjustment to interest income. The interest method is used to arrive at a periodic interest cost (including amortization) that will represent a level effective rate on the sum of the face amount of the debt and (plus or minus) the unamortized premium or discount and expense at the beginning of each period.
The monitoring fees and the backend profit share are considered a separate earnings process as compared to the origination fees and interest income. Monitoring fees are recorded at the agreed upon rate, and at the moment in which payments are made by the borrower. The backend profit share is recognized in accordance with the agreed upon rate at the time in which the amount is realizable and earned. The recognition policy was established due to the uncertainty of timing of the amount of backend profit share that will be realized.
Notes receivable, net
Our notes receivable balance consists of loans to buyers of charged-off receivable portfolios, which is considered the only loan category or segment to be reported under the applicable accounting guidance. These loans are measured at historical costs and reported at their outstanding principal balances net of any unamortized deferred fees and costs on originated loans and allowance for credit losses. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to interest income over the lives of the related loans.
21
We adopted ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC 326”) on January 1, 2023, which requires the application of a credit loss model based prospectively on current expected credit losses (CECL). Under ASC 326, we elected to evaluate notes receivable as a single pool, for individual notes receivable and borrowers with similar risk characteristics. Notes receivable and borrowers that do not share risk characteristics are evaluated on an individual basis. Management estimates the allowance for credit losses using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. As we lack historical internal data, we observe that our notes receivable are similar in character to transactions undertaken by smaller banking institutions. We elect to base our estimation of expected credit losses on the Scaled Current Expected Credit Loss (CECL) Allowance Loss Estimator ("SCALE rate") available from the Federal Reserve, which was 1.3231% as of January 1, 2023. To reflect the cumulative effects of the adoption of ASC 326, we recorded the allowance for credit losses and an increase to accumulated deficit of $0.2 million on the January 1, 2023 consolidated balance sheet, and balance of the allowance for credit losses was therefore $0.2 million as of January 1, 2023.
In order to evaluate the need for an adjustment to the receivable balance related to credit losses, or impairment, we perform a review of all outstanding loan receivables on a quarterly basis to determine if any indicators exist that suggest the loan will not be fully recoverable. As of December 31, 2023, the SCALE rate increased to 1.4183% and our credit loss rate specific to notes receivable was 3.6%. The increase over the SCALE rate was due to both risks with the concentrated balance and declining collections industry-wide. As of December 31, 2023, we have recorded an allowance for credit losses related to notes receivable outstanding of $0.7 million.
See Note 2 and Note 3 to our consolidated financial statements for further detail.
Equity Method Investments
As noted above, we conduct a portion of our business through Joint Ventures. Transactions in which our ownership share meets the criteria for the equity method investments under ASC 323 are accounted for using the equity method of accounting whereby our proportionate share of the Joint Venture’s net income (loss) is reported in the consolidated income statement as earnings of equity method investments. At the balance sheet date, our investments in these Joint Ventures are reported in the consolidated balance sheet as equity method investments. We monitor the value of each Joint Ventures’ underlying assets and liabilities, and record a write down of our investments should we conclude that there has been a decline in the value of the net assets. These investments have historically been classified as non-current in our consolidated financial statements due to the uncertainties relating to the timing of resale of the underlying assets as a result of the Joint Venture relationship.
Upon adoption of ASC 326 on January 1, 2023, we evaluated the receivable balances held by our affiliated joint ventures and recorded an adjustment to reduce earnings from equity method investments by our share of the allowance for credit losses recorded on the joint ventures’ books of $0.2 million. Similar to notes receivable, the loans held by the joint ventures are evaluated on a quarterly basis to determine if an adjustment to the allowance for credit losses is needed. As of December 31, 2023, the SCALE rate increased to 1.4183% and the credit loss rate specific to equity method investments was 4.3%. The increase over the SCALE rate was due to both risks with the concentrated balance and declining collections industry-wide. As of December 31, 2023, we have recorded an allowance for credit losses related to its equity method investments of $0.9 million.
See Note 2 and Note 5 to our consolidated financial statements for further detail.
Deferred income taxes
We recognize deferred tax assets and liabilities for temporary differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted tax rates in effect for the year in which the differences are expected to reverse. We periodically assess the recoverability of our deferred tax assets, which have been generated by a history of net operating and net capital losses, and determine the necessity for a valuation allowance that will reduce deferred tax assets to the amount expected to be realized. We evaluate which portion of the deferred tax assets, if any, will more likely than not be realized by offsetting future taxable income, taking into consideration any limitations that may exist on our use of our net operating and net capital loss carryforwards. In the fourth quarter of 2022, we recorded a reduction to the valuation allowance resulting in a net deferred tax asset balance of approximately $9.4 million as we believe that it was more likely than not that a significant portion of our net operating loss carryforwards will be utilized. In the fourth quarter of 2023, we further reduced the valuation allowance by $2.2, resulting in a net deferred tax asset balance of approximately $9.1 million, to align with our updated forecasts. For further discussion of our income taxes, see Note 14 to our consolidated financial statements.
22
Stock-based compensation
Our stock-based compensation is primarily in the form of options to purchase common shares. The fair value of stock options is calculated using the Black-Scholes option pricing model. The determination of the fair value of our stock options is based on a variety of factors including, but not limited to, the price of our common stock, the expected volatility of the stock price over the expected life of the award and expected exercise behavior. The fair value of the awards is subsequently expensed over the vesting period, net of estimated forfeitures. The provisions of our stock-based compensation plans do not require that we settle any options by transferring cash or other assets, and therefore we classify the option awards as equity. See Note 17 to our consolidated financial statements for further discussion of our stock-based compensation.
Item 7A. Quantitative and Qualitat ive Disclosures about Market Risk.
As a Smaller Reporting Company, we are electing scaled reporting obligations and therefore are not required to provide the information requested by this Item.
Item 8. Financial Statemen ts and Supplementary Data.
Our consolidated financial statements required by this Item are included herein, commencing on page F-1.
Item 9. Changes In and Disagreements with Accou ntants on Accounting and Financial Disclosure.
During the years ended December 31, 2023 and 2022, respectively, we had no disagreements with our auditors and no reportable events.
On August 9, 2022, Baker Tilly US, LLP (“Baker Tilly”) notified the Company that Baker Tilly would resign as the Company’s independent registered public accounting firm effective on August 10, 2022. The Audit Committee of the Board of Directors (the “Audit Committee”) accepted the resignation of Baker Tilly. During the interim period beginning January 1, 2022 through August 10, 2022, there were no (i) disagreements with Baker Tilly on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedure, which disagreement(s), if not resolved to the satisfaction of Baker Tilly, would have caused it to make reference thereto in its reports on the audited consolidated financial statements of the Company for such periods; or (ii) “reportable events” (as defined under Item 304(a)(1)(v) of Regulation S-K).
On August 12, 2022, the Company engaged UHY LLP (“UHY”) as its independent registered public accounting firm for the Company’s fiscal year ending December 31, 2022. The decision to engage UHY as the Company’s independent registered public accounting firm was approved by the Audit Committee.