KonaTel, Inc. 10-K

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS When used in this Annual Report, the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27a of the Securities Act and Section 21e of the Exchange Act regarding events, conditions and financial trends that may affect our future plans of operations, business strategy, operating results and financial position. Persons reviewing this Annual Report are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and actual results may differ materially from those included within the forward-looking statements as a result of various factors. Such factors are discussed at the forepart of this Annual Report under the heading “Forward-Looking Statements” on page 2 hereof, and further, below, under “Trends and Uncertainties.” Overview of Current and Planned Business Operations We continue to pursue market opportunities for the distribution of our current products and services described in our “Principal Products or Services and their Markets” summary contained on page 7 of this Annual Report. In addition, we continue to pursue expanded market distribution opportunities, development of new products and services, the addition of new lines of business and accretive acquisition opportunities that may enhance or expand our current product and service offerings. Comparison of the Year Ended December 31, 2023, to the Year ended December 31, 2022 Results of Operations In comparing our Statements of Operations between the years ended December 31, 2023, and 2022, we had declines in revenue, costs of revenue, operating expenses and lower net income. For the year ended December 31, 2023, we had $18,223,745 in revenues from operations compared to $20,023,340 in the prior year ended December 31, 2022, for a total revenue decrease of ($1,799,595) in 2023. The decrease in 2023 revenue was due to fewer activations within our Mobile Services segment. Influencing factors of this decline in revenue were partially the result of the replacement of the EBB program (which had temporarily higher reimbursements) with the ACP program in March, 2022, which reduced government subsidized revenues, as well our change in strategy in late 2022 to focus on the IM Telecom sales in the eleven (11) Lifeline states, which suspended growth in early 2023, resulting in future period revenue decreases. For the year ended December 31, 2023, our cost of revenue was $14,850,105 compared to $15,033,733 in the prior year ended December 31, 2022, for a cost of revenue decrease of ($183,628) in 2023. Our cost of revenue decrease was the result of delivering fewer devices to subscribers, which reduced the costs of devices, network and compensation. For the year ended December 31, 2023, we had gross profit of $3,373,640 compared to $4,989,607 in the prior year ended December 31, 2022, for a gross profit decrease of ($1,615,967) in 2023. This decline was partially due to reduced activations within our Mobile Services segment, as well as in early 2022, we received higher per activation claims on government subsidies through the EBB program, which was replaced with the ACP program in March, 2022. In late 2022, we changed strategy towards higher ARPU locations, which required temporary suspensions in activity as selling teams relocated. Additionally, we required an OSS/BSS system change to accommodate growth of new sales activity, which caused a pause in growth during this implementation. During lower or reduced activity periods, we had temporary improvements in profit, as compared with high growth activity periods, where our business is required to recognize up-front costs and show reduced or negative profits. Because of these factors, swings in profit occur depending on the level of activations. For the year ended December 31, 2023, total operating expenses were $6,494,243 compared to $7,544,292 in the prior year ended December 31, 2022, for a decrease of ($1,050,049) in 2023. This decrease was due primarily to lower payroll and related expenses resulting from a reduction in staff. 24 For the year ended December 31, 2023, other income (expense) was ($820,224) compared to ($397,675) in the prior year ended December 31, 2022. This increase is due primarily to interest expense related to our CCUR Loan. For the year ended December 31, 2023, we had a net loss of ($3,940,827) compared to a net loss of ($2,952,360) in the prior year ended December 31, 2022. Liquidity and Capital Resources As of December 31, 2023, we had $777,103 in cash and cash equivalents on hand. Our ability to continue as a business is dependent upon our generating profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Management intends to finance operating costs over the next twelve (12) months with revenues from operations, cash on hand and the use of financing available to the business. In comparing liquidity between the years ending December 31, 2023, and 2022, cash decreased by 62%. The decrease was primarily the result of growth in our mobile services sector, which requires up-front expenditures to acquire consumers. Total liabilities increased by 57% in 2023 when compared to 2022, as a result of the CCUR Loan delayed draw received in 2023, and the device financing from ACP Finance, which was also established in 2023. We had a working capital deficit of ($3,859,200) for the year ended December 31, 2023, primarily resulting from the addition of the CCUR Loan delayed draw and the financing of devices through ACP Finance. In January 2024, and as noted under the heading “Events Subsequent to December 31, 2023” in Part I, Item I, Business, the CCUR Loan and the outstanding obligations to ACP Finance, were fully paid off with proceeds from the sale of IM Telecom, which is discussed under that heading. Our current ratio (current assets divided by current liabilities) was .48 as of December 31, 2023, and .92 as of December 31, 2022. Cash Flow from Operations During the year ended December 31, 2023, and the year ended December 31, 2022, cash flow used in operating activities was $(1,792,032) and $(1,821,869), respectively. Cash flows used in operating activities were mainly impacted by the Company’s net loss and higher inventory due to end of year device purchases. Cash Flows from Investing Activities During the year ended December 31, 2023, and the year ended December 31, 2022, cash flow provided by investing activities was $0 and $10,000, respectively. The cash provided by investing activities during 2022 was the result of the sale of assets. Cash Flows from Financing Activities During the year ended December 31, 2023, and the year ended December 31, 2022, cash flow provided by financing activities was $513,501 and $2,934,718, respectively. In 2023, cash flow generated from financing activities consisted of $554,750 cash received from short-term notes payable ($132,000), cash used for payment of loan origination costs and $90,751 cash received from stock option exercises. In 2022, cash flow generated from financing activities consisted of $3,150,000 cash received from short-term notes payable; ($173,532) cash used for payment of loan origination costs; ($150,000) cash used for repayment of notes payable; and $108,250 cash received from the exercise of incentive stock options. Going Concern We generated a net loss of ($3,940,827) during the year ended December 31, 2023 and we had a net loss of ($2,952,360) in 2022. The Company had a net change in cash of ($1,278,531) and $1,112,849 in 2023, and 2022, respectively. The accumulated deficit as of December 31, 2023, was ($12,238,691). The Company sourced short-term financing in June, 2022, of $3,150,000. In June, 2023, the Company agreed to additional financing with CCUR, up to an additional $2,000,000 in delayed draw allocations. As of June, 2023, we had received an initial delayed draw in the amount of $500,000 to help facilitate our growing Mobile Services segment and support higher customer acquisition costs (sales). In late 2023, we secured additional device financing through ACP Finance (up to $5M), to further provide for growth and which also afforded repayment of device costs over an extended timeframe. All outstanding liabilities owing under the foregoing arrangements 25 were paid in full on the Initial Closing Date of the Excess Purchase Agreement. See heading “Events Subsequent to December 31, 2023” in Part I, Item I, Business, hereof. ACP Finance remains available to us as a growth financing partner, under prior terms, and provides continuing growth financing for our mobile services segment. Our business added distribution partners to higher profit states in 2023, and started to show higher growth in the second half of the year. High growth phases require immediate expense recognition and as a result, management expects net operating losses during these growth periods. We are one of only a few businesses to hold a national ETC license, which provides us with additive reimbursement rates within the states we operate. At the end of 2023, we held eleven (11) state licenses. This coverage area gives us additional reimbursements on claims, and we believe also increases the value of our ETC license within the marketplace. As a result of the Company’s ability to access additional financing and due to the significance of our ETC license, we have ameliorated any substantial going concern doubt. Critical Accounting Policies and Estimates Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in the accompanying financial statements could include the amortization period for intangible assets, valuation and impairment valuation of intangible assets, depreciable lives of the property and equipment, valuation of warrant and beneficial conversion feature debt discounts, valuation of share-based payments and the valuation allowance on deferred tax assets. Impairment of Long-Lived Assets We account for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards ASC 360-10, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount 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 to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Fair Value of Financial Instruments and Fair Value Measurements We measure financial assets and liabilities in accordance with generally accepted accounting principles. For certain of our financial instruments, including cash, accounts payable, accrued expenses, escrow liability and short-term loans the carrying amounts approximate fair value due to their short maturities. We have adopted accounting guidance for financial and non-financial assets and liabilities. The adoption did not have a material impact on our results of operations, financial position or liquidity. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. This guidance does not apply to measurements related to share-based payments. This guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels: Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2: Inputs other than quoted prices which are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3: Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use. 26 Leases In February, 2016, the FASB updated the accounting guidance related to leases. The most significant change in the updated accounting guidance requires lessees to recognize lease assets and liabilities on the balance sheet for all operating leases with the exception of short-term leases. The standard also expands the disclosures regarding the amount, timing, and uncertainty of cash flows arising from leases. For a lessee, the recognition, measurement, and presentation of expenses and cash flows arising from a lease did not significantly change from previous guidance. We adopted the updated guidance on January 1, 2019, on a prospective basis and as a result, prior period amounts were not adjusted to reflect the impacts of the updated guidance. In addition, as permitted under the transition guidance within the new standard, prior scoping and classification conclusions were carried forward for leases existing as of the adoption date. Revenue Recognition We earn revenue from contracts with customers, primarily through the provision of telecommunications and other services. We account for these revenues under Accounting Standards Codification (ASC) 606, “Revenue from Contracts with Customers.” This standard update, along with related subsequently issued updates, clarifies the principles for recognizing revenue and develops a common revenue standard U.S. GAAP. The standard update also amends current guidance for the recognition of costs to obtain and fulfill contracts with customers such that incremental costs of obtaining and direct costs of fulfilling contracts with customers will be deferred and amortized consistent with the transfer of the related good or service. Revenue from these services is generally recognized monthly as the services are provided. Such revenue is recognized based on usage, which can vary from month to month or at a contractually committed amount, net of credits or other billing adjustments. Advance billings for future service in the form of monthly recurring charges are not recognized as revenue until the service is provided. We distribute government subsidized mobile services through Master Agents. As part of the distribution process, we deliver mobile phones and/or tablets (devices) to our Master Agents, who then are responsible to subscribe qualifying consumers under a government sponsored program (ACP and/or Lifeline). In most cases, devices that have been delivered to our Master Agents are subscribed to and activated by qualifying consumers within sixty (60) days, at which point we would receive a subsidy from a governing body (USAC or certain states) and recognize revenue. Once a device is activated, and the intended service provided under the government program is deemed to have occurred, the program revenue is recognized, the expense is recognized, and the device is removed from inventory. Stock-Based Compensation We record stock-based compensation in accordance with the guidance in ASC 718 which requires the Company to recognize expenses related to the fair value of its employee stock option awards. This requires that such transactions be accounted for using a fair-value-based method. The Company recognizes the cost of all share-based awards on a graded vesting basis over the vesting period of the award. We account for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with ASC 718-10 and the conclusions reached by the ASC 505-50. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earliest of a performance commitment or completion of performance by the provider of goods or services. Income Taxes We account for income taxes in accordance with FASB ASC 740, “Income Taxes.” Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statements carrying amounts of existing assets and liabilities and loss carryforwards and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income (loss) in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rules on deferred tax assets and liabilities is recognized in operations in the year of change. A valuation allowance is recorded when it is “more likely-than-not” that a deferred tax asset will not be realized. Tax benefits of uncertain tax positions are recognized only if it is more likely than not that the Company will be able to sustain a position taken on an income tax return. We had no liability for uncertain tax positions as of December 31, 2023, and 2022. Interest and penalties, if any, related to unrecognized tax benefits would be recognized as interest expense. We do not have any accrued interest or penalties 27 associated with unrecognized tax benefits, nor was any significant interest expense recognized during the years ended December 31, 2023, and 2022. Earnings Per Share We follow ASC Topic 260 to account for the earnings per share. Basic earnings per common share calculations are determined by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share calculations are determined by dividing net income available to common stockholders by the weighted average number of common shares and dilutive common share equivalents outstanding. During periods when common stock equivalents, if any, are anti-dilutive they are not considered in the computation.